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, 2003 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. [X]

As of March 31, 2003, the aggregate market value of the Registrant's voting
stock held by non-affiliates was $360,419,200. 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 31, 2003
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 3, 2003, there were 38,878,587 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 2004 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

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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 novel mechanism based, targeted therapies in the areas of signal
transduction and apoptosis and next-generation cytotoxic chemotherapy agents. We
also market two products: Novantrone(R) and Gelclair(R). We acquired the rights
to market and promote Novantrone(R) (mitoxantrone concentrate for injection) for
approved oncology indications in the United States and to market and distribute
Gelclair(R) Bioadherent Oral Gel in North America during fiscal 2003.

Our most prominent 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 including lung and
pancreatic cancers. The HER1/EGFR gene is also amplified in certain tumors
including glioblastoma multiforme, an aggressive form of brain cancer. 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,
we are developing Tarceva(TM) in a global 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 the drug 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 I and Phase II trials in
non-small cell lung cancer, or NSCLC, bronchioloalveolar cell carcinoma, or BAC
(a form of lung cancer), glioblastoma multiforme, head and neck cancer and
ovarian cancer. Based upon these data, the alliance embarked upon a
comprehensive global development plan in 2001 designed to both register
Tarceva(TM) and maintain a competitive position against other EGFR inhibitors.
In October 2003, we announced that two Tarceva(TM) Phase III clinical trials for
front-line NSCLC (in combination with conventional chemotherapy versus
chemotherapy alone) did not meet their primary endpoints of improving overall
survival. We had considered these trials high risk as a result of a competitor's
previously announced failure of its EGFR inhibitor in this setting which had
demonstrated that combining an EGFR inhibitor concomitantly with conventional
chemotherapy drug regimens did not result in improved patient benefit.
Tarceva(TM) is currently in a fully enrolled 730 patient Phase III clinical
trial for second/third-line NSCLC patients, which is our primary registration
study. This study compares the use of Tarceva(TM) as a monotherapy versus
placebo in lung cancer patients who have failed conventional chemotherapy
treatments. The study is designed to detect a survival advantage as its primary
endpoint with secondary endpoints that include symptom relief and improvement of
quality of life. Based on encouraging data from a Phase I study in glioblastoma,
our partner, Genentech, initiated a Phase II program for this indication in
August 2003. Tarceva(TM) is also in a Phase III trial for pancreatic cancer
where it is being tested in combination with gemcitabine versus gemcitabine plus
placebo. We expect top-line data for the ongoing Phase III trials and Phase II
glioblastoma trial during 2004. We estimate the approval of Tarceva(TM) by the
U.S. Food and Drug Administration in the fourth quarter of calendar 2004 if the
second/third-line NSCLC study successfully meets its endpoint.

Behind Tarceva(TM), we have multiple drug candidates in clinical
development. OSI-7904L, the most promising of our next generation cytotoxic
chemotherapy candidates, is a liposomal formulation of a thymidylate synthase
inhibitor. It is being developed as a potential competitor to 5-fluorouracil, or
5-FU, and capecitabine (Xeloda(R)). OSI-7904L is in a Phase II program which
includes a Phase II trial in gastric and gastric esophageal junction cancers and
combination Phase I trials with cisplatin (Platinol(R)) and oxaliplatin
(Eloxatin(TM)). Aptosyn(R) (exisulind) was added to our pipeline with the
acquisition of Cell Pathways, Inc. in June 2003 and is currently in a Phase III
trial in combination with docetaxel (Taxotere(R)) for the treatment of advanced
NSCLC. Although Cell Pathways had advanced Aptosyn(R) to Phase III trials, we
consider it to be a

1

higher risk prototype drug candidate arising from the apoptosis platform
acquired from Cell Pathways. We believe OSI-461 (formerly CP461), the second
drug candidate acquired from Cell Pathways, to be a more promising
second-generation molecule that is currently being evaluated in a dose ranging
Phase I study and a series of exploratory Phase II studies in chronic
lymphocytic leukemia, renal cell carcinoma and prostate cancer. OSI-211 and
OSI-7836 are two additional next generation cytotoxic agents currently
undergoing Phase II and Phase I trials, respectively. Final data from the
on-going Phase I and Phase II studies is expected from both programs during the
coming year. We currently view the continued development of these two candidates
beyond these studies to be unlikely. Three molecules, CP-547,632 (targeting the
vascular endothelial growth factor receptor, or VEGFR, gene), CP-724,714
(targeting the HER2 gene) and CP-868,596 (targeting the platelet derived growth
factor receptor, or PDGFR, gene) that were discovered as part of our historical
alliance with Pfizer Inc. are currently in clinical trials conducted by Pfizer.
We will receive royalty payments on the Pfizer candidates if they are
successfully commercialized.

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 combinatorial chemistry, and automated drug profiling technology platforms
and is focused in the areas of signal transduction inhibitors (targeting the
uncontrolled cell growth exhibited by many cancers) and apoptosis (targeting the
ability of many cancer cells to avoid the tightly regulated process of
programmed cell death or apoptosis).

In March 2003, we entered into an agreement to market and promote
Novantrone(R) for approved oncology indications in the United States pursuant to
the terms of a Co-Promotion Agreement with Ares Tradings, S.A., an affiliate of
Serono S.A. Novantrone(R) is approved by the FDA for the treatment of acute
nonlymphocytic leukemia, or ANLL, which includes myelogenous, promyelocytic,
monocytic and erythroid acute leukemias, and the relief of pain associated with
advanced hormone-refractory prostate cancer, or HRPC. The drug is also approved
for certain advanced forms of multiple sclerosis. We initiated our sales
activity for Novantrone(R) during the third quarter of fiscal 2003. Serono will
continue to market Novantrone(R) for the multiple sclerosis indications. These
exclusive rights to a high quality marketed oncology product have allowed us to
establish a commercial organization and begin to build a revenue base. To
support Novantrone(R), we have built a core commercial operation comprising
approximately 60 sales, marketing, medical affairs, commercial planning and
other support personnel including an approximately 30 person sales force. We
believe that the tangible and intangible benefits of this commercial capability
are significant in that it allows us to pursue additional in-licensing and
co-promotion arrangements for other marketed products, enables us to directly
market our future pipeline products in the United States, and further validates
OSI as a quality development and commercialization partner for oncology
development candidates. In addition, it allows us to pursue our co-promotion
rights for Tarceva(TM) in the United States with our partner, Genentech. The
exclusive marketing and distribution rights to Gelclair(R) in North America
acquired as part of the Cell Pathways transaction have provided us with an
additional product that provides relief for the treatment of pain associated
with oral mucositis, a debilitating side effect often seen in cancer patients
undergoing radiation treatment or chemotherapy. We re-launched Gelclair(R) in
October 2003.

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 direct our business 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:

- support and enable the successful development, registration and
commercialization of Tarceva(TM) by reducing program execution and
registration risk and by maximizing Tarceva(TM)'s differentiation and
competitive positioning; and

2

- establish a first-class oncology franchise around Tarceva(TM) by
assembling, through mergers, acquisitions and internal growth, a full
complement of capabilities and technology and a diversified risk balanced
portfolio and pipeline of drug candidates.

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 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, including four Phase III
registration-oriented trials in lung and pancreatic cancers. This registration
strategy has focused on the execution of adequate, controlled and well-designed
studies to support a worldwide registration program. All four Phase III trials
were designed as large-scale, placebo controlled, double-blinded trials with a
primary endpoint of survival and several secondary endpoints that include
symptom relief and improvement of quality of life. The key registration study in
this program is the Phase III study of Tarceva(TM) as a single agent in
second/third-line NSCLC which last year was expanded and adjusted to allow for
the detection of a 33% improvement in survival, thereby increasing the
probability of success in this study. Another Phase III trial evaluating
Tarceva(TM) in patients with previously untreated advanced pancreatic cancer is
currently ongoing. This study accrued over 450 patients and is designed to test
Tarceva(TM) plus gemcitabine versus gemcitabine plus placebo. Genentech
initiated a Phase II trial evaluating the safety and efficacy of Tarceva(TM) in
patients with malignant glioma. The generation of compelling clinical data from
this trial could represent a possible registration option through an accelerated
approval submission to the FDA. The FDA has also granted orphan drug status for
Tarceva(TM) in glioblastoma. We have established a goal of achieving
profitability within 24 months of a successful market launch of Tarceva(TM).

Licensing and Acquiring Oncology Products and Clinical Candidates. In
order to effectively manage the risks inherent in biotechnology research and
development and to complement our internal research efforts, we believe it is
essential that we continue to aggressively manage our pipeline and 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. During fiscal 2003, we continued to execute on this
strategy through the acquisition of the rights to Novantrone(R) and through the
Cell Pathways acquisition. With these transactions, we acquired two marketed
products in Novantrone(R) and Gelclair(R). We anticipate over $35 million in
sales commissions and revenues from these two products in fiscal 2004 and these
acquisitions have allowed us to begin to establish a commercial presence in the
oncology community. In addition, through the Cell Pathways acquisition, we
acquired Aptosyn(R) and OSI-461, two clinical candidates focused on the
indication of apoptosis. With these and the Gilead Sciences, Inc. and British
Biotech plc transactions completed in prior years, we have rounded out our
capabilities set from research through to commercialization. With a full array
of cancer drug discovery, development and commercialization capabilities and a
strong cash position, we expect to be well positioned to compete for premier
in-licensing and acquisition opportunities.

Strengthening Commercial Operations. A key corporate goal for us has been
to secure rights to a marketed therapeutic product as a vehicle to enable us to
establish a sales and marketing organization and continue our mission of
building a first class oncology franchise. We believe that through the
Novantrone(R) and Cell Pathways transactions we have accomplished this goal. We
have rapidly and successfully established an internal sales, marketing and
medical affairs infrastructure consisting of sales representatives, sales and
marketing operations support personnel and infrastructure needs. To assist in
this rapid ramp up of our sales infrastructure, we have secured a short-term
transitional arrangement with a contract sales organization to provide
additional sales and marketing support.

MARKETED PRODUCTS

Novantrone(R). We market and promote Novantrone(R) for approved oncology
indications in the United States and receive commissions from Serono on net
oncology sales in the United States. Novantrone(R) is an anthracenedione used as
an intravenous chemotherapy agent. Novantrone(R) is approved by the FDA for the
treatment of ANLL, which includes myelogenous, promyelocytic, monocytic and
erythroid acute leukemias,

3

and the relief of pain associated with advanced HRPC. The drug is also approved
for certain advanced forms of multiple sclerosis, a key strategic area for
Serono. The drug was licensed by Serono from Amgen, Inc. and we signed a
co-promote agreement with Serono to market the drug for its cancer indications
in March 2003. Serono will continue to market Novantrone(R) for the multiple
sclerosis indication and to record all U.S. sales in all indications. The key
competitor in HRPC is Taxotere(R) which, although not approved for HRPC, has
been taking some market share from Novantrone(R). In addition, during the last
several years, a lack of Novantrone(R) marketing support has led to a decline in
sales. However, following our co-promote arrangement with Serono we hope to
stabilize our market share in this setting. Novantrone(R) is also used off-label
in the treatment of non-Hodgkin's lymphoma for which recently published data
have demonstrated activity of a fludarabine/ Novantrone(R) combination that was
at least equivalent to the standard CHOP therapy (cyclophosphamide, adriamycin,
vincristine and prednisone) in terms of efficacy but with a better side effect
profile. The fludarabine and Novantrone(R) combination is also active when given
with Rituxan(R). We currently project that we will receive over $30 million in
commission revenues from Serono in fiscal 2004. However, Congress has recently
passed legislation, subject to the President's approval which is expected, that
materially changes the Medicare reimbursement guidelines for intravenous and
oral oncology products which may impact the sales revenues of all intravenous
chemotherapy agents. The patent for Novantrone(R) expires in April 2006.

Gelclair(R). We market and distribute Gelclair(R) in the oncology setting
in North America. Gelclair(R) is a bioadherent oral gel that provides relief for
pain associated with oral lesions, including oral mucositis, a debilitating side
effect often seen in cancer patients undergoing radiation treatment or
chemotherapy. An estimated 320,000 cancer patients undergoing chemotherapy or
radiotherapy develop oral mucositis every year. We also have an agreement with
John O. Butler Company whereby Butler markets and distributes Gelclair(R) to the
dental market. Gelclair(R) was cleared for sale as a device by the FDA in 2002.
The product was originally licensed from Sinclair Pharmaceutical Ltd. by Cell
Pathways which in turn signed a co-promote agreement with Celgene Corporation.
We believe that the product was never effectively launched. Following the
acquisition of Cell Pathways, we entered into an agreement with Celgene to
terminate the co-promote agreement. We re-launched the product in October 2003
and believe that it has the potential to achieve peak sales of over $25 million
per year after five years. We make payments for the supply of the product to
Helsinn Healthcare, S.A. which licensed the product from Sinclair.

COMMERCIAL OPERATIONS

We have established a core commercial operation of approximately 60 people
which includes approximately 30 sales representatives covering the major
territories in the United States. Approximately half of these sales
representatives are full-time contractors assigned to us through an agreement
with a contract sales organization. We have the right to hire these individuals
at anytime. All of our sales representatives have considerable experience in the
pharmaceutical industry, and most have ample experience with oncology products.
We expect a modest expansion of our sales and commercialization group as we grow
Gelclair(R) and a possible future expansion around the launch of Tarceva(TM). We
intend to market all future products directly in the United States but we may
partner with other pharmaceutical companies to support products we own in
territories outside of the United States.

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OUR RESEARCH AND DEVELOPMENT PROGRAMS

Research and Development Pipeline

The following table summarizes the status of our more advanced oncology
product candidates as of October 31, 2003 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.

(1) We expect the results of these trials during the coming year; it is unlikely
that we will continue this program if we are unable to differentiate it from
a current competitor's product.

(2) We expect to terminate this program after the first quarter of fiscal 2004
if we are unable to overcome toxicity issues with the candidate.

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 2002 were in excess of $60 billion. The
worldwide market for anti-cancer drugs has been estimated to be $14-15 billion
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 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.

5

Our approach to cancer therapy is focused in three diversified areas in an
attempt to improve the available drug treatment options for cancer patients: (1)
signal transduction inhibitors targeting aberrant cancer cell growth, (2)
apoptosis inducers to restore and enhance programmed cell death in cancer cells
that no longer respond to this tightly regulated process, and (3)
next-generation cytotoxics. The signal transduction inhibitors and apoptosis
inducer programs are focused on 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. The next-generation
cytotoxics area is focused on the development of new cytotoxic agents which
present improvements in activity or technological innovations over existing
drugs. Liposomal formulations are technological innovations that are designed to
improve targeting of the cytotoxic agent to the tumor or change the exposure
profile of the drug molecule, thus improving the therapeutic index (the drug
benefits versus its toxic side effects). It is our belief that to be a
successful oncology franchise, we should be developing both targeted therapies
and next-generation or improved cytotoxic drugs in order to provide an array of
effective treatment options for the cancer patient.

Our drug discovery efforts in targeted therapies were for many years
(1986-2001) 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 (all of which are in clinical
development), the funded discovery phase of which concluded in April 2001. If
Pfizer is successful in commercializing any of these drug candidates, we will
receive a royalty from Pfizer on the sales of such drugs. These types of drug
candidates represent the vanguard of a substantial ongoing in-house research
effort directed toward the discovery and development of these next-generation
targeted drugs.

The novel, anti-cancer drug candidates, 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-a, or TGF-a,
sending growth signals, via the receptor's tyrosine kinase enzyme activity, to
the nucleus of the cell thereby controlling growth. HER1/EGFR can be
over-expressed or the gene can be amplified 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. A frequently occurring
mutation of the HER1/EGFR gene called EGFRvIII is also found in many tumors. In
addition, the HER1/EGFR gene is frequently amplified in glioblastoma 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 less likely than the tyrosine kinase inhibitors 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, we believe that 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 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.

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Tarceva(TM)

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 NSCLC 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 the
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).

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 clinical programs to result in a registration with the FDA. These trials
include a single agent trial for second/third-line 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, and our alliance partners, are also conducting
several trials to review the effect of Tarceva(TM) in combination with other
chemotherapy and novel mechanism drugs and additional Phase II studies both
independently and in collaboration with the U.S. National Cancer Institute's
Cancer Therapy Evaluation Program in a wide array of tumor types including
glioblastoma multiforme, head and neck and ovarian.

Clinical Data. Phase I and Phase II trials of Tarceva(TM) have
demonstrated the drug to possess activity as a single agent and to be relatively
safe with manageable side effects, principally, a reversible rash and a
generally mild diarrhea. Interstitial lung disease is a rare complication of
lung cancer and lung cancer treatment that has been associated with a
competitor's EGFR inhibitor. However, analysis of our safety database for
Tarceva(TM) indicates that the incidence of possible lung complications of this
type appear to be well within the normal range. The dose limiting side effect in
the Phase I trials was diarrhea, which was moderate to severe in advanced cancer
patients treated at 200mg per day, and 150mg per day was established as the
maximum tolerated dose in this study and the recommended Phase II dose. On a
150mg 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. More recently, rash has emerged as a
potentially important biomarker of effective Tarceva(TM) dosing to the
individual patient. Some success in treating rash has been observed with
antibiotic creams as well as with a variety of other agents. 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.

A Phase I clinical study that evaluated the safety and pharmacokinetics of
Tarceva(TM) in patients with malignant glioma was completed in 2003. Patients
were stratified based on the use of enzyme inducing antiepileptic drugs, or
EIAEDs, which are used to prevent seizures. These drugs are known to induce
enzymes in the liver which metabolize many drugs more quickly. Thus, patients on
EIAEDs frequently require higher doses of drugs to achieve the same blood levels
of active agent. This was the case for Tarceva(TM) in this study. Notably, all
patients at the higher doses in either the EIAED arm or the non-EIAED arm
developed rash on Tarceva(TM). In addition to receiving Tarceva(TM), some
patients also received temozolomide (Temodar(R)), a type of chemotherapy.
Sixteen percent of the evaluable patients (8/49) achieved a partial response
after treatment with Tarceva(TM). Dose limiting toxicities occurred in six
patients, primarily due to skin rash. Response rates of this magnitude were
considered noteworthy by the investigators and in August 2003, we, along with
Genentech, announced the initiation of a Phase II clinical trial evaluation the
safety and efficacy of Tarceva(TM) in patients with malignant glioma.

In another recent Phase II clinical study, lung cancer patients were
enrolled following pathological confirmation that their tumor was either pure
bronchioloalveoler cell carcinoma, or BAC, adenocarcinoma with a BAC component,
or BAC with focal invasion. Approximately 20% of all NSCLC patients are
estimated to fall into these categories; these patients are historically
considered to be relatively unresponsive to

7

chemotherapy. Of the 50 patients who were treated with Tarceva(TM), 13 patients
(26%) achieved a partial response. Also of interest was the observation that 46%
of the subset of patients who had never smoked achieved a partial response. Side
effects have been similar to those observed in previous Phase II studies of
Tarceva(TM), with all but one patient developing rash and one patient
experiencing grade 3 diarrhea.

Our earlier Phase II trials for Tarceva(TM) in NSCLC, head and neck cancer
and ovarian cancer consisted of patients with advanced or metastatic cancer and
had generally failed standard treatment regimens. We believe these trials were
encouraging because they demonstrated objective clinical responses and
noteworthy survival data for patients treated with Tarceva(TM) as a single agent
with generally tolerable side effects. 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 in 206 patients showed that diarrhea was experienced
by 45% of the patients, and rash and rash related disorders were seen in 79% of
the patients. Mild to moderate rash was seen in 146 of these patients and 16
patients showed severe rash.

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 retrospective
analysis of the Phase II study data that was presented at the 2003 Annual
Meeting of American Society of Clinical Oncology (ASCO) correlated rash with
survival. In all of these trials, patients with rash had longer survival than
those without rash and the duration of survival was correlated with the severity
of rash. Despite the small size of the studies, the data were statistically
significant. The analysis supports our belief that a higher dose strategy
leading to increased rash may translate into an improved survival benefit, a
strategy that differentiates our approach to Tarceva(TM) use from our main
competitor in EGFR inhibitors, Astra Zeneca plc, who claims no such correlation
of rash with benefit for its agent.

Our Phase III clinical trial program includes a single agent trial for
second/third-line NSCLC patients as well as combination trials with existing
chemotherapy regimens for front-line use in pancreatic cancer. We are managing
these two trials in collaboration with the National Cancer Institute of Canada's
Clinical Trial Group. The Phase III trials are large scale, placebo controlled
registration orientated trials. Improvement in patient survival is the primary
endpoint in these studies with symptom relief and improvement of quality-of-
life as key secondary endpoints. The Phase III study in second/third-line NSCLC
is investigating the potential survival benefit of single agent Tarceva(TM) at
150mg per day compared to placebo and was based directly on the encouraging
activity data seen in an earlier Phase II study in advanced NSCLC. The program
also included two front-line Phase III combination trials in NSCLC that were
initiated for business reasons in order for us to be competitive with Astra
Zeneca which was developing a competitive drug, Iressa(R), in this setting. On
October 1, 2003, we announced that the two front-line Phase III studies of
Tarceva(TM) plus standard chemotherapy in metastatic NSCLC did not meet their
primary endpoints of improving overall survival. We believe these results were
widely anticipated based on the competitor's previously announced failure of
Iressa(R) in this front-line setting in August 2002. This failure demonstrated
that combining EGFR inhibitors concomitantly with conventional chemotherapy
regimens did not result in improved patient benefit in this setting. These two
multi-center, randomized, controlled Phase III studies evaluated Tarceva(TM) at
150mg per day in combination with standard chemotherapy in patients with stage
IIIB/IV metastatic NSCLC. The 1,050 patients enrolled in the U.S. study were
randomized to receive Tarceva(TM) plus standard chemotherapy (carboplatin and
paclitaxel) or standard chemotherapy plus a Tarceva(TM) placebo. The study
outside of the United States randomized approximately 1,200 patients to receive
either Tarceva(TM) in combination with standard chemotherapy (gemcitabine and
cisplatin) or standard chemotherapy plus a Tarceva(TM) placebo. Genentech and
Roche intend to submit abstracts on these studies to a major oncology meeting in
2004 at which point a detailed analysis of the data will be presented for
discussion.

Registration Strategy. The following ongoing elements of the clinical
development program for Tarceva(TM) are directed toward the successful
registration of the drug in the United States and around the world:

- The second/third-line NSCLC Phase III trial is a fully enrolled 730
patient study in which Tarceva(TM) is being tested as a single agent to
treat second/third-line NSCLC versus a placebo group where

8

patients receive best supportive care but no additional drug therapy as a
control group. We have been given fast track status by the FDA for the
indication covered by this trial, and patient enrollment was completed in
January 2003. Improvement in patient symptoms is the key secondary
endpoint. The study design was based upon our earlier Phase II data with
monotherapy Tarceva(TM) in this type of patient population. This
second/third-line NSCLC trial is our highest priority and the key
registration study for Tarceva(TM). We anticipate that we will announce
top-line data from this study late in the first quarter of calendar 2004.

- The Phase II trial in malignant glioma is an open label two stage Phase
II study with a target of approximately 110 patients. The primary
endpoint in this study is response, with duration of response and time to
progression as key secondary endpoints. With compelling clinical data, we
believe accelerated approval may be an option from this study. The FDA
has granted orphan drug status for Tarceva(TM) in this setting.

- A Phase III front-line pancreatic trial compares Tarceva(TM) used in
combination with gemcitabine (Gemzar(R)) versus chemotherapy alone.
Patient enrollment was completed in January 2003. The results of the
Tarceva(TM) and Iressa(R) Phase III studies in combination with
chemotherapy in lung cancer suggest that there may be issues in using
Tarceva(TM) concurrently with chemotherapy. We, therefore, view a
positive outcome from the pancreatic study in combination with
chemotherapy to be considered high risk.

Other Proprietary Clinical Development Programs

OSI-7904L. OSI-7904L is a liposomal formulation of the thymidylate
synthase inhibitor, GW1843, which was licensed from GlaxoSmithKline and acquired
by us as part of the acquisition of Gilead's oncology business in 2001.
Thymidylate synthase inhibitors, or TSIs, are a class of cytotoxic chemotherapy
agents. OSI-7904L was formulated in liposomes with a goal of extending its
pharmacokinetic (or drug exposure) half-life and improving its therapeutic
index. The leading TSI used today is 5-FU, a generically available TSI which is
extensively used in many tumor types, notably colorectal cancer. Clinical
studies with 5-FU have shown that long term, continuous infusions of the drug
have shown better activity than more typical regimens. The goal of our OSI-7904L
program is to mimic this effect with an infusion of the liposomal formulation of
our TSI molecule. In Phase I clinical trials, OSI-7904L demonstrated promising
activity in pre-clinical testing for the potential treatment of various solid
tumors. Data from the Phase I study indicated that the liposomal formulation has
extended the drug exposure profile of OSI-7904L in patients' blood. We have
therefore recently initiated a Phase II program for OSI-7904L which includes
testing the drug in patients with previously untreated advanced gastric or
gastric esophageal junction cancer and conducting two additional Phase I
combination studies of OSI-7904L with cisplatin and oxaliplatin, respectively.
Milestone and royalty payments are due to GlaxoSmithKline upon successful
development of this product.

Aptosyn(R). Aptosyn(R) is a sulfone derivative of the nonsteroidal
anti-inflammatory drug, or NSAID, sulindac. The product was originally developed
by Cell Pathways to treat familial polyposis. Following rejection of a new drug
application, or NDA, by the FDA in September 2000, Cell Pathways initiated a
large scale Phase III program comparing a combination of Aptosyn(R) and
Taxotere(R) versus Taxotere(R) alone in second-line NSCLC. The trial was based
primarily on pre-clinical data. In March 2003, Cell Pathways completed
enrollment of an approximately 610 patient Phase III trial. Based upon the
absence of clinical data in NSCLC and the lack of potency exhibited by
Aptosyn(R) in pre-clinical models, we consider Aptosyn(R) to be a high risk drug
candidate. Our overall development strategy will require further assessment once
top-line data from the Phase III study becomes available.

OSI-461. OSI-461 is a new chemical entity that has composition of matter
patents issued or filed in the major world markets. It is a more potent second
generation follow-on candidate to Aptosyn(R). OSI-461 is an inhibitor of cGMP
phosphodiesterases which leads to sustained activation of the intracellular
signaling protein, Protein Kinase G, and subsequent stimulation of apoptosis
through the C-Jun kinase pathway. Data correlating cGMP phosphodiesterases
inhibition with apoptosis markers and the inhibition of growth in various
cultured cancer cells in vitro supports this mechanism of action. However,
OSI-461 also has effects on tubulin and microtubular biology in cells which is a
known mechanism of action for other anti-cancer agents.
9

OSI-461 was exceptionally well tolerated in pre-clinical toxicology studies and
we are currently expanding the pre-clinical anti-tumor data set in vivo. In
1999, Cell Pathways began a clinical trial program for OSI-461. By the end of
2001, OSI-461 was in pilot Phase IIa trials to investigate its safety and
efficacy in three cancer indications -- chronic lymphocytic leuxemia, renal cell
carcinoma and HRPC. The molecule was formulated as a simple packed powder in
gelatin capsules for the exploratory clinical development program conducted by
Cell Pathways. We are currently expanding our research knowledge base
surrounding OSI-461 and developing both additional formulations and analogs of
the molecule. We would likely be required to develop a tablet form of the
product before commencing full development. Following the completion of the
acquisition of Cell Pathways in June 2003, we completed a detailed review of the
OSI-461 program and concluded that further dose optimization studies would be
required before committing to a full Phase II program. These studies are
ongoing. In July 2002, Cell Pathways also commenced a Phase II trial of OSI-461
in the non-cancerous area of inflammatory bowel disease. We expect to complete
this study during the next six months and will determine how best to proceed in
this indication at that time.

OSI-211. OSI-211 is a proprietary liposomal formulation of the active
topoisomerase-1 inhibitor lurtotecan. It is a member of the camptothecin class
of cytotoxics that act as topoisomerase-1 inhibitors. OSI-211 has been
demonstrated to be active for the treatment of relapsed ovarian cancer. However,
in order to develop this agent commercially, we believe it is essential that we
clearly differentiate it from topotecan (Hycamtin(R)) in terms of activity,
safety and convenience. We have, therefore, initiated a head-to-head randomized
Phase II trial versus topotecan in relapsed ovarian cancer and an open label
Phase II trial in advanced small cell lung cancer. Data are expected from these
studies during the coming year. Without significant differentiation from
topotecan, it is unlikely that we will continue the development of OSI-211 for
commercial reasons; and therefore, we would consider out-licensing the product
for further development.

OSI-7836. OSI-7836 is a member of the nucleoside class of cytotoxic drugs
of which gemcitabine (Gemzar(R)) is the market leader. In ongoing Phase I
trials, the candidate has experienced toxicity issues, principally high-grade
fatigue. If we are unable to overcome these issues with schedule changes, we
expect to terminate this program after the first quarter of fiscal 2004.
OSI-7836 would be a candidate for out-licensing for further development.

Pfizer Collaborative Cancer Programs

Pfizer is continuing to develop three drug candidates which arose from our
collaborative drug discovery program in targeted therapies for cancer, all of
which are in clinical trials. 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 an intriguing opportunity 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 II and Phase I trials, and
CP-868,596 targets PDGFR and is in Phase I trials. An additional candidate from
the Pfizer program, CP-724,714, is a potent and selective small molecule
inhibitor of the HER2/erbB2 receptor tyrosine kinase, and is in Phase I clinical
trials. Over-expression 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.

OUR DRUG DISCOVERY AND DEVELOPMENT CAPABILITIES

Drug Discovery

In fiscal 2003, we re-focused our pre-clinical research efforts into two
areas in which we believe we can build a competitive presence in cancer drug
discovery. These areas relate to two core biological processes important in both
normal and cancer cell regulation, namely signal transduction pathways that
either drive proliferation or prevent apoptosis (programmed cell death). The
dysfunctional regulation of these two processes are key elements in the
progression of normal cells to the cancerous state. Within these areas, we have
focused our efforts on three key signaling axes described by the central signal
transduction gene products that make up these pathways; they are the
Ras-Raf-Mek-Erk axis, the PI-3K-PDK-PKB axis, and the

10

PKG-MEKK1-JNK1 axis. These three pathways are thought to be critical in driving
either cancer cell proliferation (e.g. EGFR via the Ras-Erk axis) or in
protecting cancer cells from undergoing apoptosis (e.g. 1GF-1R via the PKB
axis).

Our approach to discovering drugs which target these axes is focused on the
discovery and development of small molecule pharmaceutical products that,
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 research and
pre-clinical and clinical development. 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 technologies
and capabilities include (i) gene transcription, signal transduction, protein
kinases and other assay systems, (ii) automated high throughput screening, (iii)
an extensive library of 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. We currently employ approximately 170
scientists in our pre-clinical research activities.

In order to enhance our capabilities in drug discovery we have developed
multiple relationships with academic centers as well as with other biotechnology
partners. For instance, in collaboration with Cold Spring Harbor Laboratories we
are identifying and validating new targets for cancer drug discovery. This
collaboration focuses 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. To help complement our
medicinal chemistry efforts we have initiated collaborations (for example with
Structural Genomix, Inc.) the goals of which are to use structure based design
in the lead optimization phase of our active projects. During lead optimization,
medicinal chemists synthesize new molecules and combinatorial libraries that are
structurally related to the lead compound. Co-crystallization of the lead
compound with the target protein enhances the subsequent efforts of the
medicinal chemists designing improved compounds. 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 and
toxicity. Target identification, validation, lead identification and lead
optimization phases are expected to take 18-24 months.

To ensure that our lead compounds are active against the target of interest
they are profiled in pharmacodynamic assays. This allows us to develop surrogate
biomarkers of drug activity in vivo and may well enable and support our future
clinical development. This will ensure that our lead compounds have retained
their anticipated mechanism of action in vivo. Lead compounds are tested
extensively in order to identify a drug candidate that has the desired drug-like
pharmaceutical qualities, is biologically active and generally well-tolerated in
animal models and can be patented as a novel pharmaceutical.

Drug Development

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 development strategy are addressed. This Phase
typically takes up to one year. An investigational new drug, or IND, application
is reviewed by the FDA or its foreign equivalent prior to the commencement of
clinical studies. A drug is first assessed for its safety and pharmacokinetics.
After these Phase I trials, drugs are tested for preliminary efficacy in Phase
II trials to demonstrate initial activity and confirm safety in humans prior to
the initiation of extensive Phase III trials designed to collect the safety and
efficacy data necessary to support a filing of an NDA with the FDA or similar
marketing application authorization overseas. We currently employ over 140
physicians and specialists who are responsible for generating pre-clinical data
required for IND submission and managing clinical trials and the associated
regulatory affairs effort to support submissions and interactions with the FDA
and other regulatory agencies around the world.

The entire drug discovery and development process typically takes over a
decade and is subject to significant risk and attrition. A significant majority
of drug candidates which enter clinical trials fail to result in

11

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.

Manufacturing and Supply

In connection with our acquisition of certain of the pre-clinical research
operations of British Biotech in September 2001, we acquired a fully-integrated
current Good Manufacturing Practices, or 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 non-cytotoxic products and to support our
current and future pre-clinical and clinical development programs.

We currently rely on third-party manufacturers to manufacture our in-line
products and 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 for the supply of commercial quantities
of Tarceva(TM) tablets for sales within the United States. Under our
collaboration agreement with Roche, Roche has elected to take responsibility for
the supply of Tarceva(TM) tablets for sales outside of the United States.
Tarceva(TM) 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 manufacturing and supply
agreements with several of these manufacturers. We contracted a third party
manufacturer to formulate Tarceva(TM) into tablets. Additionally, we are working
with an additional source for the tablet manufacture. All manufacturers are
required to comply with cGMP. We have sufficient quantities of Tarceva(TM)
tablets to conduct our ongoing clinical trials and we expect to have a fully
validated supply chain in place in advance of the potential launch of
Tarceva(TM). We currently use third parties to label, inventory and distribute
the drug product. In addition, we are using third-party manufacturers to develop
an intravenous formulation and an oral solution.

In connection with our acquisition of Cell Pathways in June 2003, we
acquired the exclusive marketing and distribution rights to Gelclair(R) in North
America. The manufacturing rights and obligations were held by Sinclair and
subsequently licensed to Helsinn in July 2003.

Under the terms of the agreement entered into with Serono in March 2003, we
acquired the marketing and promotion rights to Novantrone(R) for oncology
indications in the United States. Pursuant to that agreement, we do not have the
obligation nor right to manufacture or distribute the product.

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 the one-year transition period, Gilead manufactured
and supplied us with the API for preparation of OSI-7904L and OSI-7836 drug
products. We have transitioned the manufacture of the API to new manufacturers.
Starting materials for OSI-7904L are manufactured by other third-party
manufacturers. 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-7904L and OSI-211 at its manufacturing facility in
San Dimas, California to support our ongoing clinical trial activities and, upon
FDA approval, our commercial manufacturing needs for these two liposomal
products.

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. We have entered into a Tripartite Agreement and
separate agreements with both Genentech and Roche with respect to 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

12

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 goals of obtaining regulatory approval for
commercial marketing and sale in the United States of products resulting from
the collaboration, and, subsequently, supporting the commercialization of the
product. 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 are triggered by the
fulfillment of certain conditions; we believe that we have met these conditions
and are in active discussions with Genentech regarding these rights. Genentech
will pay us certain milestone payments and we will share equally in the
operating profits or losses on products 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, that is, until the date that we and Genentech mutually
agree to terminate the collaboration or until either party exercises early
termination rights. The OSI/Genentech agreement is subject to early termination
in the event of certain customary defaults, such as material breach of the
agreement and bankruptcy. In addition, since January 8, 2003, Genentech has had
the right to terminate the OSI/Genentech agreement with six months prior written
notice.

Under the OSI/Roche agreement, we granted to Roche a license to 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), that is, until the date of expiration or revocation
or complete rejection of the last to expire patent covering Tarceva(TM) or, in
countries where there is no valid patent covering Tarceva(TM), on the tenth
anniversary of the first commercial sale of Tarceva(TM) in that country, or
until either party exercises early termination rights. The OSI/ Roche agreement
is subject to early termination in the event of certain customary defaults, such
as material

13

breach of the agreement and bankruptcy. In addition, since July 31, 2003, Roche
has had the right to terminate the agreement on a country-by-country basis with
six months prior written notice. Since such time, we also have had the right to
terminate the agreement on a county-by-country basis if Roche has not launched
or marketed a product in such country under certain circumstances.

OTHER COLLABORATIONS

We have several other product candidates 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.

As a result of our strategy to focus on oncology, we made the strategic
decision to divest all non-oncology research programs and realign our internal
research effort toward an oncology strategy focused on the discovery of novel
anti-cancer drugs targeting defects in signal transduction and apoptosis that
are necessary for the growth of many human tumors. We created a U.K. subsidiary
for our diabetes and obesity programs, Prosidion Limited, in fiscal 2003. We
transferred and/or licensed our diabetes assets to Prosidion. We have also
transferred to Prosidion our existing diabetes teams comprised of approximately
25 employees. In October 2003, we committed $7.5 million in venture funding to
Prosidion to support the organization through June 2004. We have hired a chief
executive officer for Prosidion and established a separate board of directors
comprised of senior OSI management and OSI directors. We may add additional
outside directors as the venture progresses. We are currently seeking funding or
strategic partners for the venture. If we are unable to obtain external funding
for Prosidion, we will consider other alternatives to discontinue the diabetes
program, including out-licensing our diabetes assets and reducing employee
headcount.

OUR INTELLECTUAL PROPERTY

Patents and other proprietary rights are vital to our business. Our policy
is to protect our intellectual property rights 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.

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, 2003, we held 88 U.S. patents, 151 foreign patents, 97
pending applications for U.S. patents, five of which have been allowed, and 205
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, we jointly hold, with the University of
Arizona, 11 issued U.S. patents, three U.S. pending patent applications, 17
foreign patents, and 25 pending foreign patent applications. 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 patents and patent applications include two
families of patents covering composition of matter for Tarceva(TM). They also
include other development compounds being pursued by Pfizer (i.e., VEGFR, PDGFR
and erbB2 inhibitors) as well as several families covering farnesyl transferase

14

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 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 (assigned to Vertex Pharmaceuticals Incorporated), Pharmacia Inc.,
R.W. Johnson Pharmaceutical Research Institute, Wyeth, BASF Corporation 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. 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 for 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-7904L and OSI-211 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-7904L and OSI-211.

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.

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 fully-integrated
pharmaceutical companies, as well as numerous smaller companies, which possess
extensive drug discovery programs and are pursuing the same or similar
technologies as those that comprise our technology platforms and are pursuing
pharmaceutical products or therapies that are directly competitive with ours,
including developing novel small molecule pharmaceuticals. Most of the major
pharmaceutical organizations competing with us have greater capital resources,
larger overall research and development staff and facilities and considerably
more experience in drug development, obtaining regulatory approval and
pharmaceutical product manufacturing and marketing.

With respect to our cancer drug discovery and development programs, other
companies have potential drugs in clinical trials to treat diseases in the same
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 within our small molecule programs, and may result in
effective, commercially successful products. Our lead drug candidate,
Tarceva(TM,) is currently in Phase III trials. At least three competitors,
AstraZeneca, Bristol Myers Squibb Company/ImClone Systems Incorporated/Merck
KGA, and Amgen/ Abgenix, Inc., also have substantial clinical development
programs for the same target. AstraZeneca has received approval for its
anti-EGFR, small molecule drug in the Unites States (accelerated approval,
contingent studies required by FDA) and Japan. Regulatory filings for
BMS/ImClone/Merck KGA's anti-EGFR antibody, Erbitux(TM), have recently been
submitted both in the United States and Europe. In the United States, the
biological license application for this antibody is for second-line treatment of
colorectal cancer and

15

approval is expected in early 2004. In Europe, Merck KGA is seeking an
indication as a single agent or in combination with irinotecan in metastatic
colorectal cancer patients, with approval across the European Union expected in
mid-2004; initial approvals have been granted in Switzerland.

With the acquisition of the co-promotion right for Novantrone(R) in the
oncology arena in the United States and the marketing and distribution rights
for Gelclair(R) in North America, we are facing competition in their respective
areas of use. Novantrone(R) is mainly used for the treatment of pain associated
with advanced HRPC, ANLL and Non Hodgkin's lymphoma (which is not an approved
indication in the United States). A key competitor in HRPC is Taxotere(R), a
cytotoxic agent marketed by Aventis. Taxotere(R) is not approved for HRPC but it
is used extensively in this setting and Phase III trials for HRPC are expected
to be completed in early 2004. In ANLL, Novantrone(R) competes against a variety
of generic products including idarubicin and daunorubicin. In non-Hodgkin's
lymphoma, the reference standard is the CHOP regimen consisting of four generic
agents: cyclophosphamide, doxorubicin, vincristine, and prednisone. In addition,
Rituxan(R) (Genentech/IDEC) is used extensively in non-Hodgkin's lymphoma both
as a single-agent and in combination with CHOP or other chemotherapies including
Novantrone(R). Gelclair(R) is a bioadherent oral gel for treatment of pain
associated with the oral mucosa, such as chemotherapy-induced oral mucositis.
Key competitors include a myriad of products often blended in the dispensing
pharmacy, none specifically approved for this indication, such as Xylocaine(R),
Benadryl(R) Elixir, Carafate(R), Orabase(R), and over-the-counter and
prescription analgesics.

Our next-generation cytotoxic drug candidates are designed to improve upon
in the market products of similar mechanism. We must therefore clearly
differentiate the activity or safety of our molecules if we are to successfully
register the drugs and compete in the marketplace. The most advanced of these
products is OSI-211, a topoisomerase-1 inhibitor, currently in Phase II trials
for relapsed ovarian and small cell lung cancer. It is designed to improve upon
Hycamtin(R) (GlaxoSmithKline), one of two agents in this class that are already
marketed. Camptosar(R) (Pfizer) is the second such agent approved for colorectal
cancer, but its use in small cell lung cancer is increasing. OSI-7904L,
currently in Phase II trials is a TSI and is designed to compete with generic
5-FU, as well as Xeloda(R) (Roche), an oral TSI. OSI-7836, currently in Phase I
trials, is a nucleoside analog, which was expected to compete with Gemzar(R)
(Eli Lilly and Company) that is already on the market. Companies with related
research and development activities also present significant competition for us.
Aptosyn(R) and OSI-461 are both inhibitors of cGMP phosphodiesterases.
Chemically, Aptosyn(R) is a sulfone derivative of an NSAID, sulindac, while
OSI-461 is a more potent second generation follow-on candidate to Aptosyn(R).
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(s);

- 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 IND, to support human
clinical trials and are reviewed by the FDA, with patient safety as the primary
objective, prior to the IND 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 IND. 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; however, in oncology, our area of
focus, Phase I trials are more often conducted in cancer patients. 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 or if
they decide it is unethical to continue the study. 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 the United States, 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 the 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 cGMP, which must be followed at
all times. In 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,

17

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

We believe that our success is largely dependant upon our ability to
attract and retain qualified personnel in the scientific and technical fields.
As of October 31, 2003, we employed 480 persons worldwide (325 in the United
States), of whom 174 were primarily involved in research activities and 147 in
development activities, 42 in sales and marketing, with the remainder engaged in
executive and administrative capacities. Although we believe that we are
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.

AVAILABLE INFORMATION

We file our annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 electronically with the Securities and Exchange Commission.
The public may read or copy any materials we file with the SEC at the SEC's
Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public
may obtain information on the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains
reports, proxy and information statements, and other information regarding
issuers that file electronically with the SEC. The address of that site is
http://www.sec.gov.

You may obtain a free copy of our annual reports on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K and amendments to those
reports on the day of filing with the SEC on our website on the World Wide Web
at http://www.osip.com or by contacting the Investor Relations Department at our
corporate offices by calling (631) 962-2000 or sending an e-mail message to
investorinfo@osip.com.

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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. Except for our ongoing obligations to disclose material
information under the federal securities laws, 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.

IF WE HAVE SETBACKS IN OUR TARCEVA(TM) PROGRAM, OUR STOCK PRICE WOULD MOST
CERTAINLY DECLINE.

Our registration plans for Tarceva(TM) are focused on a key Phase III study
using Tarceva(TM) as a single agent in second/third-line NSCLC. We are
conducting another Phase III study of Tarceva(TM) in pancreatic cancer in
combination with chemotherapy and a Phase II study in glioblastoma. As a result
of not meeting our primary endpoints in our two front-line Phase III studies of
Tarceva(TM) plus chemotherapy, a positive outcome from the pancreatic study in
combination with chemotherapy must now be considered high risk. If we do not
receive any positive results from the on-going Phase III trials or from our
glioblastoma Phase II program, we would need to conduct additional clinical
trials to achieve Tarceva(TM) registration. Since Tarceva(TM) is our most
advanced product candidate, a setback of this nature could almost certainly
cause a decline 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 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).
On October 1, 2003, we announced that two of our front-line Phase III studies of
Tarceva(TM) in NSCLC did not meet their primary endpoints. These studies tested
the use of Tarceva(TM) in combination with conventional chemotherapy. Although
they were expected to fail following similar results from a competitive compound
a year ago, these studies exemplify the challenge of clinical development. 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 for
oncology drugs 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 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 delay or
prevent, respectively, us from commercializing and generating revenues from
Tarceva(TM).

WE HAVE INCURRED LOSSES SINCE OUR INCEPTION, AND WE EXPECT TO INCUR LOSSES OVER
THE NEXT FEW 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, 2003, our accumulated deficit was $505.6 million. Our net losses were $181.4
million, $218.5 million, and $23.8 million for fiscal years 2003, 2002 and 2001,
respectively. The net loss for fiscal 2003 included an in-process research and
development charge of $31.5 million related to the acquisition of Cell Pathways,
Inc. in June 2003. The net

19

loss for fiscal 2002 included an in-process research and development charge of
$130.2 million related to the acquisition of certain assets from Gilead
Sciences, Inc. in December 2001. Our losses have resulted principally from costs
incurred in research and development, acquired in-process research and
development and from selling, 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 research programs and the expansion of our commercial operations.
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 achieve profitability until approximately 24
months after a successful launch of Tarceva(TM).

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) OR PRODUCE DATA INDICATING
THAT THEIR PRODUCTS ARE AS EFFECTIVE OR MORE EFFECTIVE THAN TARCEVA(TM), THEN
OUR ABILITY TO COMPETE FOR SALES IN THIS MARKET MAY BE A GREATER CHALLENGE.

If our competitors, some of which 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. On May 5, 2003, AstraZeneca plc received FDA approval for Iressa(R),
its anti-EGFR drug, as a monotherapy for the treatment of advanced NSCLC.
Another competitor, Bristol Myers Squibb Company/ImClone Systems Incorporated,
has initiated a biologics license application submission to treat colon cancer
for their product, Erbitux(TM), and may reach the U.S. market ahead of
Tarceva(TM). A third competitor, Amgen, Inc./Abgenix, Inc., has a product in
Phase II trials. If these, or other competitors, succeed in developing drugs
similar to Tarceva(TM) that are as effective or more effective than our product,
our product may not gain widespread market acceptance.

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
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 can
recover any of the expenses incurred to develop them.

IF WE DO NOT MAINTAIN OUR CO-DEVELOPMENT AND MARKETING ALLIANCE WITH GENENTECH,
INC. 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.

Tarceva(TM) is being developed in an alliance with Genentech, Inc. and
Roche. The development program is managed by the three parties under a global
development committee. Genentech and Roche each managed one of the Phase III
trials in NSCLC testing Tarceva(TM) in combination with cytotoxic chemotherapy.
We are managing two Phase III trials in second/third-line NSCLC and pancreatic
cancer. If Tarceva(TM) receives regulatory approval, Genentech will lead the
marketing effort in the United States and Roche will market the drug in the rest
of the world. We have entered into agreements with both Genentech and Roche with
respect to the alliance. The term of the OSI/Genentech agreement continues until
the date on which neither we nor Genentech is entitled to receive a share of the
operating profits or losses on any products resulting from the

20

collaboration, that is, until the date that we and Genentech mutually agree to
terminate the collaboration or until either party exercises early termination
rights as described as follows. The OSI/Genentech agreement is subject to early
termination in the event of certain customary defaults, such as material breach
of the agreement and bankruptcy. In addition, since January 8, 2003, Genentech
has had the right to terminate the OSI/Genentech agreement with six months prior
written notice. 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), that is, until the date of expiration or
revocation or complete rejection of the last to expire patent covering
Tarceva(TM) or, in countries where there is no valid patent covering
Tarceva(TM), on the 10th anniversary of the first commercial sale of Tarceva(TM)
in that country. The OSI/Roche agreement is subject to early termination in the
event of certain customary defaults, such as material breach of the agreement
and bankruptcy. In addition, since July 31, 2003, Roche has had the right to
terminate the agreement on a country-by-country basis with six months prior
written notice. After such time we also have had 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. 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). This situation would
require a greater expenditure of financial resources and may cause a delay in
launch and market penetration while we continue to 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, we may need to
replace Roche's manufacturing role in markets outside of the United States.

SETBACKS ON THE PART OF OUR COMPETITORS WHO ARE DEVELOPING DRUGS IN THE
HER1/EGFR FIELD HAVE HISTORICALLY CAUSED VOLATILITY IN OUR STOCK PRICE AND COULD
DO SO IN THE FUTURE.

Two of our major competitors, AstraZeneca and ImClone, which are developing
drugs in the HER1/ EGFR field, that are similar to our most advanced clinical
candidate, Tarceva(TM), have suffered setbacks with respect to their drug
candidates over the last two years which have impacted our stock price by
raising concerns regarding the HER1/EGFR class of targeted therapies. Additional
setbacks, whether before or after FDA approval, on the part of our competitors
could result in a further decrease in our stock price.

IF ANY OF OUR MARKETED PRODUCTS WERE TO BECOME THE SUBJECT OF PROBLEMS, OR IF
NEW, MORE EFFECTIVE TREATMENTS SHOULD BE INTRODUCED, OUR SALES REVENUES FROM
SUCH MARKETED PRODUCTS COULD DECREASE.

We currently market two products, Novantrone(R) and Gelclair(R). If these
marketed products become the subject of problems including, among others:

- efficacy or safety concerns with the products, even if not justified;

- unexpected side effects;

- regulatory proceedings subjecting the products to potential recall;

- publicity affecting doctor prescription or patient use of the product;
and

- pressure from competitive products

or if new, more effective treatments are introduced, our sales revenues from
such products could decrease. For example, efficacy or safety concerns may
arise, whether or not justified, that could lead to the recall or withdrawal of
either or both products. In the event of a recall or withdraw of a product such
as Novantrone(R), our sales revenues would significantly decline.

21

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

In order to continue to generate sales of Novantrone(R) and Gelclair(R), we
will need to maintain a successful commercial infrastructure. If we are
unsuccessful maintaining this infrastructure, we would need to enter into and
successfully maintain additional commercialization agreements. This could result
in our receipt of decreased revenues from sales of Novantrone(R) for oncology
indications and Gelclair(R) and potential oncology products other than
Tarceva(TM).

CONGRESS HAS RECENTLY PASSED LEGISLATION THAT MATERIALLY CHANGES THE MEDICARE
REIMBURSEMENT GUIDELINES FOR INTRAVENOUS AND ORAL ONCOLOGY PRODUCTS WHICH MAY
IMPACT OUR SALES REVENUES.

The formula by which Medicare reimbursement for intravenous oncology
products is rendered to the oncologist was vigorously debated by Congress. As a
result of the debates, Congress recently passed legislation that will lower the
reimbursement to oncologists for intravenous oncology products like
Novantrone(R) while providing increased reimbursement for oral drugs like
Tarceva(TM) (if approved by the FDA) which are not currently covered by
Medicare. The legislation is subject to the President's approval which is
expected. These changes in Medicare reimbursement could have a negative impact
on our sales revenues of Novantrone(R).

IF SERONO S.A. OR HELSINN HEALTHCARE, S.A. DO NOT FULFILL THEIR OBLIGATIONS OF
MANUFACTURING AND SUPPLYING NOVANTRONE(R) AND GELCLAIR(R), RESPECTIVELY, WE MAY
NOT BE ABLE TO CONTINUE THE MARKETING AND/OR DISTRIBUTION OF THE PRODUCT WHICH
COULD CAUSE OUR REVENUES TO DECREASE.

Under the terms of our agreements with Serono and Helsinn, we do not have
the obligation nor the right to manufacture Novantrone(R) or Gelclair(R). These
obligations and rights are held solely by Serono and Helsinn. If either of the
parties are delayed in and/or restricted from supplying the product, we would be
directly affected. Any delay or restrictions would impede us from selling the
product. Without the sales of Novantrone(R) and Gelclair(R), our revenues would
decrease.

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 COMMERCIAL 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 our potential oncology products, including Tarceva(TM), may never
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 various stages of development
and do not expect them to be commercially available for a number of years, if at
all. All but nine of our product candidates are in pre-clinical development. The
nine 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.

22

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 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
our 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 the other regulatory agencies (i.e.,
the European Union Health Authorities and the Japanese Ministry of Health) in
additional markets, which are material to us and our collaborative partners, may
delay or deny the approval of our proposed products. None of our proposed
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 our manufacturer are subject
to continuing regulatory oversight, 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 new drug
application.

IF OUR COLLABORATIVE PARTNERS OR OTHER THIRD PARTY CONTRACTORS GIVE OTHER
PRODUCTS GREATER PRIORITY THAN OUR PRODUCTS OR FAIL TO PERFORM THEIR OBLIGATIONS
UNDER THE AGREEMENTS, 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 OR COMPETE EFFECTIVELY IN THE MARKET.
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 commercialization, 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 commercialization, 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 commercialization, research and
development or manufacturing arrangements on acceptable terms, if at all.

OUR RELIANCE ON THIRD PARTIES SUCH AS MANUFACTURERS, CLINICAL DISTRIBUTORS, 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 engage
manufacturers, clinical distributors, and/or CROs to manufacture and distribute
the product candidate, to conduct and manage clinical studies and to assist us
in guiding products through the FDA review and approval process. For example, we
collaborate with the National Cancer Institute of Canada's Clinical Trial Group
in connection with our Tarceva(TM) Phase III trials. Because we have engaged and
intend to engage manufacturers, clinical distributors, 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 manufacturers,
clinical distributors, 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.

23

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 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,
on commercially reasonable terms is currently unknown. If 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.

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

As of September 30, 2003, we held 88 U.S. patents, 151 foreign patents, 97
pending applications for U.S. patents, five of which have been allowed, and 205
applications for foreign patents, two of which have been allowed. Moreover, we
jointly own with Pfizer Inc. 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, we jointly hold, with the University of
Arizona, 11 issued U.S. patents, three U.S. pending patent applications, 17
foreign patents, and 25 pending foreign patent applications. We intend to
continue to seek patent protection for or maintain as trade secrets all of the
commercially promising 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 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. If our pending
patent applications are not approved for any reason or if we are unable to
develop additional proprietary technologies that are patentable, the degree of
future protection for our proprietary rights will remain uncertain. 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.

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. 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.
24

In a legal action to enforce our gene transcription patents or other
patents, courts may find that the scope of our patents is not sufficiently broad
enough to cover our products or competitors infringing on our products. Further,
courts may find that our patents are invalid or unenforceable. This would lessen
our ability to enforce or license our patents and would lessen our ability to
prevent competitors from marketing similar products.

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 that 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 U.S. Patent and Trademark Office, to
administrative proceedings in foreign patent offices 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 that 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 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.

As of September 30, 2003, our cash reserves, consisting of cash, cash
equivalents, restricted short and long-term investments, and unrestricted
short-term investments, aggregated approximately $404.1 million, following the
completion and assimilation of the Cell Pathways and Novantrone(R) transactions.
Additionally, we estimate our cash burn will be approximately $115 million in
fiscal 2004, and we have established a goal of achieving profitability and
positive cash flow within 24 months of a successful market launch of
Tarceva(TM). 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 and debt securities,
as well as from collaborative partners in order to further our growth. We may
not be able to obtain adequate funding from the sale of our securities or from
collaborative partners 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.

OUR OUTSTANDING INDEBTEDNESS INCREASED SUBSTANTIALLY WITH THE ISSUANCE OF
CONVERTIBLE SENIOR SUBORDINATED NOTES IN FEBRUARY 2002 AND SEPTEMBER 2003, AND
WE MAY NOT BE ABLE TO MAKE THE REQUIRED PAYMENTS ON THESE NOTES WHEN DUE.

As a result of the issuance of our 4% Convertible Senior Subordinated notes
due 2009 in February 2002 and the issuance of our 3.25% Convertible Senior
Subordinated Notes due 2023 in September 2003, our long-term debt represented by
these notes was $310.0 million as of September 30, 2003. Our Convertible Senior
Subordinated Notes due 2009 and 2023 significantly increased our interest
expense and related debt service costs. Interest on these notes accrues at the
rate of 4% and 3.25% per annum, respectively. This amounts to interest payments
of $3.2 million due and payable on the 2002 notes semi-annually on February 1
and August 1 of each year and $2.4 million due and payable on the 2003 notes
semi-annually on March 8 and September 8 of each year on the outstanding amount
of the notes. Cumulative interest payments of $35.2 million are

25

scheduled to be paid between February 1, 2004 and February 1, 2009 on the 2009
notes and $97.5 million between March 8, 2004 and September 8, 2023 on the 2023
notes. This long-term debt 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; and

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

We currently are not generating sufficient cash flow to satisfy the annual
debt service payments on 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, we will default on our
2002 notes and our 2003 notes, and we would face liquidity problems as a result.

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. From October
1, 2000 through September 30, 2001, the range of our stock price was between
$86.38 and $30.19, and the range of the Nasdaq Biotechnology Index was between
$1,323.41 and $608.24. From October 1, 2001 through September 30, 2002, the
range of our stock price was between $50.94 and $11.50, and the range of the
Nasdaq Biotechnology Index was between $978.42 and $397.36. From October 1, 2002
through September 30, 2003, the range of our stock price was between $38.34 and
$12.84, and the range of the Nasdaq Biotechnology Index was between $801.40 and
$442.09. 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;

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

- comments by securities analysts and general market conditions.

If our stock price falls, our stockholders may not be able to sell their
stock when desired or at desirable prices.

OUR GOVERNANCE DOCUMENTS AND STATE LAW PROVIDE CERTAIN ANTI-TAKEOVER MEASURES
WHICH WILL DISCOURAGE A THIRD PARTY FROM SEEKING TO ACQUIRE US AND MAY IMPEDE
THE ABILITY OF STOCKHOLDERS TO REMOVE AND REPLACE OUR BOARD OF DIRECTORS AND,
THEREFORE, OUR MANAGEMENT.

We have had a shareholder rights plan, commonly referred to as a "poison
pill," since January 1999. The purpose of the shareholder rights plan is to
protect stockholders against unsolicited attempts to acquire control of us that
do not offer a fair price to our stockholders as determined by our board of
directors. Under the plan,

26

the acquisition of 17.5% or more of our outstanding common stock by any person
or group, unless approved by our board of directors, will trigger the right by
our stockholders to acquire additional shares of our common stock (and in
certain cases the stock of the potential acquiror) at a bargain purchase price,
thus significantly increasing the acquisition cost to a potential acquiror. The
shareholder rights plan may have the effect of dissuading a potential hostile
acquiror from making an offer for our common stock at a price that represents a
premium to the then current trading price. Our certificate of incorporation and
by-laws contain certain additional anti-takeover protective devices. For
example,

- no stockholder action may be taken without a meeting, without prior
notice and without a vote; solicitations by consent are thus prohibited;

- special meetings of stockholders may be called only by our board of
directors;

- nominations by stockholders of candidates for election to the board of
directors at our annual meeting of stockholders must be made at least 45
days prior to the date on which we first mailed our proxy materials for
the prior year's annual meeting of stockholders; and

- 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.

An issuance of preferred stock with dividend and liquidation rights senior
to the common stock and convertible into a large number of shares of common
stock could prevent a potential acquiror from gaining effective economic or
voting control. 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 a 15% stockholder. In addition
to discouraging a third party from acquiring control of us, the foregoing
provisions could impair the ability of existing stockholders to remove and
replace our management and/or our board of directors.

27

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 approximately 30,000 square feet, and one located at One
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 Farmingdale facility houses our U.S. drug
discovery and pre-clinical laboratories. In August 2003, we consolidated our
employees from the Uniondale facility into the Farmingdale facility. We are
currently in the process of attempting to either assign or sublease our rights
under the lease agreement for the Uniondale facility.

We currently lease three facilities in Colorado, one located at 2860
Wilderness Place, Boulder, Colorado, consisting of approximately 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. We are currently in the process of attempting to
either assign or sublease our rights under the lease agreement for the facility
at 2900 Center Green Court South.

In June 2003, in connection with our acquisition of Cell Pathways, Inc. we
acquired a lease to a facility in Horsham, Pennsylvania, consisting of
approximately 40,000 square feet. We are currently in the process of attempting
to either assign or sublease our rights under the lease agreement for this
facility.

Our subsidiary, OSI Pharmaceuticals (UK) Limited, leases two facilities,
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. The
Oxford facilities house research and development laboratories and administrative
offices as well as our Prosidion Limited subsidiary. We ceased operations at our
Aston Science Park, Birmingham, England facility in March 2002 and have
consolidated the Birmingham operations into the Oxford facilities. In March 2003
we entered into a surrender agreement whereby the landlord released us of our
obligations under the lease at the Aston Science Park, Birmingham, England
facility in consideration for a payment of approximately $662,000.

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 2003.

28

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, 2001 through September 30, 2003 as reported on the NASDAQ National
Market:

HOLDERS AND DIVIDENDS

As of November 3, 2003, there were approximately 997 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.

RECENT SALES OF UNREGISTERED SECURITIES

In September, we issued $150 million aggregate principal amount of 3.25%
Convertible Senior Subordinated Notes due 2023 to Merrill Lynch & Co., Merrill
Lynch, Pierce, Fenner & Smith Incorporated, and Morgan Stanley & Co.,
Incorporated, the initial purchasers of the notes, for resale in transactions
exempt from the registration requirements of the Securities Act of 1933, as
amended, to persons reasonably believed by the initial purchasers to be
"qualified institutional buyers" as defined in Rule 144A under the Securities
Act. The initial purchasers' discount was approximately $4.9 million. We used
approximately $19.0 million of the net proceeds to repurchase 503,800 shares of
our common stock. We also used approximately $14.2 million to acquire U.S.
government securities that we pledged to the trustee as security for the notes
sufficient to pay the first six interest payments on the notes. We intend to use
the remainder of the net proceeds to continue the development of our oncology
franchise, which may include additional product or corporate acquisitions, and
for general corporate purposes. Interest on the notes accrue at a rate of 3.25%
per year and will mature in 2023. The notes are convertible into shares of our
common stock at any time on or prior to maturity, at a conversion price of
$50.02 per share, subject to normal and customary adjustments in certain
circumstances. We will file a registration statement to enable the selling
securityholders to sell their notes and the shares issuable upon conversion of
the notes.

29

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

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

(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 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 Pharmaceuticals (UK) Limited, and options granted to outside directors.

(d) Includes 807,736 shares reserved for issuance under the 1993 Employee Stock
Purchase Plan, the 1995 Employee Stock Purchase Plan, the stock purchase
plan for employees of OSI-UK and the Stock Purchase Plan for Non-Employee
Directors (see notes 11(d) and 11(e) to the accompanying consolidated
financial statements).

We have a policy of rewarding employees who achieve ten, fifteen, and
twenty years of continued service with OSI 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.

30

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, 2003.
The information below should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this report.

31

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

(a) The fiscal 2003 consolidated financial statements include the acquisition of
the marketing and promotion rights to Novantrone(R) for approved oncology
indications in the United States for approximately $45.0 million in cash;
the acquisition of Cell Pathways, Inc. for approximately $55.0 million in
common stock, contingent value rights and cash; the issuance of $150.0
million of convertible senior subordinated notes for net proceeds of
approximately $145.1 million and the purchase of 503,800 shares of our
common stock for $19.0 million. (See notes 2, 3(a) and 10(a) to the
accompanying consolidated financial statements.)

(b) 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 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; the issuance of
$200.0 million of convertible senior subordinated notes for net proceeds of
approximately $192.9 million; and the early retirement of $40.0 million
aggregate principal amount of convertible senior subordinated notes
resulting in a net gain of approximately $12.6 million. (See notes 3(b),
5(b) and 10(b) to the accompanying consolidated financial statements.)

(c) 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
Birmingham, England and Tarrytown, New York facilities. (See notes 1(b),
3(d), 5(a), 11(f), 11(g), 17(a) and 17(b) to the accompanying consolidated
financial statements.)

(d) The fiscal 2000 consolidated financial statements include 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; 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; and 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. (See notes
5(c), 11(a) and 18 to the accompanying consolidated financial statements.)

(e) The fiscal 1999 consolidated financial statements include the acquisition of
Cadus' research business for $2.2 million in cash, including a $806,000
charge to operations for in-process research and development 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.

32

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 novel mechanism based, targeted therapies in the areas of signal
transduction and apoptosis and next-generation cytotoxic chemotherapy agents. We
also market two products: Novantrone(R) and Gelclair(R). We acquired the rights
to market and promote Novantrone(R) (mitoxantrone concentrate for injection) for
approved oncology indications in the United States and to market and distribute
Gelclair(R) Bioadherent Oral Gel in North America during fiscal 2003.

Our most prominent 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 including lung and
pancreatic cancers. The HER1/EGFR gene is also amplified in certain tumors
including glioblastoma multiforme, an aggressive form of brain cancer. 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,
we are developing Tarceva(TM) in a global 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 the drug 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 I and Phase II trials in
non-small cell lung cancer, or NSCLC, bronchioloalveolar cell carcinoma, or BAC
(a form of lung cancer), glioblastoma multiforme, head and neck cancer and
ovarian cancer. Based upon these data, the alliance embarked upon a
comprehensive global development plan in 2001 designed to both register
Tarceva(TM) and maintain a competitive position against other EGFR inhibitors.
In October 2003, we announced that two Tarceva(TM) Phase III clinical trials for
front-line NSCLC (in combination with conventional chemotherapy versus
chemotherapy alone) did not meet their primary endpoints of improving overall
survival. We had considered these trials high risk as a result of a competitor's
previously announced failure of its EGFR inhibitor in this setting which had
demonstrated that combining an EGFR inhibitor concomitantly with conventional
chemotherapy drug regimens did not result in improved patient benefit.
Tarceva(TM) is currently in a fully enrolled 730 patient Phase III clinical
trial for second/third-line NSCLC patients, which is our primary registration
study. This study compares the use of Tarceva(TM) as a monotherapy versus
placebo in lung cancer patients who have failed conventional chemotherapy
treatments. The study is designed to detect a survival advantage as its primary
endpoint with secondary endpoints that include symptom relief and improvement of
quality of life. Based on encouraging data from a Phase I study in glioblastoma,
our partner, Genentech, initiated a Phase II program for this indication in
August 2003. Tarceva(TM) is also in a Phase III trial for pancreatic cancer
where it is being tested in combination with gemcitabine versus gemcitabine plus
placebo. We expect top-line data for the ongoing Phase III trials and Phase II
glioblastoma trial during 2004. We estimate the approval of Tarceva(TM) by the
U.S. Food and Drug Administration in the fourth quarter of calendar 2004 if the
second/third-line NSCLC study successfully meets its endpoint.

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 direct our business 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:

- support and enable the successful development, registration and
commercialization of Tarceva(TM) by reducing program execution and
registration risk and by maximizing Tarceva(TM)'s differentiation and
competitive positioning; and

33

- establish a first-class oncology franchise around Tarceva(TM) by
assembling, through mergers, acquisitions and internal growth, a full
complement of capabilities and technology and a diversified risk balanced
portfolio and pipeline of drug candidates.

Behind Tarceva(TM), we have multiple drug candidates in clinical
development. OSI-7904L, the most promising of our next generation cytotoxic
chemotherapy candidates, is a liposomal formulation of a thymidylate synthase
inhibitor. It is being developed as a potential competitor to 5-fluorouracil, or
5-FU and capecitabine (Xeloda(R)). OSI-7904L is in a Phase II program which
includes a Phase II trial in gastric and gastric esophageal junction cancers and
combination Phase I trials with cisplatin (Platinol(R)) and oxaliplatin
(Eloxatin(TM)). Aptosyn(R) (exisulind) was added to our pipeline with the
acquisition of Cell Pathways, Inc. in June 2003 and is currently in a Phase III
trial in combination with docetaxel (Taxotere(R)) for the treatment of advanced
NSCLC. Although Cell Pathways had advanced Aptosyn(R) to Phase III trials, we
consider it to be a higher risk prototype drug candidate arising from the
apoptosis platform acquired from Cell Pathways. We believe OSI-461 (formerly
CP461), the second drug candidate acquired from Cell Pathways to be a more
promising second-generation molecule that is currently being evaluated in a dose
ranging Phase I study and a series of exploratory Phase II studies in chronic
lymphocytic leukemia, renal cell carcinoma and prostate cancer. OSI-211 and
OSI-7836 are two additional next generation cytotoxic agents currently
undergoing Phase II and Phase I trials, respectively. Final data from the
on-going Phase I and Phase II studies is expected from both programs during the
coming year. We currently view the continued development of these two candidates
beyond these studies to be unlikely. Three molecules, CP-547,632 (targeting the
vascular endothelial growth factor receptor, or VEGFR, gene), CP-724,714
(targeting the HER2 gene) and CP-868,596 (targeting the platelet derived growth
factor receptor, or PDGFR, gene) that were discovered as part of our historical
alliance with Pfizer Inc. and are currently in clinical trials conducted by
Pfizer. We will receive royalty payments on the Pfizer candidates if they are
successfully commercialized.

Key Transactions in Fiscal 2003

We have carried out three major transactions in fiscal 2003 in keeping with
our strategy of building an oncology franchise around Tarceva(TM), maintaining a
strong cash position as we do so and assembling a commercial operation in the
United States ahead of Tarceva(TM)'s projected launch.

On March 11, 2003, we entered into an agreement to market and promote the
drug Novantrone(R) for approved oncology indications in the United States
pursuant to the terms of a Co-Promotion Agreement with Ares Tradings, S.A., an
affiliate of Serono S.A. In consideration for exclusive marketing and promotion
rights, we paid $45.0 million in cash. In consideration for certain transition
services provided by Serono during a four-month transition period starting on
the effective date of the agreement, we also paid a one-time fee of $10.0
million. Under the terms of the agreement, we pay quarterly maintenance fees to
Serono until the later of the expiration of the last valid patent claim or the
first generic date. We receive commissions on net sales of Novantrone(R) in the
United States for oncology indications. These commission rates increase upon the
achievement of certain annual sales goals for Novantrone(R) in oncology
indications. Novantrone(R) is approved by the FDA for the treatment of acute
nonlymphocytic leukemia, which includes myelogenous, promyelocytic, monocytic
and erythroid acute leukemias, and the relief of pain associated with advanced
hormone-refractory prostate cancer. The drug is also approved for certain
advanced forms of multiple sclerosis. Serono will continue to market
Novantrone(R) in the multiple sclerosis indications and will record all U.S.
sales in all indications. We initiated our sales activity for Novantrone(R)
during the third quarter of fiscal 2003.

On June 12, 2003, we completed our acquisition of Cell Pathways. Cell
Pathways was a development stage biotechnology company focused on the research
and development of products to treat and prevent cancer, and the future
commercialization of such products. Cell Pathways also marketed and sold
Gelclair(R), the manufacturing rights and obligations of which were held by
Sinclair Pharmaceuticals Ltd. of the United Kingdom and subsequently licensed to
Helsinn Healthcare S.A. in July 2003. The assets purchased and liabilities
assumed by us included: (a) two drug candidates in clinical development:
Aptosyn(R) and OSI-461 and the related technology platform and patent estate;
(b) exclusive distribution rights to Gelclair(R), a marketed oncology device;
(c) inventory; (d) rights to Cell Pathways' leased facility in Horsham,
Pennsylvania, as well as leasehold improvements and certain equipment; and (e)
certain other assets and liabilities.
34

As consideration for the merger, each share of Cell Pathways common stock was
exchanged for (i) 0.0567 shares of OSI common stock and (ii) a contingent value
right to receive 0.04 shares of OSI common stock. The contingent value right is
triggered in the event a new drug application is accepted for filing with the
U.S. Food and Drug Administration by June 12, 2008 for either of the two newly
acquired clinical candidates, Aptosyn(R) or OSI-461. Based on the exchange ratio
of 0.0567, we issued approximately 2.2 million shares of OSI common stock to
Cell Pathways' stockholders in connection with the merger.

On September 8, 2003, we issued $135.0 million aggregate principal amount
of convertible senior subordinated notes in a private placement for net proceeds
of $130.3 million. On September 17, 2003, the bankers associated with this
convertible debt offering exercised an option to purchase an additional $15.0
million of notes, for additional net proceeds of $14.5 million. The notes bear
interest at 3.25% per annum, payable semi-annually, and mature on September 8,
2023. The notes are convertible into shares of our common stock at a conversion
price of $50.02 per share. We used $19.0 million of the net proceeds for the
purchase of 503,800 shares of our common stock and $14.2 million to acquire U.S.
government securities that were pledged to the trustee as security for the notes
in an amount sufficient to pay the first six interest payments on the notes. We
are planning to use the remainder of the proceeds from the sale of the notes for
the continued development of our oncology franchise which may include additional
product or corporate acquisitions and general corporate purposes.

To support Novantrone(R), we have built a core commercial operation
comprising of approximately 60 sales, marketing, medical affairs, commercial
planning and other support personnel including an approximately 30 person sales
force. We believe that the tangible and intangible benefits of this commercial
capability are significant in that it allows us to pursue additional
in-licensing and co-promotion arrangements for other marketed products, enables
us to directly market our future pipeline products in the United States, and
further validates OSI as a quality development and commercialization partner for
oncology development candidates. In addition, it allows us to pursue our
co-promotion rights for Tarceva(TM) in the United States with our partner,
Genentech.

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 revenues
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

Sales commissions represent the commissions earned on sales of
Novantrone(R) for oncology uses pursuant to the Co-Promotion Agreement with
Serono. Serono will continue to market Novantrone(R) for multiple sclerosis
indications and will record all U.S. sales for all indications, including
oncology indications. Sales commissions from Novantrone(R) on net oncology sales
are recognized in the period the sales occur based on the estimated split
between oncology sales and multiple sclerosis sales of Novantrone(R), as
determined on a quarterly basis by an external third party. The split between
oncology and multiple sclerosis sales is subject to further adjustment based on
final review by the external party, in the subsequent quarter. Management does
not believe these adjustments, if any, will be significant to the consolidated
financial statements.

Product sales represent revenues earned on sales of Gelclair(R). The
marketing and distribution rights to Gelclair(R) were acquired in our
acquisition of Cell Pathways effective June 12, 2003. In accordance with SFAS

35

No. 48, "Revenue Recognition When Right of Return Exists," given the limited
sales history of Gelclair(R), we at this time defer the recognition of revenue
on product shipments of Gelclair(R) to wholesale customers until such time as
the product is sold from the wholesale customer to the retail and non-retail
outlets. For each reporting period, we monitor shipments from wholesale
customers to pharmacies and hospitals and wholesale customer reorder history
based on data from an external third party.

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. Our most significant
application of this policy, to date, is the $25.0 million in upfront fees
received from Genentech and Roche in January 2001, which were 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 from three years 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 $5.0
million for fiscal 2003, compared to $8.3 million had the upfront fees continued
to be recognized over the 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.

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.

Accounting for Goodwill and Other Intangible Assets

Effective October 1, 2002, we fully adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 142 requires that goodwill and certain other
intangibles with indefinite useful lives, are not amortized into results of
operations but instead are reviewed for impairment at least annually and written
down, and charged to results of operations in periods in which the recorded
value of goodwill and certain other intangibles is more than their implied fair
value. We completed our impairment review of goodwill during the first quarter
of fiscal 2003 and determined that no impairment charge was required upon
adoption. In addition, no indications of impairment were identified during the
fiscal year ended September 2003.

Our identifiable intangible assets are subject to amortization. We
reassessed the useful life of our intangible assets upon adoption of SFAS No.
142 to make any necessary amortization period adjustments to our then existing
intangible assets. No adjustments resulted from this assessment. SFAS No. 142
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 Asset
to be Disposed Of. "Under SFAS No. 121, intangible and other long-lived assets
are reviewed for impairment whenever events or changes in circumstances indicate
the carrying value of an asset may not be recoverable. As a result of our
acquisition of the exclusive rights to market and promote Novantrone(R) for the
approved oncology indications in the United States, we recorded an identifiable
intangible asset with an estimated useful life through the expiration of the
Novantrone(R) patent in April 2006. In connection with our

36

acquisition of Cell Pathways, we assumed the exclusive rights to market and
distribute Gelclair(R) in North America which Cell Pathways had acquired from
Sinclair in January 2002 for a period of 10 years. As a result, we recorded an
identifiable intangible asset which is being amortized over eight and a half
years, the remaining term of the agreement.

Accounting for the Impairment of Long-Lived Assets

On October 1, 2002, we adopted the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." 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. Intangibles with determinable lives
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 intangibles with determinable
lives and other long-lived assets are impaired which may result in an adverse
impact on our financial condition and results of operations. The adoption of
SFAS No. 144 did not have an impact on our consolidated financial statements as
of and for the fiscal year ended September 30, 2003.

COMPARISON OF FISCAL 2003 AND FISCAL 2002

Results of Operations

Our fiscal 2003 net loss of $181.4 million decreased $37.1 million compared
to our fiscal 2002 net loss of $218.5 million. The fiscal 2003 loss included an
in-process R&D charge of $31.5 million in connection with the acquisition of
Cell Pathways. The fiscal 2002 loss included an in-process R&D charge of $130.2
million in connection with the acquisition of Gilead Sciences, Inc.'s oncology
assets. The increase in net loss excluding the in-process R&D charges was in
part related to a one-time fee and quarterly maintenance fees expended in
connection with the Novantrone(R) licensing agreement with Serono, fees
associated with the Celgene Corporation deal to acquire full North American
marketing rights to Gelclair(R), the costs of scaling up and recruiting a
commercial organization and increased amortization expense.

Revenues

Total revenues for fiscal 2003 were $32.4 million compared to revenues of
$21.8 million for fiscal 2002. The increase in revenues was primarily due to
Novantrone(R) sales commissions. On March 11, 2003, we began recording
Novantrone(R) sales commissions, upon the execution of the Co-Promotion
Agreement with Serono. Total sales commissions for fiscal 2003 were $16.3
million. We launched our sales efforts for Novantrone(R) during the third
quarter of fiscal 2003. We project that our total fiscal 2004 sales commissions
on Novantrone(R) oncology sales will be in excess of $30 million. However,
Congress has recently passed legislation, subject to the President's approval
which is expected, that materially changes the Medicare reimbursement guidelines
for intravenous and oral oncology products which may impact the sales revenues
of all intravenous chemotherapy agents. We began recognizing Gelclair(R) product
sales on June 12, 2003, upon the closing of our acquisition of Cell Pathways.
Total product sales for the period June 12, 2003 to September 30, 2003 were
$437,000. We launched our sales effort for this product in October 2003. We
estimate that our total fiscal 2004 product sales of Gelclair(R) will be between
$3.0 million to $4.0 million.

License and other revenues decreased $3.8 million or 38% for fiscal 2003
compared to fiscal 2002. This decrease was primarily due to the decrease in the
amount of revenue recognized relating to the $25.0 million upfront fees received
from Genentech and Roche (see note 5(a) to the accompanying consolidated
financial statements). In accordance with the provisions of SAB No. 101, we were
recognizing the $25.0 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 from three years to
four years to reflect the revised estimated timing of our research and
development commitment for

37

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 Changes," the remaining unearned revenue is being recognized
prospectively over the revised term. As a result, we recorded revenues of $5.0
million during fiscal 2003 compared to revenues of $7.5 million during fiscal
2002. The decrease in fiscal 2003 was also due to a decrease in revenues of
$923,000 related to certain administrative services provided to British Biotech
plc and Gilead during the transition periods following the acquisitions of
certain assets of each company in fiscal 2002.

Total collaborative program revenues decreased $2.4 million or 20% for
fiscal 2003 compared to fiscal 2002. The decrease was primarily due to the
phase-down of our collaboration in cosmeceuticals with Anaderm Research
Corporation. In July 2002, we entered into an agreement with Pfizer to
accelerate the phase-down period of the collaboration with Anaderm so that it
would terminate no later than April 23, 2003. In consideration for the work
performed by us during the accelerated phase-down period, we received $4.5
million in September 2002 and $3.5 million in March 2003 upon the successful
completion of the transition period. The $4.5 million was recognized as revenue
ratably over the term of the transition period and the $3.5 million was
recognized during the second quarter of fiscal 2003 upon the successful
completion of the transition. The decrease for the year was also due to a
decrease in activity related to our collaboration in diabetes with Tanabe
Seiyaku Co., Ltd., which expired in October 2003 and was not renewed. As a
result of our strategic decision to divest all non-oncology research programs,
as well as the completion of the Anaderm and Tanabe collaborations in fiscal
2003, we no longer expect collaborative revenues from research alliances going
forward.

Expenses

Total operating expenses of $214.1 million decreased $47.7 million or 18%
for fiscal 2003 compared to operating expenses of $261.8 million for fiscal
2002. Excluding the acquired in-process R&D charges of $31.5 million and $130.2
million recorded in fiscal 2003 and fiscal 2002, respectively, operating
expenses increased $51.0 million or 39% for fiscal 2003. These in-process R&D
charges related to the acquisition of Cell Pathways in June 2003 and the
acquisition of certain assets from Gilead in December 2001. We do not deem these
charges to be indicative of the day-to-day operations of our company. Operating
expenses recognized in fiscal 2003 and 2002 primarily included (i) research and
development expenses, which included expenses related to the development of our
lead clinical candidate, Tarceva(TM) and our other clinical candidates, and
proprietary and collaborative-based research; (ii) in-process R&D charges
related to the acquisition of Cell Pathways in June 2003 and the acquisition of
oncology assets acquired from Gilead in December 2001; (iii) selling, general
and administrative expenses; and (iv) amortization of intangibles.

Cost of products sold related to sales of Gelclair(R) were $157,000 for the
period June 12, 2003 to September 30, 2003, or 36% of product sales. There were
no costs of products sold prior to June 12, 2003 since we acquired the rights to
Gelclair(R) on June 12, 2003 in connection with the Cell Pathways acquisition.

The largest component of our total expenses, excluding the in-process R&D
charges, is our ongoing investments in research and development, and
particularly, the clinical development of our product pipeline. We currently
have multiple drug candidates in clinical development including our most
prominent candidate, Tarceva(TM), which is currently in Phase III trials for
NSCLC and pancreatic cancer, Phase II trials for glioblastoma, and various other
Phase I and II trials. The other drug candidates are in various stages of
clinical development. Aptosyn(R) was added to our pipeline with the acquisition
of Cell Pathways and is currently in Phase III trials. OSI-461, which was
acquired along with Aptosyn(R) in connection with our acquisition of Cell
Pathways, is a second-generation molecule that is being evaluated in chronic
lymphocytic leukemia, renal cell carcinoma and prostate cancer. Three candidates
(OSI-7904L, OSI-211 and OSI-7836) are next generation cytotoxic chemotherapy
agents, which we are developing. Three other candidates (CP-547,632, CP-724,714
and CP-868,596) are gene-targeted therapies currently being developed by Pfizer
and require no further research and development investment by us. We consider
the active management and development of our clinical pipeline crucial to the
long-term approval process. We manage our overall research, development and
in-licensing efforts in a manner designed to generate a constant flow of
clinical candidates into development to
38

offset both the advancement of products to the market and the anticipated
attrition rate of drug candidates that fail in clinical trials or are terminated
for business reasons. The table below summarizes the typical duration of each
phase of clinical development and the typical cumulative probabilities of
success for approval of drug candidates entering clinical development. The
numbers are based upon industry survey data for small molecule drugs:

The Tufts Center for the Study of Drug Development estimates that the
average cost to develop a new prescription drug is $802 million. The actual
probability of success for each drug candidate and clinical program will be
impacted by a variety of factors, including the quality of the molecule, the
validity of the target and disease indication, early clinical data, investment
in the program, competition and commercial viability. Because we manage our
pipeline in a dynamic manner, it is difficult to give accurate guidance on the
anticipated proportion of our research and development investments assigned to
any one program prior to the Phase III stage of development, as well as the
future cash inflows from these programs. In fiscal 2003, we invested a total of
approximately $46.5 million in research and approximately $56.1 million in
pre-clinical and clinical development. We consider this level of investment
suitable to sustain one major Phase III program and two to four earlier clinical
stage programs at any time and we manage our overall research and development
investments toward this level of activity.

Research and development expenses marginally increased by $440,000 in
fiscal 2003 compared to fiscal 2002. Increases in costs associated with the
clinical development of Tarceva(TM) and transition costs associated with the
assimilation of Cell Pathways were offset by a shift from non-oncology and
collaborative programs to oncology programs. Also included in research and
development expenses for fiscal 2003 was a severance charge of $694,000. This
charge related to a reduction in our headcount in October 2002 as we refocused
our business on oncology and away from services that we had historically
provided to our former collaborative partners.

Our most advanced development program is for Tarceva(TM). In January 2001,
we entered into the alliance with Genentech and Roche for the global development
and commercialization of Tarceva(TM). The significant perceived market potential
for Tarceva(TM) has resulted in the alliance partnership committing to an
unusually large and comprehensive global development plan for the candidate. The
global development plan comprises of major Phase III clinical trials in lung and
pancreatic cancers and a large number of earlier stage trials in a variety of
disease settings, including glioblastoma. In addition, numerous collaborative
and investigator sponsored studies are ongoing in a number of other disease
settings including bronchioloalveolar cell-carcinoma and gynecological
malignancies. The alliance partners have committed to invest a combined $300
million in the global development plan to be shared equally by the three
parties. Additional research and development investments can be made by the
parties outside of the global development plan with the consent of the other
parties. We estimate that we will invest an additional $10-$15 million in
Tarceva(TM) research and development outside of the global development plan
prior to the drug's targeted FDA approval in the fourth quarter of calendar
2004. As of September 30 , 2003, we have invested in excess of $75 million,
representing our share of the costs incurred to date in the tripartite global
development plan and additional investments outside the plan. Our research and
development expenses for Tarceva(TM) incurred for fiscal 2003 were $35.9
million. We anticipate investing a majority of the remaining $35-$40 million we
have provisionally budgeted for this program over the next two years. Should
Tarceva(TM) be successfully registered and launched, we would anticipate
continued research and development investment in the product to support its
commercial growth. For our second Phase III clinical candidate, Aptosyn(R), we
expect the cost to complete the Phase III trials to be between $4.0 and $5.0
million as of September 30, 2003.

39

In connection with the acquisition of Cell Pathways in June 2003, we
recorded an in-process R&D charge of $31.5 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). The in-process R&D charge
was assigned to the two development projects and their related technology
platform and patent estates for Aptosyn(R) ($3.7 million) and OSI-461 ($27.8
million), based on their value on the date of the acquisition. In determining
the value of the in-process R&D, the assumed commercialization dates for these
products ranged from 2005 to 2006. Significant assumptions and estimates used in
the valuation of in-process R&D included: the stage of development for each of
the two 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 25% to reflect present value.

In connection with the acquisition of certain assets from Gilead in
December 2001, we recorded an in-process R&D charge of $130.2 million during
fiscal 2002, 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(b) to the accompanying consolidated financial
statements). The in-process R&D was allocated to three oncology candidates
acquired: OSI-7904L, OSI-211 and OSI-7836. The value of the acquired in-process
R&D charges were 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.

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 applied risk adjustments 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.

For each project, we need to successfully complete a series of clinical
trials and to receive FDA or other regulatory approvals prior to
commercialization. There can be no assurance that any of these candidates will
ever reach feasibility or develop into products that can be marketed profitably,
nor can there be any assurance that 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 candidates, we may discontinue such further
development of certain or all of these candidates.

Selling, general and administrative expenses increased $42.4 million or
151% for fiscal 2003 compared to fiscal 2002. The increase was due to (i)
additional management and personnel relating to the establishment of commercial
operations to support Gelclair(R) and Novantrone(R); (ii) subcontracting
expenses relating to our short-term transitional arrangement with a contract
sales organization comprising a core of sales representatives as we build our
commercial operations; (iii) increased commercialization and marketing costs
relating to Tarceva(TM) which are shared with Genentech in accordance with the
terms of our collaboration with Genentech; (iv) expenses for maintenance fees
and transition support services provided by Serono relating to Novantrone(R)
sales in oncology indications; and (v) expenses associated with the full
recovery of rights to market and distribute Gelclair(R) from Celgene, as well as
transition support services provided by Celgene. Included in selling, general
and administrative expenses for fiscal 2003 is a severance charge of $249,000
relating to a reduction in our headcount in October 2002. We expect selling,
general and administrative costs to increase as we expand our commercial
operations which include a sales force and an associated marketing and sales
management infrastructure. The sales and marketing infrastructure is comprised
of approximately 60 sales, marketing, medical affairs, commercial planning and
support personnel, including an approximately 30 person sales force.

40

Amortization of intangibles increased $8.0 million or 641% for fiscal 2003
compared to fiscal 2002. The increase primarily related to $8.1 million in
amortization expense related to the exclusive rights to market and promote the
drug Novantrone(R) for approved oncology indications in the United States. Also
included in amortization for fiscal 2003 is $984,000 in amortization expense
related to the exclusive rights to market and distribute Gelclair(R) in North
America. Offsetting these increases was a $1.0 million decrease in amortization
expense from fiscal 2002 attributable to the full adoption of SFAS No. 142 on
October 1, 2002, whereby we ceased amortizing the assembled workforce acquired
from British Biotech and reclassified the balance of $2.1 million to goodwill.

Other Income and Expense

Net investment income decreased $6.9 million or 47% for fiscal 2003
compared to fiscal 2002. The decrease was primarily attributable to a decrease
in the average rate of return on our investments and to less funds available for
investment during the respective periods. Interest expense increased $1.5
million or 28% for fiscal 2003 compared to fiscal 2002. The increase was
primarily due to the interest expense incurred on the convertible senior
subordinated notes. In February 2002, we issued $200.0 million aggregate
principal amount of convertible senior subordinated notes, which bear interest
at 4% per annum, are payable semi-annually, and mature in February 2009. In
August and September 2002, we retired a total of $40.0 million in principal
amount of these notes. In September 2003, we issued $150.0 million aggregate
principal amount of convertible senior subordinated notes, which bear interest
at 3.25% per annum, are payable semi-annually, and mature in September 2023. For
fiscal 2003, other expense-net was $737,000 compared to other expense-net of
$1.6 million for fiscal 2002. Included in fiscal 2003 was the amortization of
debt issuance costs of $834,000, offset by realized gains from the sale of
investments of $347,000. 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-held healthcare information company (see note 4(b)
to the accompanying consolidated financial statements). With respect to the
early retirement of the convertible senior subordinated notes in August and
September 2002, 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 10(b) 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 18 to the accompanying consolidated
financial statements).

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 in-process R&D charge of $130.2 million in
connection with the acquisition of Gilead's oncology assets. The increase in the
net loss, excluding the in-process R&D charge, is primarily due to an increase
in development costs associated with Tarceva(TM) and our three next generation
cytotoxic chemotherapy agents 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 for fiscal 2002 were $21.8 million compared to revenues of
$26.0 million for fiscal 2001. License and other revenues increased $1.8 million
or 22% for fiscal 2002 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
41

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 quarter of fiscal 2002 compared to $2.1
million had we continued to recognize the upfront fees over a three-year period.
The increase was also related to certain administrative services provided to
provided to British Biotech and Gilead during the transition periods following
the acquisitions of certain assets of each company in fiscal 2002.

Total collaborative program revenues decreased $6.0 million in fiscal 2002
or 33% compared to fiscal 2001. This decrease was 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 would 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 $3.5 million in March 2003 upon the successful completion of the transition
period. The $4.5 million was recognized as revenue ratably over the expected
term of the transition period and the $3.5 million was recognized during the
second quarter of fiscal 2003 upon the successful completion of the transition.
For fiscal 2002, we recognized $1.8 million of revenue related to the
phase-down.

Expenses

Total 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 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.

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 150,000 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
42

$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 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(b) to the accompanying consolidated financial statements). The value was
determined by estimating the costs to develop the 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-7904L (Phase I), OSI-211
(Phase II) and OSI-7836 (Phase I). Value was assigned to each program ($13.4
million to OSI-7904L; $19.9 million to OSI-211; $96.9 million to OSI-7836) based
on the assessment of estimated value at the date of acquisition.

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 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 $12.1 million or 76%
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.

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.

43

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, primarily due to the interest expense incurred on the convertible
senior subordinated notes issued in February 2002 (see note 10(b) 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 10(b) 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 18 to the accompanying
consolidated financial statements).

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2003, working capital, representing primarily cash, cash
equivalents, and restricted and unrestricted short-term investments, aggregated
$379.6 million compared to $445.6 million at September 30, 2002. This decrease
of $66.0 million is primarily due to the payment for the exclusive rights to
market and promote Novantrone(R) and related fees totaling $46.0 million, the
purchase of our common stock in September 2003, the transition services fees and
maintenance fees paid to Serono, as well as net operating cash burn for the
period. This decrease was offset by the net proceeds of $145.1 million from the
issuance of the convertible senior subordinated notes in September 2003, offset
by the long-term portion of restricted investment securities purchased, sales
commissions earned on Novantrone(R) sales for oncology uses in the United
States, and cash proceeds from the exercise of options.

On September 8, 2003, we issued $135.0 million aggregate principal amount
of convertible senior subordinated notes in a private placement for net proceeds
of $130.3 million. On September 17, 2003, the bankers associated with this
convertible debt offering exercised an option to purchase an additional $15.0
million of notes, for an additional net proceeds of $14.5 million. The notes
bear interest at 3.25% per annum, payable semi-annually, and mature on September
8, 2023. The notes are convertible into shares of our common stock at a
conversion price of $50.02 per share, subject to normal and customary
adjustments such as stock dividends. We may redeem the notes, in whole or in
part, at any time after September 8, 2008 for a price equal to 100% of the
principal amount of the notes to be redeemed, plus any accrued and unpaid
interest. If we redeem the notes, the purchase price must be paid in cash. The
holders of the notes have the right to require us to purchase all of the notes,
or a portion thereof, on September 8, 2008, September 8, 2013 and September 8,
2018. Upon a change of 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. Upon the election by the holders of the right
to require us to purchase the notes or upon a change in control, we 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 purchase 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 purchase date.
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 related
debt issuance costs of $5.2 million were deferred and are being amortized on a
straight-line basis over the term of the notes. In connection with the issuance
of the notes, we used $19.0 million of the net proceeds for the purchase of
503,800 shares of our common stock. With respect to the notes, we pledged $14.2
million of U.S. government

44

securities with maturities at various dates through August 2006. Upon maturity,
the proceeds of these restricted investment securities will be sufficient to pay
the first six scheduled interest payments on the notes when due. We consider
these 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, 2003 were $14.3 million and $14.2 million, respectively.

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 $192.9 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. Upon a change of control, 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 purchase 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 purchase date. In August and September 2002, we
retired a total of $40.0 million in principal amount of the 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.

If all or any portion of the notes issued in September 2003 and February
2002 have not been converted into common stock prior to their maturity dates, we
will be required to pay, in cash, the outstanding principal amounts of the notes
plus any accrued and unpaid interest. This could have a significant impact on
our liquidity depending on our cash position at 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 out debt obligations.

We expect to incur continued losses over the next few years as we continue
our investment in Tarceva(TM) and other product candidates in our pipeline as
well as our research programs and our commercial operations. The major expenses
associated with the broad-based Phase III development program for Tarceva(TM)
were incurred in fiscal 2003. We estimate that our fiscal 2004 cash burn will be
approximately $115 million. We have established a goal of achieving
profitability and positive cash flow within 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. In
addition, as we continue to pursue strategic in-licensing and acquisition
opportunities that would bring additional products and clinical development
candidates to our cancer pipeline, we will be required to use our available cash
and/or equity securities. 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

45

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, 2003 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 and 3.25% per annum
relating to convertible senior subordinated notes issued in February 2002
and September 2003, respectively.

(b) Includes interest payments.

Other significant commitments and contingencies include the following:

- We are committed to share equally with Genentech and Roche a combined
$300 million in certain global development costs for Tarceva(TM). As of
September 30, 2003, we have spent approximately 75% of our commitment
under the agreement. We are also committed to share certain
commercialization costs relating to Tarceva(TM) with Genentech.

- In connection with our agreement with Serono to market and promote
Novantrone(R) in approved oncology indications, we are required to pay
quarterly maintenance fees to Serono until the later of the expiration of
the last valid patent claim or the first generic date, as defined in the
agreement, or unless the agreement is earlier terminated.

- In connection with the exclusive distribution agreement to market and
distribute Gelclair(R) in North America, we are committed to additional
inventory purchases of $3.0 million and $5.0 million in 2003 and 2004,
respectively, and annual marketing expenditures of $750,000, $500,000 and
$250,000 for 2003 through 2006, 2007 through 2008 and 2009 through 2011,
respectively. In addition, we are obligated to spend $1.3 million
annually for direct sales force efforts. We could be responsible for
milestone payments totaling $3.0 million related to achievement of
certain sales, patent and clinical trial milestones.

- Under agreements with external CROs we will continue to incur expenses
relating to the progress of Tarceva(TM) and other candidate clinical
trials. These 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 termination agreement with Celgene, we are
required to make a payment to Celgene on the first anniversary of the
effective date provided that the transition services, as defined in the
agreement, have been provided to us. The agreement also provides for a
milestone payment to Celgene upon the achievement of a specified amount
of net sales of Gelclair(R).

46

- We have outstanding letters of credit issued by a commercial bank. One is
an irrevocable letter of credit related to our Oxford, England facility
and expires annually with a final expiration date of September 27, 2007.
The amount under this letter of credit is $2.3 million of which the full
amount was available on September 30, 2003. Another is an irrevocable
letter of credit related to our Horsham, Pennsylvania facility, whose
lease we assumed through the acquisition of Cell Pathways. The letter
expires annually with a final expiration date of September 22, 2008. The
amount under this letter of credit is $400,000 of which the full amount
was available on September 30, 2003.

- In May 2003, we entered into a contract with a third-party contract sales
organization for the outsourcing of sales representatives and other sales
force infrastructure. The remaining commitment is approximately $1.6
million as of September 30, 2003.

- 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 $3.1 million at September
30, 2003.

- In connection with the acquisition of Cell Pathways in June 2003, we
provided additional consideration in the form of five-year contingent
value rights through which each share of Cell Pathways' common stock will
be eligible for an additional 0.04 share of OSI common stock in the event
of a filing of a new drug application by June 12, 2008 for either of the
two clinical candidates acquired from Cell Pathways, OSI-461 or
Aptosyn(R).

- 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 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 certain license and 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.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value method of
accounting for stock-based employee compensation as originally provided by SFAS
No. 123 "Accounting for Stock-Based Compensation." Additionally, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosure in both the annual and interim financial statements about the method
of accounting for stock-based compensation and the effect of the method used on
reported results. The transitional requirements of SFAS No. 148 are effective
for all financial statements for fiscal years ending after December 15, 2002. We
adopted the disclosure portion of this statement beginning in the fiscal quarter
ended March 31, 2003. The application of the disclosure portion of this standard
will have no impact on our consolidated financial position or results of
operations. On April 22, 2003, FASB determined that stock-based compensation
should be recognized as a cost in the financial statements and that such cost be
measured according to the fair value of the stock options. The FASB has not as
yet determined the methodology for calculating fair value and plans to issue an
exposure draft and final statement in 2004. We will continue to monitor
communications on this subject from the FASB in order to determine the impact on
our consolidated financial statements.

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
47

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 issued in September 2003 and February 2002, we pledged $14.2
million and $22.9 million, respectively, of U.S. government securities
(restricted investment securities) with maturities at various dates through
August 2006 and November 2004, respectively. 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 10 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. We have
not used or held derivative financial instruments in our investment portfolio.

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. 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 13(d) to the accompanying consolidated financial statements. We did not
have any forward foreign exchange contracts as of September 30, 2003.

At September 30, 2003, 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 principally comprised of
government and government agency obligations and corporate obligations that 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, 2003 would have resulted in approximately a $781,000 change in our
net loss.

Our long-term debt totaled $310.0 million at September 30, 2003 and was
primarily comprised of the convertible senior subordinated notes we issued in
September 2003 and February 2002 which bear interest at a fixed rate of 3.25%
and 4%, respectively.

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.

48

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS

Index to Consolidated Financial Statements:

49

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, 2003
and 2002, 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, 2003. 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, 2003 and 2002, and
the results of their operations and their cash flows for each of the years in
the three-year period ended September 30, 2003, in conformity with accounting
principles generally accepted in the United States of America.

As discussed in notes 1(j) and 8 to the consolidated financial statements,
the Company fully adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" in 2003 and
adopted provisions of SFAS No. 141, "Business Combinations" and SFAS No. 142,
for acquisitions consummated on or after July 1, 2001.

As discussed in note 10 to the consolidated financial statements, the
Company early adopted 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 17, 2003

50

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements.
51

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements.
52

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
(IN THOUSANDS)

See accompanying notes to consolidated financial statements.
53

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

See accompanying notes to consolidated financial statements.
54

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

In this Annual Report on Form 10-K, "OSI," "our company," "we," "us," and
"our" refer to OSI Pharmaceuticals, Inc. and subsidiaries.

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation

Our consolidated financial statements include the accounts of OSI
Pharmaceuticals, Inc., and our wholly-owned subsidiaries, OSI Pharmaceuticals
(UK) Limited ("OSI-UK"), MYCOsearch, Inc., OSDI, Inc. ("OSDI"), and Applied
bioTechnology, Inc. During fiscal 2003, we created a UK subsidiary, Prosidion
Limited ("Prosidion") into which we transferred our diabetes and obesity
research programs. As of September 30, 2003, we held an approximately 80%
ownership interest in Prosidion. All intercompany balances and transactions have
been eliminated in consolidation. We operate in one segment. We are 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

Sales commissions represent commissions earned on the sales of the drug,
Novantrone(R) (mitoxantrone for injection concentrate), in the United States for
oncology indications pursuant to a Co-Promotion Agreement dated March 11, 2003
with Ares Trading S.A. ("Ares Trading"), an affiliate of Serono S.A. ("Serono")
(see note 2). Serono will continue to market Novantrone(R) in multiple sclerosis
indications and will record all U.S. sales for all indications including
oncology indications. Sales commissions from Novantrone(R) on net oncology sales
are recognized in the period the sales occur based on the estimated split
between oncology sales and multiple sclerosis sales of Novantrone(R), as
determined on a quarterly basis by an external third party. The split between
oncology and multiple sclerosis sales is subject to further adjustment based on
final review by the external party, in the subsequent quarter. Management does
not believe these adjustments, if any, will be significant to the consolidated
financial statements.

Product sales represent sales of Gelclair(R) Bioadherent Oral Gel
("Gelclair(R)") in accordance with an exclusive distribution agreement with
Sinclair Pharmaceuticals, Ltd. ("Sinclair") to market and distribute Gelclair(R)
in North America. We acquired the rights under this agreement on June 12, 2003
in connection with the acquisition of Cell Pathways, Inc. ("Cell Pathways") (see
note 3(a)). Sinclair licensed its worldwide rights to Gelclair(R) to Helsinn
Healthcare S.A. ("Helsinn") in July 2003. In accordance with SFAS No. 48,
"Revenue Recognition When Right of Return Exists," given the limited sales
history of Gelclair(R), we at this time defer the recognition of revenue on
product shipments of Gelclair(R) to wholesale customers until such time as the
product is sold from the wholesale customer to the retail and non-retail
outlets. For each reporting period, we monitor shipments from wholesale
customers to pharmacies and hospitals, and wholesale customer reorder history
based on data from an external third party. The related cost of the product
shipped to wholesale customers that has not been recognized as revenue has been
reflected as inventory subject to return (see note 1(l)). The unearned revenue
related to shipments of Gelclair(R) to wholesale customers was $779,000 as of
September 30, 2003 and is included in unearned revenue-current on the
accompanying consolidated balance sheet.

We account for upfront nonrefundable technology access and other upfront
fees over the term of the related research and development 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. We received a total of $25.0 million in
upfront fees from Genentech, Inc. ("Genentech") and Roche ("Roche") in January
2001 which was originally being recognized on a straight-line basis evenly over
the expected three-year term of our required research and development efforts
under the terms of a Tripartite Agreement with Genentech and Roche. In the
fourth quarter of fiscal 2002, the expected

55

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

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
agreement (see note 5(a)). In accordance with Accounting Principle Board Opinion
No. 20, "Accounting Changes," the remaining unearned revenue is being recognized
prospectively over the revised term. We recorded revenues relating to these
upfront fees of $5.0 million, $7.5 million and $6.3 million for fiscal 2003,
2002, and 2001, respectively, which is included in license and other revenues in
the accompanying consolidated statements of operations.

For the year ended September 30, 2000, we recognized as revenue the full
$3.5 million technology access fee received from Tanabe Seiyaku Co., Ltd.
("Tanabe") related to a four-year term collaboration (see note 5(c)). Our
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).

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 related research and development
activities undertaken.

(c) 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 2003, 2002 and 2001, R&D activities included $99.8 million, $95.1 million,
and $44.6 million, respectively, of proprietary R&D. Proprietary R&D includes
our proportionate share of development expenses related to the Tripartite
Agreement with Genentech and Roche (see note 5(a)), and R&D activities funded by
government research grants and other independent R&D programs. The balance of
R&D represents expenses under our collaborative agreements.

(d) Acquired In-Process Research and Development

Costs to acquire in-process research and development projects and
technologies which have no alternative future use and which have not reached
technological feasibility at the date of acquisition are expensed as incurred
(see notes 3(a) and 3(b)).

(e) Accounting for Stock-Based Compensation

We follow the provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." The provisions of SFAS No. 123 allow us 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") 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. We have
elected to continue to apply APB No. 25 in accounting for stock options issued
to employees.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value method of
accounting for stock-based employee compensation as originally provided by SFAS
No. 123. Additionally, SFAS No. 148 amends the disclosure requirements of SFAS
No. 123 to require

56

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

prominent disclosure in both the annual and interim financial statements about
the method of accounting for stock-based compensation and the effect of the
method used on reported results. The transitional requirements of SFAS No. 148
are effective for all financial statements for fiscal years ending after
December 15, 2002. We adopted the disclosure portion of this statement beginning
in the fiscal quarter ended March 31, 2003. The application of the disclosure
portion of this standard will have no impact on our consolidated financial
position or results of operations.

Stock option grants are generally set at the closing price of our 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 (see note 11(a)). Therefore under the
principles of APB Opinion No. 25, we do not recognize compensation expense
associated with the grant of stock options. SFAS No. 123 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 we had accounted for our employee stock options and shares
sold under our 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 2003, 2002 and 2001, respectively: risk-free interest
rates of 1.76%, 3.86% and 3.28%; dividend yields of 0%; volatility factors of
the expected market price of our common stock of 81.63%, 77.19% and 81.9%;
expected life of the employees' options of 3.0 years, 3.0 years, and 3.0 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 $14.82, $17.19 and $25.29 per share for stock options granted in fiscal 2003,
2002 and 2001, respectively.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. Our pro forma
information for fiscal 2003, 2002 and 2001 is as follows (in thousands, except
per share information):

(f) 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.
If fiscal 2003 and fiscal 2002 had resulted in net income and had the common
share equivalents for the 4% convertible senior subordinated notes (3,200,000
shares) issued in February 2002 and the 3.25% convertible senior subordinated
notes (2,998,800 shares) issued in September 2003 been dilutive, interest
expense related to the notes would have been added back to net income (loss) to
calculate diluted earnings per share. The related interest expense for fiscal
2003 and fiscal 2002 totaled $6.7 million and $5.2 million, respectively.

57

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

Common share equivalents (the convertible senior subordinated notes, stock
options and warrants) and contingent shares pursuant to the contingent value
rights are not included since their effect would be anti-dilutive. Such common
share equivalents (convertible senior subordinated notes, stock options and
warrants) and contingent shares amounted to 5,016,096 and 1,584,973,
respectively, for fiscal 2003. Such common share equivalents (convertible senior
subordinated notes and stock options) amounted to 4,894,588 for fiscal 2002.
Such common share equivalents (stock options and warrants) amounted to 2,105,676
for fiscal 2001.

(g) Comprehensive Income (Loss)

Comprehensive income includes foreign currency translation adjustments and
unrealized gains or losses on our available-for-sale securities.

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

(h) Cash and Cash Equivalents

We include as cash equivalents reverse repurchase agreements, treasury
bills, commercial paper and time deposits with original maturities of three
months or less. Such cash equivalents amounted to $192.8 million and $142.8
million as of September 30, 2003 and 2002, respectively.

(i) Investments

Investment securities at September 30, 2003 and 2002 consist of U.S.
Treasury obligations, municipal obligations and corporate debt and equity
securities. We classify our investments as available-for-sale securities, as
defined by SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." 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 September 2003, in connection with the issuance of convertible senior
subordinated notes (see note 10(a)), we pledged $14.2 million of U.S. government
securities (restricted investment securities) with maturities at various dates
through August 2006. In February 2002, in connection with the issuance of
convertible senior subordinated notes (see note 10(b)), 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 respective convertible senior subordinated
notes when due. We consider our restricted investment securities to be
held-to-maturity, as defined by SFAS No. 115. These securities are

58

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

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.

With respect to our facility leases at Horsham, Pennsylvania and Oxford,
England, which were assumed in connection with our acquisition of Cell Pathways
and our acquisition of certain assets of British Biotech plc ("British
Biotech"), respectively (see notes 3(a) and 3(d)), we have outstanding letters
of credit issued by a commercial bank. The irrevocable letter of credit for our
Oxford, England facility expires annually on September 27th with a final
expiration date of September 27, 2007. The amount under this letter of credit is
$2.3 million of which the full amount was available on September 30, 2003. The
collateral for these letters of credit are maintained in a restricted investment
account. Included in cash and cash equivalents and investments securities as of
September 30, 2003 is $35,000 and $3.4 million, respectively, relating to
restricted cash and investments to secure these letters of credit. Included in
cash and cash equivalents and investments securities as of September 30, 2002 is
$1.0 million and $2.0 million, respectively, relating to restricted cash and
investments to secure the letter of credit for the Oxford lease.

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

We have 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) Goodwill and Intangible Assets

In July 2001, the FASB 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. The provisions of SFAS No. 141 and No. 142 were adopted for
acquisitions consummated on or after July 1, 2001. Effective October 1, 2002, we
fully adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that goodwill and intangible assets determined to have indefinite lives
no longer be amortized but instead be tested for impairment at least annually
and whenever events or circumstances occur that indicate impairment might have
occurred. SFAS No. 142 also requires that intangible assets with estimable
useful lives be amortized over their respective estimated useful lives and
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying value of an asset may not be recoverable (see note 8).

As a result of our R&D programs, including programs funded pursuant to R&D
funding agreements (see note 5), we have applied for a number of patents in the
United States and abroad. Costs incurred in connection with patent applications
for our R&D programs have been expensed as incurred.

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

In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets", we review long-lived assets to determine whether an event
or change in circumstances indicates the carrying value of the asset may not be
recoverable. We base our evaluation on such impairment indicators as the nature
of the assets, the future economic benefit of the assets and any historical or
future profitability measurements, as well as other external market conditions
or factors that may be present. If such impairment indicators are present or
other factors exist that indicate that the carrying amount of the asset may not
be recoverable, we determine whether an impairment has occurred through the use
of an undiscounted cash flows analysis at the

59

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

lowest level for which identifiable cash flows exist. If impairment has
occurred, we recognize a loss for the difference between the carrying amount and
the fair value of the asset. Fair value is the amount at which the asset could
be bought or sold in a current transaction between a willing buyer and seller
other than in a forced or liquidation sale and can be measured as the asset's
quoted market price in an active market or, where an active market for the asset
does not exist, our best estimate of fair value based on discounted cash flow
analysis. Assets to be disposed of by sale are measured at the lower of carrying
amount or fair value less estimated costs to sell.

(l) Inventory

Inventory is comprised solely of Gelclair(R) and is stated at the lower of
cost or market, as determined using the first-in, first-out method. Inventory at
September 30, 2003 and September 30, 2002, consisted of the following (in
thousands):

Inventory subject to return represents the amount of Gelclair(R) shipped to
wholesale customers which has not been recognized as revenue (see note 1(b)).

(m) Depreciation and Amortization

Depreciation of equipment is recognized over the estimated useful lives of
the respective asset groups on a straight-line basis. 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 compounds acquired by us (which are included in other
assets on the accompanying consolidated balance sheets) are on a straight-line
basis over five years.

(n) Computer Software Costs

We record the costs of computer software in accordance with AICPA Statement
of Position 98-1, "Accounting for the Costs of Computer Software Developed 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.

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

We record 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. We
analyze 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, 2003 and 2002 were $5.0
million and $3.1 million, respectively.

60

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(p) Foreign Currency Translation

The assets and liabilities of our non-U.S. subsidiaries, OSI-UK and
Prosidion, which operate in their local currency, are 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.

(q) 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
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.

(r) Use of Estimates

We have made a number of estimates and assumptions related to the reported
amounts in our financial statements and accompanying notes to prepare these
consolidated financial statements in conformity with accounting principles
generally accepted in the United States. Actual results could differ from those
estimates and assumptions.

(s) Reclassifications

We have made certain reclassifications to the prior period consolidated
financial statements to conform them to current presentations.

(2) CO-PROMOTION AGREEMENT

On March 11, 2003, we entered into the Co-Promotion Agreement with an
affiliate of Serono, Ares Trading, to market and promote Novantrone(R) for
approved oncology indications in the United States through December 2017. In
consideration for these exclusive rights, we paid $45.0 million in cash. This
payment and related professional fees are included in other intangible assets in
the accompanying consolidated balance sheet as of September 30, 2003 and are
being amortized on a straight-line basis through expiration of the Novantrone(R)
patent in April 2006. In consideration for certain transition services required
to be provided by Serono, we also paid a fee of $10.0 million, which was
recognized over the four-month transition period from the effective date of the
agreement and is included in selling, general and administrative expenses in the
accompanying statement of operations for fiscal 2003. Under the terms of the
agreement, we are also required to pay quarterly maintenance fees to Serono
until the later of the expiration of the last valid patent claim or the first
generic date, as defined in the agreement. Such maintenance fees will be
expensed as incurred. We receive commissions on net sales of Novantrone(R) in
the United States for oncology indications. Sales commissions for the period
March 11, 2003 to September 30, 2003 were $16.3 million.

(3) ACQUISITIONS

(a) Cell Pathways

On June 12, 2003, we completed our acquisition of Cell Pathways, pursuant
to the terms of an Agreement and Plan of Merger dated February 7, 2003. The
acquisition was structured as a merger of a wholly-owned subsidiary of OSI with
and into Cell Pathways. The resulting subsidiary was merged with and into OSI on
61

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

July 14, 2003. Cell Pathways was a development stage biotechnology company
focused on the research and development of products to treat and prevent cancer,
and the future commercialization of such products.

The assets purchased and liabilities assumed by us included: (a) two drug
candidates in clinical development, Aptosyn(R) (exisulind) and OSI-461 (formerly
CP461), and the related technology platform and patent estate; (b) exclusive
distribution rights to the marketed product, Gelclair(R), in North America; (c)
rights to Cell Pathways' leased facility in Horsham, Pennsylvania, as well as
leasehold improvements and certain equipment; (d) inventory; and (e) certain
other assets and liabilities. We also retained three former Cell Pathways
employees and entered into consulting agreements with other former Cell Pathways
employees and officers engaged to assist us with the transition. Certain of
these agreements also provide for the forgiveness of certain loans to these
former officers, at our discretion based on the successful integration of Cell
Pathways' assets. As of September 30, 2003, the full amount of these loans has
been forgiven as a result of such officers' efforts with the transition.

Gelclair(R) is a bioadherent oral gel that provides relief for the
treatment of pain associated with oral mucositis, a debilitating side effect
often seen in patients undergoing chemotherapy or radiation treatment. In
January 2002, Cell Pathways entered into a ten-year exclusive distribution
agreement with Sinclair to market and distribute Gelclair(R) in North America
(United States, Canada and Mexico). Sinclair licensed its worldwide rights to
Gelclair(R) to Helsinn in July 2003. Cell Pathways entered into a four-year
marketing agreement with John O. Butler Company ("Butler"), under which Butler
markets Gelclair(R) to the dental market within the United States and will
market in Canada if and when Gelclair(R) is approved for marketing in Canada. In
October 2002, Cell Pathways entered into a three-year agreement with Celgene
Corporation ("Celgene") for the promotion of Gelclair(R), primarily in the U.S.
oncology market. On June 12, 2003, we entered into an agreement with Celgene by
which we recovered full rights to market and distribute Gelclair(R)in the
oncology setting in North America. This agreement required us to make a payment
to Celgene, which was expensed in the fourth quarter of fiscal 2003, upon the
return of certain sales and marketing data. The agreement also requires us to
make a payment to Celgene upon the first anniversary of the effective date
provided the transition services, as defined in the agreement, have been
provided to us. The transition services are being expensed ratably over the
transition period, which is expected to be completed by December 2003. The
agreement also provides for a milestone payment to Celgene upon the achievement
of a specified amount of net sales of Gelclair(R).

As consideration for the merger, each share of Cell Pathways common stock
was exchanged for (i) 0.0567 shares of our common stock and (ii) a contingent
value right to receive 0.04 shares of our common stock in the event a new drug
application is accepted for filing with the U.S. Food and Drug Administration by
June 12, 2008 for either of the two newly acquired clinical candidates,
Aptosyn(R) or OSI-461. Based on the exchange ratio of 0.0567, approximately 2.2
million shares of our common stock were issued to Cell Pathways' stockholders in
connection with the merger. The 2.2 million common shares were valued at $31.2
million which was based on the average five-day closing price of our common
stock around the date of the announcement of the merger which occurred on
February 10, 2003. Any outstanding options that were not exercised prior to the
effective date of the merger were, in accordance with their terms, terminated.
We assumed approximately 44,000 outstanding and unexercised warrants to purchase
shares of Cell Pathways common stock under the same terms and conditions as the
original Cell Pathways' warrants except that the exercise price of the warrants
and the number of shares of our common stock for which the warrants are
exercisable were adjusted based on the exchange ratio described above.

The acquisition was accounted for under the purchase method of accounting.
The results of operations of Cell Pathways have been included in the
consolidated statements of operations commencing as of June 12, 2003. The
purchase price was allocated to the acquired assets and assumed liabilities
based on the fair values as of the date of the acquisition. The excess of the
fair value of the net identifiable assets acquired over the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

purchase price paid represented negative goodwill of approximately $49.2
million. Since a portion of the negative goodwill is a result of not recognizing
contingent consideration (i.e., the contingent value rights), the maximum value
of the contingent value rights at the date of the acquisition has been recorded
as if it were a liability, thereby reducing the negative goodwill. The value of
the contingent value rights of $22.0 million was based on the average five day
closing price of our common stock around the date of the announcement of the
merger which occurred on February 10, 2003. The remaining negative goodwill of
$27.0 million was allocated proportionately to reduce the value of the
non-current assets acquired and the in-process research and development which
was charged to operations.

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

Acquired in-process R&D..................................... $ 31,451
Gelclair(R) rights.......................................... 28,957
Inventory................................................... 3,102
Fixed assets................................................ 402
Cash........................................................ 1,791
Prepaid expenses and other assets........................... 1,420
--------
Total assets and acquired in-process R&D.................... 67,123
Less liabilities assumed.................................... (12,118)
--------
Common stock & contingent rights issued and cash paid....... $ 55,005
========

During the fourth quarter of fiscal 2003, we recorded a net adjustment of
$311,000 to the preliminary purchase price allocation for the amount of deferred
revenue and inventory acquired in the transaction. This adjustment affected the
allocation of the purchase price between the inventory, deferred revenue,
in-process R&D and the Gelclair(R) rights.

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 $31.5
million after the allocation of the negative goodwill, expensed on the
acquisition date, and included in the accompanying consolidated statements of
operations for the year ended September 30, 2003. The portion of the purchase
price assigned to the acquired in-process R&D was allocated to the following two
clinical candidates: Apotsyn(R) ($3.7 million), currently in a Phase III trial
in combination with Taxotere(R) for the treatment of advanced non-small cell
lung cancer ("NSCLC"), and OSI-461 ($27.8 million), a more potent,
second-generation molecule that is currently being evaluated in dose ranging
Phase I studies and a series of exploratory Phase II studies in chronic
lymphocytic leukemia, renal cell carcinoma and prostate cancer. In addition,
OSI-461 is being evaluated in a Phase II study for inflammatory bowel disease
where there has been encouraging initial indications of activity in the form of
symptom improvement and a remission.

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 these products ranged from 2005 to 2006. 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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

such projects were based on management's estimates of revenues and operating
profits related to such projects. The value of the in-process R&D was 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 two 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 25% to reflect present value.

(b) Gilead's Oncology Assets

On December 21, 2001, we acquired certain assets from Gilead Sciences, Inc.
("Gilead") 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 us 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, we 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, we paid approximately $135.7 million, which includes professional fees
and the assumption of 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 our stock for the five days around the
date of closing. We 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, the most advanced of Gilead's oncology product
candidates acquired by us. Additionally, we assumed certain royalty and
milestone obligations to third parties in connection with the oncology
candidates, acquired as part of the acquisition.

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 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, we recorded an
increase of $800,000 to the goodwill for additional payments to Gilead for
acquisition-related costs. 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, a liposomal
lurtotecan ($19.9 million), OSI-7904L, a liposomal thymidylate ($13.4 million)
and OSI-7836, a nucleoside analog ($96.9 million).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

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 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, 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
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 24 months.

(c) Unaudited Pro Forma Financial Information

The following unaudited pro forma financial information presents a summary
of our consolidated results of operations for fiscal 2003 and fiscal 2002,
assuming (i) the Cell Pathways acquisition had taken place as of October 1, 2002
and October 1, 2001, respectively and (ii) the acquisition of certain assets
from Gilead had taken place as of October 1, 2001 (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 Cell Pathways and certain assets from Gilead for
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

the respective periods. The pro forma financial information includes adjustments
to our historical results to reflect the issuance of approximately 2.2 million
shares of common stock and excludes the charge of $31.5 million related to the
acquired in-process R&D related to Cell Pathways and includes the issuance of
approximately 925,000 shares of common stock and excludes the charge of $130.2
million related to the acquired in process R&D related to Gilead. 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.

(d) British Biotech Assets

On September 28, 2001, we acquired certain assets from British Biotech 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
=======

We 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, we acquired a non-exclusive
license to compound libraries and we 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 libraries will be used.
Also in connection with the acquisition, we acquired 58 employees of which 42
were in research and development, two were in information technology and the
remainder were in administrative positions.

(4) INVESTMENTS

(a) Investment Securities

We invest our excess cash in U.S. Government securities, municipal
obligations and debt and equity instruments of financial institutions and
corporations with strong credit ratings. We have established guidelines relative
to diversification of our 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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

Government and corporate debt securities include interests in mutual funds
with a cost basis and fair market value of $1.6 million as of September 30, 2003
and a cost basis and fair market value of $15.4 million and $15.7 million
respectively, as of September 30, 2002. Net realized gains (losses) on sales of
investments during fiscal 2003, 2002 and 2001 were $347,000, $(143,000), and
$278,000, respectively.

Maturities of securities classified as available-for-sale were as follows
at September 30, 2003 (in thousands):

(b) Other Investments

In July 1997, we, together with Cold Spring Harbor Laboratory and Roche,
formed Helicon Therapeutics, Inc. ("Helicon"), a Delaware corporation. In
exchange for approximately 30% of Helicon's outstanding capital stock, we
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, 2003, we owned approximately 5.68% of Helicon
common stock. As of September 30, 2003 and 2002, our investment in Helicon was
fully reserved.

We have an investment in a venture capital fund limited partnership that is
focused on emerging companies that are developing therapeutics to treat cancer
and other diseases. We account for our investment under the cost method of
accounting. As of September 30, 2003 and 2002, our investment in the limited
partnership was $1.2 million and $790,000, respectively, representing a 1.96%
ownership interest, and is included in other assets in the accompanying
consolidated balance sheets.

We had 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, we 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 to fully reserve our investment. Such
investment was written off in fiscal 2003. In addition, in fiscal 2002 we
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

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YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

consolidated statement of operations for the year ended September 30, 2002. The
remaining portion of the prepaid balance was expensed in fiscal 2003.

(5) PRODUCT DEVELOPMENT CONTRACTS

(a) Roche and Genentech

On January 8, 2001, we entered into an alliance with Genentech and Roche
for the global co-development and commercialization of Tarceva(TM). We have
entered into a Tripartite Agreement and separate agreements with both Genentech
and Roche with respect to the alliance.

We received upfront fees of $25 million related to this alliance, which was
being recognized evenly over the expected term of our required R&D efforts under
these agreements. We are also entitled to up to $92 million upon the achievement
of certain milestones under the terms of the alliance. As discussed in note
11(g), concurrent with the execution of the alliance agreements, Genentech and
Roche each purchased 462,570 newly-issued shares of our common stock for $35
million ($75.66 per share).

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. 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.

Under the OSI/Genentech agreement, we agreed to collaborate in the product
development of Tarceva(TM) with the goals of obtaining regulatory approval for
commercial marketing and sale in the United States of products resulting from
the collaboration and, subsequently, supporting the commercialization of these
products. 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 are triggered by the
fulfillment of certain conditions; we believe that we have met these conditions
and we are in active discussions with Genentech regarding these rights.
Genentech will pay us certain milestone payments and we will share equally in
the operating profits or losses on products 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/
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

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, that is, until the date that we and
Genentech mutually agree to terminate the collaboration or until either party
exercises early termination rights as described as follows. The OSI/Genentech
agreement is subject to early termination in the event of certain customary
defaults, such as material breach of the agreement and bankruptcy. In addition,
since January 8, 2003, Genentech has had the right to terminate the
OSI/Genentech agreement with six months prior written notice.

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), that is until the date of expiration or revocation
or complete rejection of the last to expire patent covering Tarceva(TM) or, in
countries where there is no valid patent covering Tarceva(TM), on the tenth
anniversary of the first commercial sale of Tarceva(TM) in that country. The
OSI/Roche agreement is subject to early termination in the event of certain
customary defaults, such as material breach of the agreement and bankruptcy. In
addition, since July 31, 2003, Roche has had the right to terminate the
agreement on a country-by-country basis with six months prior written notice.
After such time, we also have had 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.

(b) Anaderm

On April 23, 1996, we formed Anaderm Research Corporation ("Anaderm") with
Pfizer Inc. ("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
received an $8 million wind-down fee in consideration for transferring all
research being performed by us to Anaderm. Of such amount, we received $4.5
million in September 2002 and received $3.5 million in March 2003 after
completion of the transfer. The $4.5 million was recognized as revenue ratably
over the expected term of the transition period and the $3.5 million was
recognized upon the successful completion of the transition. For the years ended
September 30, 2003 and 2002, we recognized $6.2 million and $1.8 million,
respectively, of collaborative program revenues relating to the phase-down.

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YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(c) Tanabe

Effective as of October 1, 1999, we entered into a Collaborative Research
and License Agreement with Tanabe focused on discovering and developing novel
pharmaceutical products to treat diabetes. The contract period under this
agreement expired on October 1, 2003 and was not renewed. Tanabe continues to
maintain responsibility for further development and marketing of a lead compound
in exchange for milestone and royalty payments to us.

(d) Vanderbilt

Effective as of April 28, 1998, we entered into a Collaborative Research,
Option and Alliance Agreement with Vanderbilt University ("Vanderbilt") 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. Upon our collaboration with Tanabe and concurrently with the execution
of the Tanabe agreement, we 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 we conducted
with Vanderbilt ended on the termination of the contract period under the Tanabe
agreement which occurred on October 1, 2003.

We provided funding to Vanderbilt to conduct the OSI/Vanderbilt research
program. A portion of this funding came 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.

(e) Pfizer

In April 1986, we entered into a collaborative research agreement and a
license agreement with Pfizer. We 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 us a royalty if
ultimately commercialized. We continue to have rights in joint technology
developed during the collaboration.

In June 2000, we 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
the 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, we 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 us to make any payments to Pfizer for the license. In January 2001,
we entered into a co-development and marketing partnership with Genentech and
Roche for Tarceva(TM) (see note 5(a)).

(f) Other

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

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YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

Total collaborative program revenues under our collaborative research
agreements are as follows (in thousands):

(6) LICENSE AGREEMENTS

We have entered into various license agreements with third parties to grant
the use of our proprietary assets. These licenses include the use of 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. Licensees may be obligated to pay our 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.

(7) PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

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

We capitalized $3.4 million and $2.7 million of computer software costs as
of September 30, 2003 and 2002, respectively, of which $2.0 million and $980,000
was amortized as of September 30, 2003 and 2002, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(8) INTANGIBLE ASSETS

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

As of September 30, 2002, our intangible assets were $39.1 million,
consisting of $36.5 million of goodwill, $2.1 million of acquired workforce, and
$458,000 for a license to compound libraries. In accordance with SFAS No. 142,
the goodwill has not been amortized as it was acquired in connection with the
acquisition of certain oncology assets from Gilead, which occurred after July 1,
2001. Upon full adoption of SFAS No. 142, acquired workforce no longer meets the
definition of an identifiable intangible asset. As a result, the net balance of
$2.1 million as of September 30, 2002 was reclassified to goodwill. The carrying
amount of goodwill as of September 30, 2003, inclusive of the acquired
workforce, was $38.8 million, which includes a $162,000 effect from foreign
currency exchange rate fluctuations during fiscal 2003.

As of September 30, 2003, our identifiable other intangible assets were
$66.1 million, net of accumulated amortization, consisting primarily of $37.9
million for the rights to market and promote Novantrone(R) and net $28.0 million
for the rights to market and distribute Gelclair(R). As a result of our
acquisition from Serono in March 2003 of the exclusive rights to market and
promote the drug Novantrone(R) for the approved oncology indications in the
United States, we recorded an intangible asset of $46.0 million, which is being
amortized over the remaining 37-month life of the underlying patent (see note
2). In connection with the acquisition of Cell Pathways, we assumed the
exclusive rights to market and distribute Gelclair(R) in North America which
Cell Pathways had acquired from Sinclair in January 2002 for a period of ten
years. We recorded an identifiable intangible asset of $29.0 million which is
being amortized over eight and a half years, the remaining term of the
agreement. These identifiable intangible assets are subject to amortization. We
reassessed the useful life of the license to compound libraries upon the
adoption of SFAS No. 142 to make any necessary amortization period adjustments.
No adjustments resulted from this assessment. Amortization expense for these
intangible assets for the years ended September 30, 2003 and 2002, was $9.3
million and $216,000, respectively. Amortization expense is estimated to be
$18.5 million in fiscal 2004, $18.3 million in fiscal 2005, $11.5 million in
fiscal 2006, $3.4 million in fiscal 2007 and $3.4 million in fiscal 2008.

Under the non-amortization approach, goodwill and intangible assets with
indefinite lives are not amortized into results of operations but instead are
reviewed for impairment, written down, and charged to results of operations in
periods in which the recorded value of goodwill and certain other intangibles is
more than their implied fair value. We completed our impairment review of
goodwill during the first quarter of fiscal 2003 and determined that no
impairment charge was required upon adoption. A reconciliation of previously

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

reported net loss and net loss per share for fiscal 2003, 2002 and 2001 to the
amounts adjusted for the exclusion of acquired workforce and goodwill
amortization is as follows (in thousands except per share data):

Goodwill amortization in fiscal 2001 represented amortization of goodwill
from the acquisition of Aston Molecules Ltd., which was fully amortized as of
September 30, 2001.

(9) ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses at September 30, 2003 and 2002 are
comprised of (in thousands):

(10) CONVERTIBLE SENIOR SUBORDINATED NOTES

(a) 3.25% Convertible Senior Subordinated Notes

On September 8, 2003, we issued $135.0 million aggregate principal amount
of convertible senior subordinated notes (the "2003 Notes") in a private
placement for net proceeds to us of $130.3 million. On September 17, 2003, the
bankers associated with this convertible debt offering exercised an option to
purchase an additional $15.0 million of 2003 Notes, for an additional net
proceeds to us of $14.5 million. The 2003 Notes bear interest at 3.25% per
annum, payable semi-annually, and mature on September 8, 2023. The 2003 Notes
are convertible into shares of our common stock at a conversion price of $50.02
per share, subject to normal and customary adjustments such as stock dividends
or other dilutive transactions. We may redeem the 2003 Notes, in whole or in
part, for cash, at any time after September 8, 2008 for a price equal to 100% of
the principal amount of the 2003 Notes to be redeemed, plus any accrued and
unpaid interest. The holders of the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

2003 Notes have the right to require us to purchase all of the 2003 Notes, or a
portion thereof, on September 8, 2008, September 8, 2013 and September 8, 2018
for a price equal to 100% of the principal amount of the 2003 Notes plus any
accrued and unpaid interest. Upon a change in control, as defined in the
indenture governing the 2003 Notes, the holders of the 2003 Notes will have the
right to require us to purchase all of the 2003 Notes, or a portion thereof, not
previously called for redemption at a purchase price equal to 100% of the
principal amount of the 2003 Notes purchased, plus accrued and unpaid interest.
Upon the election, by the holders, of the right to require us to purchase the
2003 Notes or upon a change of control, we 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 purchase 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 purchase date. The related debt issuance costs
of $5.2 million were deferred and are being amortized on a straight-line basis
over the 20-year term of the 2003 Notes.

With respect to the 2003 Notes, we pledged $14.2 million of U.S. government
securities ("Restricted Investment Securities") with maturities at various dates
through August 2006. Upon maturity, the proceeds of the Restricted Investment
Securities will be sufficient to pay the first six scheduled interest payments
on the 2003 Notes when due. The aggregate fair value and amortized cost of the
Restricted Investment Securities at September 30, 2003 were $14.3 million and
$14.2 million, respectively.

At September 30, 2003, the fair value of the outstanding 2003 Notes was
approximately $147.7 million based on their quoted market value. In connection
with the issuance of the 2003 Notes, we used $19.0 million of the net proceeds
for the purchase of 503,800 shares of our common stock (see note 11(i)).

(b) 4.00% Convertible Senior Subordinated Notes

On February 1, 2002, we issued $200.0 million aggregate principal amount of
convertible senior subordinated notes (the "2002 Notes") in a private placement
for net proceeds to us of $192.9 million. The 2002 Notes bear interest at 4% per
annum, payable semi-annually, and mature on February 1, 2009. The 2002 Notes are
convertible into shares of our common stock at a conversion price of $50 per
share, subject to normal and customary adjustments such as stock dividends. We
may redeem the 2002 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 ("Provisional
Redemption"). Upon any such Provisional 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 2002 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 2002 Notes, the holders of the 2002 Notes will
have the right to require us to repurchase all of the 2002 Notes, or a portion
thereof, not previously called for redemption at a purchase price equal to 100%
of the principal amount of the 2002 Notes purchased, plus accrued and unpaid
interest. We 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 our
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
seven-year term of the 2002 Notes.

With respect to the 2002 Notes, we pledged $22.9 million of 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 2002 Notes
when due. The aggregate fair value and amortized cost of the Restricted
Investment Securities were $13.5 million and $13.4 million, respectively, at
September 30, 2003 and $19.6 million and $19.3 million, respectively, at
September 30, 2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

In August and September 2002, we retired a total of $40.0 million in
principal amount of the 2002 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 2002 Notes retired and accrued
interest, resulted in a net gain on the early retirement of the 2002 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. We early adopted
SFAS No. 145, "Recission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" in fiscal 2002 and as a result, we
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, 2003, the fair value of the outstanding 2002 Notes was
approximately $154.3 million based on their quoted market value.

(11) STOCKHOLDERS' EQUITY

(a) Stock Option Plans

We have established eight stock option plans for our employees, officers,
directors and consultants, including the 2001 Incentive and Non-Qualified Stock
Option Plan and the stock option plan adopted upon the acquisitions of Gilead's
oncology assets in December 2001 (see note 3(b)). 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.

Our Board of Directors adopted the 2001 Incentive and Non-Qualified Stock
Option Plan (the "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 we 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 our directors, officers, employees and consultants of our parent or
subsidiaries. The plan also continues the automatic, formula-based grants of
non-qualified stock options to directors who are not our employees. On December
11, 2002, our Board of Directors approved an amendment to the Stock Option Plan
that only affected the automatic, formula-based grants of non-qualified stock
options to directors who are not our employees. Under the amended formula, each
individual who becomes a director on or after January 1, 2003 will receive an
initial option to purchase 50,000 shares of common stock upon his or her
election to the Board. Persons elected to the Board after June 13, 2001 but
prior to January 1, 2003 were entitled to an initial grant of an option to
purchase 30,000 shares of common stock upon their initial election. All persons
elected to the Board after June 13, 2001 receive annual grants of options to
purchase 7,500 shares upon reelection to the Board. Persons elected to the Board
prior to June 13, 2001 will continue to be eligible, upon reelection to the
Board, 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,

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

options granted to employees of OSI-UK, and options granted to outside directors
during 2003, 2002 and 2001:

At September 30, 2003, we have reserved 7,743,422 shares of our authorized
common stock for all shares issuable under options. At September 30, 2003, 2002
and 2001, the number of options exercisable were 2,757,136, 2,291,689, and
2,147,374, respectively.

Information regarding stock options outstanding as of September 30, 2003,
is as follows:

On August 17, 2000, our Board of Directors granted non-qualified options to
purchase up to 250,000 shares of common stock 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
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 150,000 options resulted in

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

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.

In fiscal 2002 and 2001, we granted options to certain non-employees to
purchase 8,500 and 127,000 shares of common stock, respectively. Such options
vest over a three-year period, based upon future service requirements. We
recorded net deferred compensation of $1,000 and $49,000 based on the fair value
of such options as of September 30, 2003 and 2002, respectively, as determined
using a Black-Scholes option pricing model (see note 1(e) 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. We recorded compensation expense in fiscal 2003 of $47,000 for options
granted in fiscal 2002 and 2001. We recorded compensation expense in fiscal 2002
of $612,000 for options granted in fiscal 2002, 2001 and 2000. We recorded
compensation expense in fiscal 2001 of $1.8 million for options granted in
fiscal 2001, 2000 and 1999.

(b) Shareholder Rights Plan

On September 27, 2000, our 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 our then current
shareholder rights plan. We 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 our outstanding common
stock 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 we merge with, or sell 50% or more of our 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 us
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.

We can redeem the rights at any time before (but not after) a person has
acquired 17.5% or more of our 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

We have 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 our Board of Directors.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(d) Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan under which eligible employees may
contribute up to 10% of their base earnings toward the quarterly purchase of our
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 2003, 2002 and 2001, 26,442, 19,046
and 3,350 shares were issued with 118, 163 and 57 employees participating in the
plan, respectively. At September 30, 2003, we had 582,262 shares of our
authorized common stock reserved in connection with this plan.

We sponsor a stock purchase plan for employees of OSI-UK, our 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 our 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. During fiscal 2003, the maximum shares that may be issued
under this plan was increased from 100,000 shares to 200,000 shares. As of
September 30, 2003, there were 50 employees, 85 employees, and eight employees
in the 2003, 2002 and 2001 stock purchase plans, respectively. At September 30,
2003, we had 156,070 shares of our common stock reserved in connection with this
plan.

(e) Stock Purchase Plan for the Non-Employee Directors

Our Board of Directors approved the adoption of a stock purchase plan for
non-employee directors on June 21, 1995 subject to the stockholders' approval.
On March 25, 1996 at the annual meeting of stockholders the stockholders
approved the Stock Purchase Plan for Non-Employee Directors (the "Stock Purchase
Plan").

On December 11, 2002, our Board of Directors approved an amendment to the
Stock Purchase Plan. Pursuant to the amended Stock Purchase Plan, fifty-percent
of the annual retainer fee earned by each non-employee director will be paid to
the director in the form of a restricted stock award. The restricted stock award
will be made as of each annual stockholder meeting at which directors are
elected beginning with the Annual Meeting of Stockholders which occurred on
March 19, 2003. Annual restricted stock awards will vest in monthly installments
over the one-year term for which the award is made. In the event a director's
membership on the Board terminates prior to the end of such one-year term, any
unvested portion of the director's restricted stock award will be forfeited.
Shares of restricted stock awarded annually may not be sold or transferred by
the director until the first anniversary of the date of grant of such award.
Non-employee directors may elect to receive the remaining fifty-percent of the
director's annual retainer in the form of shares of common stock under the Stock
Purchase Plan as well. At September 30, 2003, we had 69,405 shares of our common
stock reserved in connection with this plan.

(f) Public Offering

On November 6, 2000, we 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), we entered into separate Stock Purchase Agreements on January 8,
2001 with each of Genentech and Roche Holdings for the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

sale to each of 462,570 newly-issued shares of our 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, we issued 924,984 shares of common stock valued at
$40.0 million (see note 3(b)).

(i) Convertible Notes

On September 8, 2003, we issued $135.0 million aggregate principal amount
of convertible senior subordinated notes in a private placement for net proceeds
to us of $130.3 million. On September 17, 2003, the bankers associated with this
convertible debt offering exercised an option to purchase an additional $15.0
million of 2003 Notes, for an additional net proceeds to us of $14.5 million.
The 2003 Notes are convertible into shares of our common stock at a conversion
price of $50.02 per share, subject to normal and customary adjustments such as
stock dividends or other dilutive transactions (see note 10(a)). In connection
with the issuance of the 2003 Notes, we used $19.0 million of the net proceeds
for the purchase of 503,800 shares of our common stock.

On February 1, 2002, we issued $200.0 million aggregate principal amount of
the notes in a private placement. In August and September 2002, we retired a
total of $40.0 million in principal amount of the 2002 Notes for an aggregate
purchase price of approximately $26.2 million. The 2002 Notes are convertible
into shares of our 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 10(b)).

(12) INCOME TAXES

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

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):

Included in our deferred tax assets at September 30, 2003 are approximately
$32 million of net operating loss carry forwards and $29 million of other
temporary differences and research and development tax credit carry forwards
acquired from Cell Pathways that may be subject to significant limitation under
Section 382 of the Internal Revenue Code. Accordingly, all or a portion of the
benefit of these deferred tax assets may not be available to us in the future.
As of September 30, 2003, we have available federal net operating loss carry
forwards of approximately $529 million (of which approximately $95 million
relates to net operating loss carry forwards acquired from Cell Pathways) which
will expire in various years from 2004 to 2023 and may be subject to certain
annual limitations. Our research and development tax credit carry forwards
expire in various years from 2006 to 2023.

Of the $300 million valuation allowance at September 30, 2003, $93 million
relates to deductions for employee stock options for which the tax benefit will
be credited to additional paid in capital if realized.

(13) COMMITMENTS AND CONTINGENCIES

(a) Lease Commitments

We lease office, operating and laboratory space under various lease
agreements.

Rent expense was $7.4 million, $6.2 million and $2.1 million for fiscal
2003, 2002 and 2001, respectively. The rent expense for fiscal 2003 includes the
Oxford, England facility leases (acquired in September 2001), the Boulder,
Colorado facility leases (acquired in December 2001), the Farmingdale, New York
lease

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(commenced in June 2002), the Melville, New York facility lease (commenced in
June 2001), the Uniondale, New York facility lease (commenced in July 1991) and
the Horsham, Pennsylvania facility lease (acquired in June 2003). This was
offset by the termination of the Tarrytown, New York lease (August 2002). From
April 2002 through April 2003, rental payments for the Birmingham, England
facility were charged against the closing cost accrual (see note 17(a)).

The following is a schedule of future minimum rental payments for the next
five fiscal years and thereafter required as of September 30, 2003, assuming
expiration of the leases for the Boulder facilities in October 2006, the
Uniondale facility in June 2006, the Horsham facility in June 2008, the Melville
facility in December 2009, the two Oxford, England facilities in August 2009 and
March 2021, respectively, and the Farmingdale facility in May 2022. Also
included in the amounts below are commitments for equipment under various
operating leases (in thousands).

As of September 30, 2003, we have entered into capital commitments of
$624,000 relating to the purchase of laboratory equipment and compound
libraries.

Deferred rent expense reflected on the accompanying consolidated balance
sheet reflects the expense recorded in excess of the required lease payments in
connection with our facility leases.

(b) Contingencies

Under certain license and 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.

From time to time, we have received letters from other companies and
universities advising us that various products under research and development by
us may be infringing on existing patents of such entities. These matters are
reviewed by management and our outside counsel. Where valid patents of other
parties are found by us 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. Our future royalties, if any, may be reduced by up
to 50% if our licensees or collaborative partners are required to obtain
licenses from third parties whose patent rights are infringed by our products,
technology or operations. In addition, should any infringement claims result in
a patent infringement lawsuit, we could incur substantial costs in defense of
such a suit, which could have a material adverse effect on our business,
financial condition and results of operations, regardless of whether we were
successful in the defense.

(c) Borrowings

As of September 30, 2003, we 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, 2003 or 2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

In connection with the acquisition of certain assets from Gilead in
December 2001 (see note 3(b)), we assumed certain liabilities from Gilead
including loans utilized to finance equipment. The loans had fixed interest
rates ranging from 11.50% to 11.90% and were fully repaid in the third quarter
of fiscal 2003. In connection with the acquisition of Cell Pathways in June 2003
(see note 3(a)), we assumed certain liabilities from Cell Pathways including two
capital leases to finance equipment. The leases have fixed interest rates of
8.20% and 11.00%, respectively, and are due in full by March 2005. Our
wholly-owned subsidiary, OSI-UK, also maintains certain loans to finance
equipment. The loans have interest rates ranging from 11.64% to 15.17% and are
due in full by October 2003. The loan balance as of September 30, 2003 was
$15,000.

(14) RELATED PARTY TRANSACTIONS

One director is a partner in a law firm which represents us on our patent
and license matters. Fees paid to this firm in fiscal 2003, 2002 and 2001 were
approximately $579,000, $504,000, and $546,000, respectively. One director is a
controlling member of Mehta Partners LLC ("Mehta") with which we had a strategic
and financial services arrangement that expired in December 2002. In fiscal 2002
and 2001, we paid Mehta $175,000 per annum for consulting services received. In
addition, we have compensated other directors for services performed pursuant to
consultant arrangements. In fiscal 2003, 2002 and 2001, consulting fees in the
amounts of $150,000, $153,000 and $151,000, respectively, were paid by us
pursuant to these arrangements. A director is an officer of Cold Spring Harbor
Laboratory which was a founder of Helicon. In fiscal 2003, we entered into a
research agreement with Cold Spring Harbor Laboratory. One of our former
executive officers 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. We have a fully reserved investment in
Helicon (note 4(b)). A director is on the faculty of Vanderbilt with which we
had a collaborative research agreement through September 30, 2003, and also has
a consulting agreement with our subsidiary, Prosidion, and is a shareholder of
Prosidion. A director is a non-executive director of Genentech and is an advisor
to Roche, both entities with which we have collaboration agreements.

One of our officers and one of our vice presidents have outstanding loans
with us aggregating $200,000 with a carrying amount of $174,000 as of September
30, 2003. We assumed these loans in connection with the acquisition of certain
assets from Gilead on December 21, 2001.

(15) EMPLOYEE SAVINGS AND INVESTMENT PLAN

We sponsor an Employee Savings and Investment Plan under Section 401(k) of
the Internal Revenue Code. The plan allows our U.S. 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, we will contribute an additional 50 cents into the funds. For fiscal
2003, 2002 and 2001, our expenses related to the plan were approximately
$543,000, $502,000 and $350,000, respectively.

We also sponsor four pension plans covering the employees of OSI-UK. 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. We 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(d)), as well
as certain former employees of British Biotech hired by us 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, we will contribute up to 9% into the funds. We also
sponsor 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

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

invests, we will contribute up to 9% into the funds. For fiscal 2003, 2002, and
2001, our expenses related to the plans were $714,000, $602,000 and $186,000,
respectively.

(16) EMPLOYEE POSTRETIREMENT PLAN

On November 10, 1992, we 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.

We follow 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 2003, 2002 and 2001 includes the
following components (in thousands):

The accrued postretirement benefit cost at September 30, 2003 and 2002 was
as follows (in thousands):

The changes in the accumulated postretirement benefit obligation during
fiscals 2003 and 2002 were as follows (in thousands):

The accumulated postretirement benefit obligation was determined using a
discount rate of 6% and 6.75% in 2003 and 2002, 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. This assumption was not changed in fiscal
2003. Increasing the assumed health care cost trend rates by one percentage
point in each year and holding all other assumptions

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

constant would increase the accumulated postretirement benefit obligation as of
September 30, 2003 by approximately $975,000 and the fiscal 2004 net
postretirement service and interest cost by approximately $247,000. Benefits
paid during fiscal 2003, 2002 and 2001 were $60,000, $60,000 and $127,000,
respectively.

(17) CONSOLIDATION OF FACILITIES

(a) Birmingham

During the fourth quarter of fiscal 2001, we announced the decision to
consolidate our Birmingham, England facility with the newly acquired Oxford,
England facility as a result of the acquisition of the British Biotech assets
(see note 3(d)). The operations at the facility ceased on March 31, 2002 and we
completed closing down the facility in April 2003. 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 was included 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 consisted 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, we 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, we have 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. We 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. We also wrote-off approximately $2.3 million of leasehold
improvements and furniture and equipment which were not relocated to the Oxford
facility. We 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. In March 2003, we entered into a surrender agreement
whereby the landlord released us of our obligations under the remaining facility
leases in consideration for a payment of approximately $662,000. This payment
was made in April 2003. As a result of the terms of the surrender agreement, we
recorded an adjustment to reduce the restructuring reserve by $180,000 during
the second quarter of fiscal 2003. As of September 30, 2003, the plan was
completed and no liability remains. The consolidation activity for the fiscal
year ended September 30, 2003 was as follows (in thousands):

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(b) Tarrytown

During the fourth quarter of fiscal 2001, we announced our strategic
decision to close down our Tarrytown, New York facility and consolidate our
operations into our Farmingdale, New York facility. The operations at the
facility ceased on June 30, 2002 and we 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, we entered into a Termination and Surrender Agreement
with the landlord of the Tarrytown facility whereby we were released from our
obligations under the lease.

The estimated cost of closing this facility as of September 30, 2001 was
$775,000, and has been included 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 consisted of write down of
equipment and leaseholds, which were not relocated, of $384,000, and severance
costs of $391,000.

During fiscal 2002, we 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. We 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. We 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,
the plan was completed and no liability remains.

(18) SALE OF DIAGNOSTICS BUSINESS

On November 30, 1999, we sold assets of our diagnostics business to Bayer
including the assets of our 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, we and OSDI entered
into certain agreements with Bayer including an Assignment and Assumption of
Lease with respect to the OSDI facility located in Cambridge. We recorded a gain
on the sale of approximately $3.7 million during fiscal 2000. Under the terms of
the agreement, we received $9.2 million up-front from Bayer with additional
contingent payments of $1.0 million made to us, and recorded as a gain, in
December 2001.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

(19) QUARTERLY FINANCIAL DATA (UNAUDITED)

The tables below summarize our unaudited quarterly operating results for
fiscal 2003 and 2002.

The basic and diluted net loss 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 per common share for the fiscal year.

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

Not Applicable.

ITEM 9A. CONTROLS AND PROCEDURES

CEO and CFO Certifications. Attached to this Annual Report as Exhibits
31.1 and 31.2, 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 control over financial reporting 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 as of the end of the period covered by 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)-15(e)) under the Securities Exchange Act of 1934, or the Exchange
Act, and report on the effectiveness of the design and operation of our
disclosure controls and procedures. Accordingly, 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 as of the end of the period covered by this Annual Report on Form
10-K.

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 below, our disclosure controls and procedures are effective to provide
reasonable assurance that material information relating to OSI and our
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.

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 control over financial reporting will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. 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.

Changes in Internal Control Over Financial Reporting. There were no
changes in our internal control over financial reporting (as defined in Rule
13(a)-15(f)) under the Exchange Act identified in connection with the evaluation
of such internal control over financial reporting that occurred during the
period covered by this Annual Report on Form 10-K, that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.

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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 2004 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2003.

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 2004 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2003.

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 2004 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2003.

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 2004 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2003.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated by reference to the
similarly named section of our Proxy Statement for our 2004 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2003.

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PART IV

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

(a) (1) The following consolidated financial statements are included 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

(2) All schedules are omitted as the required information is
inapplicable or the information is presented in the financial
statements or related notes.

(3) The exhibits listed in the Index to Exhibits are attached or
incorporated herein by reference and filed as a part of this
report.

(b) Reports on Form 8-K

We filed a current report on August 12, 2003 with the Securities and
Exchange Commission via EDGAR, with respect to a press release regarding our
financial results for the quarter ended June 30, 2003. The earliest event
covered by this report occurred on August 11, 2003.

We filed a current report on September 3, 2003 with the Securities and
Exchange Commission via EDGAR, with respect to a press release regarding the
offering of $135 million in convertible notes. The earliest event covered by
this report occurred on September 2, 2003.

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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.
Chief Executive Officer

Date: December 1, 2003

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.

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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.

95