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, 2004 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, 2004 the aggregate market value of the Registrant's voting
stock held by non-affiliates was $1,140,265,997. 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, 2004 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 December 1, 2004, there were 50,634,509 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 2005 annual
meeting of stockholders are incorporated by reference into Part III of this Form
10-K.

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

i

PART I

ITEM 1. BUSINESS

We are a leading biotechnology company primarily focused on the discovery,
development and commercialization of high quality oncology products that both
extend life and improve the quality-of-life for cancer patients worldwide. Our
flagship product, Tarceva(TM), is an oral, once-a-day, small molecule inhibitor
of the epidermal growth factor receptor, or HER1/EGFR. Tarceva(TM) is the first
EGFR inhibitor, and the first non-chemotherapy agent, to demonstrate a survival
benefit in advanced non-small cell lung cancer, or NSCLC, and also in pancreatic
cancer, two forms of cancer widely recognized as amongst the toughest treatment
challenges facing oncologists. On November 18, 2004, after a review lasting only
three and a half months, the U.S. Food and Drug Administration, or FDA, approved
our New Drug Application, or NDA, for monotherapy Tarceva(TM) use in the
treatment of all NSCLC patients who have failed at least one prior chemotherapy
regimen. We launched Tarceva(TM) on November 22, 2004, the second business day
after approval. We intend to file a supplemental NDA, or sNDA, for the treatment
of front-line pancreatic cancer patients (in combination with gemcitabine) in
2005. In addition, our partner, Roche, has completed a regulatory filing under
the centralized process in the European Union, or EU, for Tarceva(TM) in NSCLC.
Beyond Tarceva(TM), we have a balanced pipeline of oncology drug candidates that
includes signal transduction inhibitors, apoptosis inducers and a
next-generation cytotoxic chemotherapy agent. We market and promote
Novantrone(R) (mitoxantrone concentrate for injection) for approved oncology
indications in the United States, and we market and distribute Gelclair(R), a
bioadherent oral gel for the relief of pain associated with oral mucositis, a
frequent side-effect of chemotherapy, in North America. We also have a diabetes
and obesity subsidiary, Prosidion Limited, which is based in the United Kingdom.
Prosidion's lead clinical candidate, PSN9301, an inhibitor of dipeptidyl
peptidase IV, or DP-IV, is in Phase II clinical trials for the treatment of type
2 diabetes. PSN9301 was acquired by Prosidion from Probiodrug AG in July 2004.
Behind PSN9301, Prosidion has an emerging pipeline of diabetes and obesity drug
candidates.

OUR STRATEGY

Our strategy is to build upon Tarceva(TM)'s significant market potential
and to capitalize on the experienced management team and the comprehensive set
of capabilities from discovery to commercialization that we have established
over the last several years in order to create a premier biotechnology
organization and drive value creation for our stockholders. To accomplish this,
we intend to:

- maximize Tarceva(TM)'s value by supporting an effective launch in the
United States, a timely registration and effective launch in the EU and
Japan, and an effective product growth strategy;

- establish our position as a premier oncology franchise by advancing our
pipeline, reinforcing our commercial presence, validating our research
capabilities and actively pursuing in-licensing and acquisition
opportunities; and

- diversify our business through continued investment in Prosidion to grow
a second business unit focused on diabetes and obesity in order to help
drive long term growth.

Maximize Tarceva(TM)'s value. Our immediate focus is on the timely
registration and launch of Tarceva(TM) in the key global markets of the United
States, the EU and Japan. Our primary indication is NSCLC after failure of at
least one prior chemotherapy regimen; however, we intend to submit an sNDA to
the FDA for the pancreatic cancer indication during 2005. On July 30, 2004, we
filed our NDA for Tarceva(TM) as a monotherapy for the treatment of patients
with advanced NSCLC for whom chemotherapy has failed. Tarceva(TM) was designated
Fast Track status in September 2002 and, in June 2004, Tarceva(TM) was granted
priority review status and Pilot 1 status which required the FDA to initiate a
six-month review of each unit of the submission as it was received, or upon
granting of Pilot 1 status, whichever was later. After a review lasting only
three and a half months, the FDA approved Tarceva(TM) on November 18, 2004, at
which time we and our partner, Genentech, Inc., announced pricing for the United
States. Tarceva(TM) is the first EGFR inhibitor to receive full approval from
the FDA. We launched Tarceva(TM) on November 22, 2004. We anticipate that Roche
will launch Tarceva(TM) for NSCLC in the EU, assuming an approval by the
European Agency for the Evaluation of

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Medicinal Products, or EMEA, in the second half of calendar 2005 and that Chugai
Pharmaceutical Co., Ltd., Roche's subsidiary in Japan, will pursue a timely
registration for NSCLC in Japan.

We have responsibility for manufacturing and supply of Tarceva(TM) in the
United States, and we believe we have a supply chain in place with inventory on
hand to support the launch of the product. While Genentech has primary
responsibility for distribution and commercialization of Tarceva(TM) in the
United States and Roche has responsibility for registration, manufacturing and
commercialization outside of the United States, we are actively engaged in
supporting the activities of our partners in order to successfully launch
Tarceva(TM). We are also co-promoting the product in the United States and field
at least 25% of the combined U.S. sales force.

Our strategy to rapidly grow and expand Tarceva(TM) post-launch has three
main themes:

- Expand the use of Tarceva(TM) to earlier stage NSCLC patients, both in
the front-line and adjuvant settings. We believe that the survival data
from our BR.21 study is similar to the survival data from the recent
Phase III study comparing the cytotoxic chemotherapy agents, Taxotere(R)
and Alimta(R), and the side-effect profile for Tarceva(TM) is
considerably more benign than these cytotoxic chemotherapy agents. The
FDA has approved Tarceva(TM) for use in patients who have failed at least
one prior regimen of chemotherapy, a second-line label comparable to
these cytotoxic chemotherapy agents. To expand on this, we intend to move
directly to registration-oriented studies in both the front-line and
adjuvant settings. As part of our Phase IV agreement with the FDA, we
will be conducting a front-line maintenance trial, which if positive,
would lead to a front-line indication for Tarceva(TM).

- Expand the use of Tarceva(TM) to other oncology disease
settings. Tarceva(TM) is designed to target the HER1/EGFR signaling
pathway. The EGFR gene itself is known to be over-expressed, mutated or
amplified in a significant portion of the approximately 1.3 million new
cases of cancer diagnosed each year in the United States. The positive
results from our pancreatic cancer Phase III trial are an endorsement of
our belief that Tarceva(TM) will have broad utility in a wide variety of
disease settings beyond NSCLC. To date, indications of anti-tumor
activity have been documented in Phase II studies for monotherapy
Tarceva(TM) in bronchioalveolar cell carcinoma, glioblastoma multiforme,
head and neck cancer, hepatocellular carcinoma, breast cancer and ovarian
cancer. We will continue programs to broaden the use of Tarceva(TM) to
additional indications.

- Develop all-targeted therapy combinations of Tarceva(TM) with other
targeted agents, particularly the anti-angiogenic antibody
Avastin(R). Targeted therapies like Tarceva(TM) and Avastin(R) are
designed to deliver a treatment benefit without the significant
toxicities evident with the use of cytotoxic chemotherapy agents. We
believe that combinations of these novel targeted therapies have the
potential to deliver enhanced efficacy without the severe cumulative
toxicities associated with widely used combinations of cytotoxic
chemotherapy. This program is already underway and has revealed promising
indications of activity in single arm Phase II studies, using
combinations of Tarceva(TM) and Avastin(R) in renal cell carcinoma and in
NSCLC patients with adenocarcinoma. We will also explore combinations of
Tarceva(TM) with other oral targeted therapies that offer patients the
important benefits of ease-of-use and convenience in addition to the
potential for enhanced efficacy with more benign side-effects.

To pursue these strategic themes, we will continue to execute, together
with our alliance partners, Genentech and Roche, a development program comprised
of both registration oriented and publication studies designed to expand the
indications and market potential for Tarceva(TM).

Establish our position as a premier oncology franchise. Over the past
several years we have assembled through acquisitions and internal investment the
necessary components of a high quality oncology franchise operating from drug
discovery through commercialization. A key goal for us is to raise awareness of
the value of our franchise by advancing our pipeline, validating our research
and exploiting our broad capabilities to effectively pursue in-licensing,
acquisition and partnering opportunities. We have a diverse pipeline of oncology
drug candidates which includes signal transduction inhibitors, apoptosis
inducers and a next-generation cytotoxic agent. We plan to add to our pipeline
both from our internal research efforts and through third-party transactions,
such as partnering, in-licensing and product acquisitions. We intend to continue
to

2

focus our research efforts on two main areas of cancer drug discovery, namely
the discovery of modulators of signal transduction pathways that either (i)
drive cancer cell proliferation or (ii) prevent apoptosis in cancer cells. In
order to effectively manage the risks inherent in biotechnology research and
development and to complement our internal research efforts, we believe that we
must continue to aggressively manage our pipeline and actively explore
in-licensing and acquisition initiatives. We expect these activities to add to
our pipeline of oncology products and clinical candidates and strengthen our
growing presence in oncology.

We believe that we are also well positioned to enhance our commercial
presence by competing for co-promotion and product acquisition opportunities.
Our marketed products, Novantrone(R) and Gelclair(R), have allowed us to
establish a core commercialization group, which includes approximately 50 sales
representatives and managers. We believe that our commercial group and research
and development capabilities make us a highly attractive partner in oncology.

Diversify our business through continued investment in Prosidion. We
believe that expansion into a second disease area is an important part of our
strategy for long term value creation, and will ultimately be important in
establishing ourselves as a premier biotechnology organization. We, therefore,
consider it important that we continue to invest in our diabetes and obesity
subsidiary, Prosidion, based in Oxford, United Kingdom. To this end, we
announced in July 2004 the acquisition by Prosidion of the type 2 diabetes
clinical candidate, PSN9301, currently in Phase II clinical trials, and its
associated intellectual property estate from Probiodrug AG. PSN9301 is an oral,
small molecule inhibitor of DP-IV, which is recognized as an important target in
diabetes. In addition to composition of matter claims for PSN9301, the acquired
intellectual property estate includes issued U.S. method-of-use claims, covering
the inhibition of DP-IV as a target in diabetes that have been non-exclusively
licensed to Novartis Pharma AG and Merck & Co. Inc., among others, for
milestones and royalties. Prosidion also anticipates initiating clinical trials
for two diabetes candidates, PSN105, a glucokinase activator, and PSN357, a
glycogen phosphorylase inhibitor, in the first half of calendar 2005.

We believe that we have the integrated capabilities and the strength and
depth of management to accomplish our goal of establishing ourselves as a
premier biotechnology company. In the past several years, we have demonstrated a
proven capability to execute complex, large scale development and registration
programs, manage intricate partnerships, execute transactions, integrate
acquisitions, and build new capabilities, such as our commercial group, in a
manner that positions us well for future growth.

TARCEVA(TM)

Tarceva(TM) was discovered jointly by us and Pfizer Inc. in the course of a
long-standing discovery collaboration between us and Pfizer that terminated in
2001. We gained full development and marketing rights to Tarceva(TM) in June
2000, when the U.S. Federal Trade Commission, or FTC, ordered Pfizer to divest
its rights to Tarceva(TM) to us as a result of an antitrust finding upon the
FTC's review of Pfizer's merger with the Warner-Lambert Company.

Tarceva(TM) is an oral, once-a-day, small molecule drug designed to inhibit
the receptor tyrosine kinase activity of the product of the HER1/EGFR gene.
HER1/EGFR is a key component of the HER signaling pathway, which plays a role in
the regulation of growth in many normal cells. EGFR inhibitors were designed to
arrest the growth of tumors (cytostasis); however, under certain circumstances
EGFR inhibition can lead to apoptosis which in turn would result in tumor
shrinkage. The HER1/EGFR gene is over-expressed, mutated or amplified in
approximately 40% to 60% of all cancers and contributes to the abnormal growth
signaling in these cancer cells. A frequently occurring mutation of the
HER1/EGFR gene called EGFRVIII is also found in many tumors, including
glioblastoma multiforme and NSCLC, and recently publications in scientific
literature have associated tumor response in lung cancer patients treated with
EGFR inhibitors with additional newly identified mutations. There is a strong
scientific rationale and a substantial potential market for EGFR inhibitors. We
believe that Tarceva(TM) is likely to have utility in many oncology disease
settings. However, the initial focus of the program has been on NSCLC and
pancreatic cancer since effective treatment of both of these forms of cancer
remains a major unmet need. According to the American Cancer Society, lung
cancer is the leading cause of cancer-related deaths in the United States each
year with an estimated 160,000 deaths in

3

2004. Patients with NSCLC account for approximately 80% of these deaths. The
American Cancer Society also estimates that 31,000 cancer patients in the United
States will die from pancreatic cancer in 2004.

In order to help us accomplish the goals of a registration program focused
on NSCLC and pancreatic cancer and to ensure the optimal competitive positioning
of Tarceva(TM), we entered into a co-development and commercialization alliance
with Genentech and Roche in January 2001. Since the inception of our alliance,
we have implemented a global development strategy for Tarceva(TM) with our
partners. This strategy was a broad-based approach that implemented simultaneous
clinical programs designed to result in a registration with the FDA. This plan
included a single agent Phase III trial for second and third-line NSCLC patients
as well as combination trials with existing cytotoxic chemotherapy regimens for
front-line use in pancreatic cancer and NSCLC. Currently, there are
approximately 100 investigator-sponsored studies and National Cancer
Institute/Cancer Therapy Evaluation Program Studies ongoing or planned in the
Tarceva(TM) program. These studies are exploring monotherapy and combination
uses of Tarceva(TM) in various tumor types, with a variety of treatment
modalities, such as radiation, and in the adjuvant setting.

CLINICAL DATA

NSCLC

In April 2004, we announced that Tarceva(TM) met all its key predetermined
study endpoints (including overall survival, progression-free survival, and
objective tumor response) in a 731-patient randomized, double-blind placebo
controlled Phase III trial, known as the BR.21 study. Tarceva(TM) also delayed
the deterioration of selected lung cancer symptoms in the BR.21 study. The trial
compared Tarceva(TM) to placebo in the treatment of patients with advanced NSCLC
who had previously received one or two prior chemotherapy regimens. Patients
were randomized to the Tarceva(TM) or placebo arm in a 2:1 ratio, respectively.
Approximately 50% of the patients in the study had failed one prior regimen of
chemotherapy and the other half had failed at least two prior regimens. In
addition, a large proportion of the patients entered the study with poor
performance status (25% with performance status 2 and 9% with performance status
3). This international study was conducted by the National Cancer Institute of
Canada's Clinical Trial Group in collaboration with our own clinical development
team.

Patients receiving Tarceva(TM) had a median survival of 6.7 months versus
4.7 months for patients receiving placebo, a 42% improvement. A hazard ratio of
0.73 and a p-value of 0.001 were determined for comparisons of overall survival,
indicating a highly statistically significant treatment benefit. In addition,
31.2% of patients receiving Tarceva(TM) in the study were alive at one year
versus 21.5% in the placebo arm, a 45% improvement. The results of the study
also revealed a treatment benefit in virtually all subsets of patients examined.
A treatment effect (hazard ratio of 1) was seen in males, smokers and patients
with squamous cell carcinoma histology (subsets that, consistent with previous
studies with EGFR inhibitors, had a relatively low rate of tumor response in our
study), as well as in females, non-smokers and patients with adenocarcinoma
histology (subsets with higher rates of tumor response). Recent publications
have shown an association between tumor response and a group of newly identified
EGFR mutations which are clustered in patients who are non-smokers or have
tumors with adenocarcinoma histology. The BR.21 study results clearly show that
tumor response is not always a good surrogate for survival benefit and that the
improvement in overall survival seen in our BR.21 study cannot be explained by
the reported incidence (10%) of these mutations. The patient population was also
unusual in that patients with ECOG performance status 3 were included in the
study.

In the course of following up on the collection of tumor samples from the
BR.21 study, we have been able to determine, to date, the EGFR status of 325 of
the 731 patients in the study. We have determined that 71% of the patients for
whom we have results were found to express EGFR. This group had a hazard ratio
of 0.7 in exploratory analysis. In addition, EGFR negative subsets had hazard
ratios numerically less than one although the confidence intervals are too wide
to draw any definitive conclusions. Moreover, the package insert for Tarceva(TM)
does not contain any restriction related to EGFR status nor does it require any
sort of testing for EGFR status. More importantly, even after considerable
effort we were only able to obtain a sample analysis on 44% of the patients in
the study. We believe this to be representative of clinical practice, where most
patients who will present for Tarceva(TM) treatment will likely have no
available biopsy sample and therefore a

4

tumor of unknown status. In the BR.21 study this group of patients, of unknown
status, had a survival benefit with a hazard ratio of 0.77.

SUMMARY DATA FOR THE TARCEVA(TM) PHASE III STUDY IN SECOND AND THIRD-LINE NSCLC

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

Note: The data is based on our statistical analysis of data from the BR.21
study.

(1) Hazard ratio is a statistical measure of the difference in overall survival
between the study drug group and the control group. A hazard ratio of less
than 1 indicates a reduction in the risk of death; for example, a hazard
ratio of 0.73 represents a 27% reduction in the risk of death and a 37%
improvement in overall survival.

(2) P-value is a statistical measure of significance. A p-value of 0.05
indicates a statistically significant difference.

(3) Data is adjusted for stratification factors prior to randomization.

(4) Objective tumor response rate represents the sum of the percentage of
patients who exhibited a PR or a CR.

In the BR.21 study, the average (or mean) duration of Tarceva(TM) therapy
was slightly more than four months.

The safety profile observed in the BR.21 study was relatively benign
compared to cytotoxic chemotherapy and was consistent with that seen in prior
Tarceva(TM) studies with 75% of patients receiving Tarceva(TM) exhibiting rash
versus 17% in the placebo group and 54% of patients receiving Tarceva(TM)
experiencing diarrhea versus 18% for placebo. Most of these events were mild to
moderate. In this large placebo controlled study, severe pulmonary events,
including potential cases of interstitial lung disease, were rare and generally
equally distributed between the Tarceva(TM) and placebo arms. We believe this
combination of survival benefit with a relatively benign side-effect profile
positions Tarceva(TM) as an important treatment option for oncologists treating
advanced lung cancer patients who have failed front-line chemotherapy.

Pancreatic Cancer

In September 2004, we announced that Tarceva(TM) also met its primary
endpoint of improving overall survival in a 569-patient randomized, double-blind
placebo controlled Phase III trial in front-line pancreatic cancer patients with
locally advanced or metastatic disease. This study was also conducted by the
National Cancer Institute of Canada's Clinical Trial Group in collaboration with
our own clinical development team. The trial compared a combination of
Tarceva(TM) and the chemotherapy agent gemcitabine (the only recently approved
agent for the treatment of pancreatic cancer) with gemcitabine plus placebo. The
data demonstrates a 23.5% improvement in overall survival (a hazard ratio of
0.81 and a p-value of 0.025) for the Tarceva(TM) arm compared to the placebo
arm. Median and projected one-year survival in the Tarceva(TM) plus gemcitabine
arm were 6.4 months and 24%, respectively, compared to 5.9 months and 17%,
respectively, in the gemcitabine plus placebo arm. A statistically significant
improvement in progression-free survival was also observed. A preliminary
analysis of the safety data did not reveal any unexpected safety signals beyond
that seen in the prior use of Tarceva(TM) in both monotherapy and combination
settings. As expected, rash and diarrhea were the principal Tarceva(TM)-related
side effects in the study. The results were noteworthy in that Tarceva(TM) was
used at a lower dose (100 mg) for the majority of patients randomized in the
study (521 patients were randomized to 100 mg per day of Tarceva(TM) or placebo
and 48 patients were randomized to 150 mg per day of Tarceva(TM) or

5

placebo) and Tarceva(TM) was used in combination with a chemotherapy agent. We
believe that the data demonstrates that Tarceva(TM) is likely to have broad
utility beyond the initial lung cancer indication and will also have profound
implications for our understanding of this new class of drugs.

Other Data

Earlier Phase I and Phase II trials of Tarceva(TM) in NSCLC, head and neck
cancer and ovarian cancer demonstrated that the drug possessed activity as a
single agent and was relatively well-tolerated with manageable side-effects,
principally, a reversible rash and generally mild diarrhea. Indications of
anti-tumor activity have been documented in Phase II studies for monotherapy
Tarceva(TM) in bronchioalveolar cell carcinoma, glioblastoma multiforme, breast
cancer and hepatocellular carcinoma. Our Phase III clinical trial program also
included two front-line Phase III combination trials in NSCLC that had been
initiated for business reasons in order for us to be competitive with a similar
clinical trial program with a competitor's EGFR product, 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. These results were
widely anticipated based on the competitor's previously announced failure of
Iressa(R) in this front-line setting in August 2002. The failure of these
combination trials of Tarceva(TM) with chemotherapy in NSCLC are such that
Tarceva(TM) treatment in combination with platinum-based chemotherapy regimens
is not indicated for front-line NSCLC.

Competitive Positioning

The market for NSCLC therapeutics is competitive with multiple treatment
options available in the market today. These therapeutic options include
cytotoxic chemotherapy agents, targeted therapeutics and radiation and surgery.
These available options are often ineffective or have severe side-effects. For
example, front-line combination cytotoxic chemotherapy treatment of NSCLC only
provides a median survival of approximately ten months and is accompanied by
severe side-effects. Patients subsequently also may be treated with cytotoxic
chemotherapy agents, such as Taxotere(R) or Alimta(R), in the second-line
setting. While these agents have previously shown similar survival results to
Tarceva(TM), they exhibit a more severe side-effect profile than those seen in
the Tarceva(TM) trial. Furthermore, only approximately 46,000 people a year
suffering from NSCLC receive second and/or third-line treatments, usually with
limited success, while many other patients either decline treatment or have
treatment withheld due to the side-effects of cytotoxic chemotherapy or a
perception that further treatment would be of limited benefit.

The table below summarizes the results announced within the last 18 months
of three large, randomized, placebo controlled Phase III trials in advanced
NSCLC, consisting of our BR.21 study, a study comparing Taxotere(R) to
Alimta(R), and our study comparing Taxotere(R) plus Aptosyn(R) to Taxotere(R)
plus placebo. The table is presented for comparative purposes only and does not
purport to represent all existing second and third-line NSCLC trials after
failure of initial therapy.

6

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

(1) OSI data from our Phase III study for Aptosyn(R) unblinded on June 11, 2004.

(2) Tarceva(TM) Median Survival in performance status 0-1: 8.2 months

Although Tarceva(TM) has not been tested in a direct head-to-head study
with either Taxotere(R) or Alimta(R), the table shows that Tarceva(TM) produced
similar survival data to Taxotere(R) and Alimta(R) in this comparison of
contemporary studies. This was despite the fact that Tarceva(TM) was tested in a
more advanced patient population, both in terms of number of prior regimens and
overall performance status, which makes the ability to show a survival benefit
in absolute terms more challenging. Tarceva(TM) demonstrated statistically
significant delays in the time-to-symptom deterioration of the key lung cancer
symptoms of cough, dyspnea and pain in the BR.21 study, as well as avoiding the
severe drug related toxicities associated with chemotherapy, such as
neutropenia, thrombocytopenia, neurotoxicity and alopecia. We therefore believe
that Tarceva(TM) will provide oncologists with an attractive option in the
treatment of NSCLC patients who have failed at least one prior chemotherapy
regimen.

Patients may also be treated with another EGFR inhibitor, Iressa(R), which
was recently approved for the third-line setting based on response rate data
only. Iressa(R) has yet to demonstrate a survival benefit. Recent scientific
publications have also identified a subset of NSCLC patients, predominantly
females with tumors that typically have adenocarcinoma histology, who possess
mutations in their EGFR gene. This subset of patients has now been shown to be
responsive to treatment with EGFR targeted agents like Tarceva(TM) and
Iressa(R). Data suggests that patients with lung tumors possessing these
mutations may constitute the majority of patients seen to have a tumor response
when treated with these agents and some investigators have hypothesized that the
clinical benefits observed for EGFR inhibitors may be restricted to patients
whose tumors have these EGFR mutations. However, our BR.21 study clearly shows
that tumor response is not always a good surrogate for survival benefit and that
the improvement in overall survival cannot be explained by the reported
incidence (approximately 10%) of these mutations. For example, patients treated
with Tarceva(TM) in our BR.21 study who had tumors with squamous cell carcinoma
histology had only a 3.8% tumor response rate but a 49% improvement in survival
(hazard ratio 0.67) whereas patients in the study with tumors of adenocarcinoma
histology had a similar improvement in survival of 41% (hazard ratio 0.71) but a
13.9% response rate. Based on this data, we and others believe that patients
that express non-mutant forms of EGFR will also benefit from EGFR treatment at
higher doses of drug even if this is not manifested by high response rates. The
pancreatic cancer trial supports this belief in that a survival benefit was seen
in the study despite the fact that there was no difference in the percentage of
patients achieving a partial response between the Tarceva(TM) plus gemcitabine
arm and the gemcitabine plus placebo arm and that publications in the scientific
literature indicate that the mutations may be largely confined to lung cancer.
Based on published studies, Tarceva(TM) at 150mg/day produces greater drug
exposure in patients' blood than 700mg/day of Iressa(R), which is approved for
use only at 250mg/day. We believe that dose and drug exposure will be

7

important components to the activity of EGFR targeted agents for this larger
second group of patients and that the ability to safely dose these agents at
higher dose levels will be critical to their effective use for these patients.
Tarceva(TM) is currently the only EGFR inhibitor to have demonstrated a survival
benefit in NSCLC patients at a dose accompanied by a relatively mild side-effect
profile.

Antibody products are also under development which target the EGFR pathway
and have demonstrated improved anti-cancer activity when used in conjunction
with existing treatment and chemotherapy regimens. One of these, Erbitux(TM),
has been approved for advanced colorectal cancer in the United States and is
marketed by Bristol-Myers Squibb Company, or BMS, and ImClone Systems
Incorporated for this indication. Erbitux(TM) also recently demonstrated a
survival benefit in combination with radiotherapy in a Phase III study in the
treatment of squamous cell carcinoma of the head and neck. However, to date
clinical studies in lung cancer have yet to demonstrate robust activity for
Erbitux(TM) and it is significantly more expensive than the small molecule
inhibitors. Furthermore, we believe these antibodies may be less likely than the
tyrosine kinase inhibitors to effectively inhibit mutated forms of HER1/EGFR.
Antibody products also require mandatory EGFR testing and also require delivery
via intravenous infusion and are relatively 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 non-mutuant forms of HER1/EGFR, are convenient once-a-day oral
therapies and are relatively easy and inexpensive to manufacture.

REGISTRATION STRATEGY

Tarceva(TM) was granted a Fast Track designation from the FDA in September
2002 for the second and third-line NSCLC indication. In January 2004, we
initiated the rolling submission of our NDA with the FDA for the use of
Tarceva(TM) in this indication. Following the release of the positive results of
the BR.21 study, the FDA informed us that Tarceva(TM) had been granted a
priority review designation and also Pilot 1 status, a new FDA initiative aimed
at reducing drug approval times for agents with Fast Track status. Tarceva(TM)
is among the first group of drugs to be accepted into the new Pilot program. The
Pilot 1 program introduces a six-month review period for each submitted
reviewable unit of the rolling NDA. Unlike the Fast Track designation which does
not require the FDA to begin review of the sections at the time they are
submitted, the Pilot 1 program requires the FDA to complete its review of each
section within six months following the submission of such section, or from the
date of granting of Pilot 1 status, whichever is later. On November 18, 2004
after a review lasting only three and a half months we received FDA full
approval for monotherapy Tarceva(TM)use in the treatment of NSCLC patients who
have failed at least one prior chemotherapy regimen. Tarceva(TM) is the first
EGFR inhibitor to receive full approval from the FDA. In conjunction with the
approval, we have agreed with the FDA to conduct the following post-marketing
clinical studies: (i) a double-blind randomized Phase III study to evaluate the
efficacy of Tarceva(TM) or placebo following four cycles of chemotherapy in
patients with advanced, recurrent or metastatic NSCLC who have not experienced
disease progression or unacceptable toxicity during chemotherapy and (ii) a
randomized Phase III study to evaluate the efficacy of Tarceva(TM) or
chemotherapy (Alimta(R) or Taxotere(R)) following four cycles of chemotherapy in
advanced, recurrent metastatic NSCLC who have experienced disease progression or
unacceptable toxicity during chemotherapy. We launched Tarceva(TM) on November
22, 2004, two business days following approval, shortly prior to which we and
our partner, Genentech, announced pricing for the United States. The NDA was
prepared in the International Committee of Harmonization-approved common
technical dossier format which can facilitate registration in the EU and Japan.
Roche filed the EU application under the centralized process for the NSCLC
indication in the third quarter of calendar 2004 and we anticipate that Roche
will launch Tarceva(TM) in the NSCLC indication in the EU, assuming an approval
by the EMEA, in the second half of calendar 2005 and that Chugai, Roche's
subsidiary in Japan, will pursue a timely registration in Japan. We plan to
discuss the submission of an sNDA for the pancreatic cancer indication with the
FDA and other regulatory agencies in the near future.

OTHER MARKETED PRODUCTS

Novantrone(R). We market and promote Novantrone(R) for approved oncology
indications in the United States and receive commissions from Serono, S.A. on
net oncology sales in this market. Novantrone(R) is an

8

anthracenedione used as an intravenous chemotherapy agent. Novantrone(R) is
approved by the FDA for the treatment of acute non-lymphocytic 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. Novantrone(R) is also used extensively by oncologists
for the treatment of non-Hodgkin's lymphoma which is not an approved indication
in the United States. 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-promotion agreement with Serono to
market the drug for its cancer indications in March 2003. Serono is continuing
to market Novantrone(R) for the multiple sclerosis indication and records all
U.S. sales in all indications. The patent for Novantrone(R) expires in April
2006.

Gelclair(R). We market and distribute Gelclair(R) in the oncology setting
in the United States. Gelclair(R) was cleared for sale as a device by the FDA in
2002. 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.

On October 15, 2004, we announced that it would be necessary to record an
impairment charge related to the intangible asset for exclusive distribution
rights to Gelclair(R). In performing our recoverability test, we determined that
the total of the expected future undiscounted cash flows directly related to the
Gelclair(R) asset was less than the carrying value of the Gelclair(R) asset. As
a result, we determined that an impairment charge of approximately $24.6
million, which represented the full unamortized balance of the Gelclair(R)
intangible asset, was necessary and will be recorded during the quarter ended
September 30, 2004.

The impairment charge is non-cash and will not result in future cash
expenditures. The impairment charge resulted from both the recent discontinuance
of discussions with a replacement dental partner and slower than originally
expected sales growth in the oncology marketplace following the re-launch of the
product in October 2003. In addition to the impairment charge related to the
Gelclair(R) intangible asset, we also recorded a provision for excess inventory
of $8.6 million related to inventory on-hand as well as additional purchase
commitments with Helsinn Healthcare S.A. This excess inventory relates to the
substantial inventory obtained upon acquisition of Cell Pathways and the
required purchase commitments that we assumed in the acquisition and the current
low demand for the product. In late October 2004, we exercised our right to
terminate the agreement with Helsinn. Under the terms of the agreement, Helsinn
has the option to purchase any and all of our inventory at cost plus 5%. If
Helsinn does not elect to purchase our inventory, we are permitted to continue
to sell such inventory. We are currently negotiating a new agreement with
Helsinn.

COMMERCIAL OPERATIONS

We have established a core commercial group of approximately 80 people,
which includes approximately 50 sales representatives and managers covering the
major territories in the United States. All of our sales representatives have
considerable experience in the pharmaceutical industry, and most have ample
experience with oncology products. We intend to market all future products
directly in the United States but we may partner with other pharmaceutical
companies to support our products in territories outside of the United States.

CONSOLIDATION OF OUR ONCOLOGY OPERATIONS

On August 5, 2004, we announced to our employees a plan to consolidate our
U.K. based oncology research and development activities into our New York
locations by November 30, 2004. This decision was based on the need to
prioritize the expansion of our commercial operation infrastructure and increase
our level of investment in both translational research and our diabetes and
obesity subsidiary, Prosidion.

This consolidation has primarily affected our Oxford facility where the
consolidation has resulted in the reduction of our work force by 82 employees.
Following the consolidation, the only operations remaining at the Oxford
facility are those related to our international clinical trials group and
Prosidion.

9

OUR APPROACH TO CANCER THERAPY

Cancer remains a major 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 total
cancer market has been estimated to be $14 to $15 billion and is expected to
grow as new 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.

Our approach to cancer therapy includes three diversified areas in an
attempt to improve the available drug treatment options for cancer patients:
signal transduction inhibitors that target either aberrant cancer cell growth or
the induction of apoptosis in cancer cells that no longer respond to these
tightly regulated processes, and next-generation cytotoxics. The aberrant cancer
cell growth and apoptosis inducer programs are targeted therapy approaches
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. These areas
are the focus of our pre-clinical research efforts. 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.

We have also previously acquired drug candidates in the cytotoxic area
where we believe these new cytotoxic agents represent improvements in activity
or technological innovations over existing drugs. OSI-7904L is a liposomal
formulation of a thymidylate synthase inhibitor, or TSI, a known class of
cytotoxic agents. Liposomal formulations are technological innovations that are
designed either to improve targeting of the cytotoxic agent to the tumor or to
change the exposure profile of the drug molecule, thus improving the therapeutic
index, the drug benefits versus its toxic side-effects.

Our drug discovery efforts in targeted therapies were conducted in
partnership with Pfizer from 1986 to 2001. Tarceva(TM) was jointly discovered as
part of this alliance. Pfizer is continuing to develop three other clinical
stage targeted therapies from this alliance, 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 these
drugs. If Pfizer chooses to discontinue development of any of these drug
candidates, we will have the right to pursue development of them.

10

OUR RESEARCH AND DEVELOPMENT PROGRAMS

Research and Development Pipeline

The chart below summarizes our marketed products and the status of our
research and development pipeline, including Tarceva(TM.)

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

Note: Bars indicate the current stage of development of each program.

(1) Being developed by Pfizer for which we are entitled to royalties if
commercialized and to which we have development rights if Pfizer chooses to
halt development for any reason.

Proprietary Clinical and Pre-Clinical Development Programs

OSI-7904L. OSI-7904L is a liposomal formulation of the TSI, which was
licensed from GlaxoSmithKline plc and acquired by us as part of the acquisition
of Gilead Sciences, Inc.'s oncology business in 2001. TSIs are a class of
cytotoxic chemotherapy agents. 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, continuous infusions of
the drug have shown better activity than more typical intravenous bolus infusion
regimens. The goal of our OSI-7904L program is to mimic this effect with a
single short infusion of the liposomal formulation of our TSI molecule.
OSI-7904L was formulated in liposomes with a goal of extending its
pharmacokinetic, or drug exposure, half-life and improving its therapeutic
index. We are developing OSI-7904L primarily for gastrointestinal tract cancers.
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 the free drug in patients' blood. Our Phase II single-agent study of
OSI-7904L for gastric and gastroesophageal junction cancer in patients who have
received no prior chemotherapy has moved forward to its second stage. The study,
having met the initial requirement of achieving at least three objective
responses in the first 18 evaluable patients has

11

completed accrual of 53 patients in Europe and the United States. The primary
endpoint of this trial is response rate. This open-label, non-randomized study
was initiated in October 2003. We also broadened the OSI-7904L development
program by initiating an additional randomized Phase II study versus 5-FU
infusion in gall bladder/biliary and two additional studies evaluating the use
of OSI-7904L in combination with the chemotherapy agents cisplatin and
oxaliplatin commonly used in the treatment of gastrointestinal malignancies.
Milestone and royalty payments are due to GlaxoSmithKline upon successful
development of this product.

OSI-930. OSI-930 is a tyrosine kinase inhibitor that acts as a potent
co-inhibitor of the receptor tyrosine kinases c-kit and VEGFR, and is designed
to target both cancer cell proliferation and blood vessel growth (angiogenesis)
in selected tumors. It is the first de novo development candidate to emerge from
our discovery research operation since we realigned the focus of our core
business towards oncology research in the fall of 2002. We have continued to
advance OSI-930 through pre-clinical development and anticipate initiating a
clinical program in the first half of calendar 2005. The mutated Kit receptor is
directly involved in tumor progression in the majority of gastrointestinal
stromal tumors and certain leukemias, and over-expressed normal Kit is thought
to play a role in small cell lung cancer. The inhibition of the tyrosine kinase
activity of Kit is expected to result in reduced cancer cell proliferation and
increased cellular apoptosis in tumor types driven by Kit, thus resulting in
inhibition of tumor growth. In addition to inhibiting Kit activity, OSI-930 is
also capable of inhibiting the receptor tyrosine kinase called KDR. KDR, or
vascular endothelial growth factor receptor-2, or VEGFR-2, is present on
endothelial cells and is the key mediator of blood vessel growth in response to
the angiogenic growth factor VEGF. The pathway is believed to be the single most
important mechanism for recruitment of new blood vessels in nearly all solid
tumors; hence, inhibition of this pathway should impact the growth and
metastases of a wide range of angiogenesis-dependent malignancies. While the
combination of Kit and KDR inhibition would be expected to offer the greatest
therapeutic benefit to patients bearing Kit expressing solid tumors, the KDR
component is considered an attractive target for all solid tumors. At this
year's National Cancer Institute/European Organization for Research and
Treatment of Cancer/American Association of Cancer Research meeting we presented
data showing that OSI-930 was able to inhibit the growth of human tumor
xenografts. We believe that OSI-930 may represent a less promiscuous split
kinase inhibitor when compared to other known inhibitors of Kit/KDR driven
tumors and other promiscuous kinase inhibitors in development (such as Pfizer's
SU11248).

SAANDs Platform. The SAANDs platform that we acquired from Cell Pathways,
Inc. in June 2003 consisted of two clinical candidates, Aptosyn(R) and OSI-461,
designed to induce apoptosis through the sustained activation of protein kinase
G, and associated intellectual property. Aptosyn(R), the prototype product was
originally developed by Cell Pathways to treat familial adenomatous polyposis.
Following rejection of an 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) and placebo in second-line NSCLC. The
610-patient trial was based primarily on promising pre-clinical data in
orthotopic rat models, and on June 11, 2004, we announced that this Phase III
trial failed to meet its primary endpoint of improving patient survival.
Survival in the Taxotere(R) plus Aptosyn(R) arm (median survival = 6.9 months;
one-year survival rate = 30.7%) was essentially indistinguishable from survival
in the Taxotere(R) plus placebo arm (median survival = 6.9 months; one-year
survival rate = 29.5%). Since our acquisition of Cell Pathways in June 2003, we
had anticipated a negative outcome for this trial due to the absence of clinical
data for the compound in advanced NSCLC. To date there have been some
indications of activity for Aptosyn(R) in pre-cancerous settings; however, we do
not believe Aptosyn(R) will have utility in advanced cancers and have halted
development of the agent as an anti-cancer drug. Like 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. OSI-461 also has effects on tubulin
and microtubular biology in cells which is a known mechanism of action for other
anti-cancer agents. OSI-461 is more potent than Aptosyn(R) in in-vitro assays
but has proven to be difficult to dose to therapeutic levels in animal models.
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. In February 2004, we expanded an ongoing Phase I dose escalating and
pharmacokinetic trial of OSI-461 in patients with advanced solid tumors. This
study has

12

been amended to allow us to explore the possibility that administering OSI-461
with food may increase drug exposure levels achievable in humans following oral
dosing of OSI-461. Data from this study is expected in the first quarter of
calendar 2005. In July 2002, Cell Pathways also commenced a Phase II trial of
OSI-461 in the non-cancerous area of inflammatory bowel disease at doses we
consider to be sub-optimal. We recently received inconclusive results from this
study which we need to further analyze in order to determine how best to proceed
with this compound in this indication.

ONCOLOGY DISCOVERY RESEARCH

In fiscal 2003, we refocused 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 the discovery of targeted therapies focused on
two core biological processes important in both normal and cancer cell
regulation, namely signal transduction pathways that either (i) drive cancer
cell proliferation or (ii) prevent apoptosis in cancer cells. The dysfunctional
regulation of these two processes is a key element 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. These pathways are thought to be critical
in driving either cancer cell proliferation or in protecting cancer cells from
undergoing apoptosis.

More advanced discovery projects include co-inhibitors of PDK and EGFR and
those targeting IGF-1R inhibitors. Recent studies have indicated that NSCLC
patients who respond to EGFR inhibitors show both loss of EGFR phosphorylation
as well as loss of protein kinase B, or PKB, phosphorylation. PKB, also known as
AKT, is another important regulatory protein on the EGFR signaling axis. In
contrast, NSCLC patients who are not responsive to EGFR inhibitors, show a loss
of EGFR phosphorylation, but do not show the same degree of reduction in PKB
phosphorylation to that observed in the responding patients. This data suggests
that the PKB/AKT pathway is activated in an EGFR independent fashion in the
non-responding NSCLC patients. Similar data has been observed in NSCLC cell
lines as well as in other tumor types. We believe the PKB activation is
dependent upon phosphorylation by phosphoinositide-dependent kinase-1, or PDK-1.
PDK-1 is a serine/threonine kinase ubiquitously expressed in human tissues. We
have postulated that a dual PDK-1/EGFR inhibitor would be expected to have a
broader range of antitumor activity in NSCLC patients when compared with a
selective EGFR inhibitor, such as Tarceva(TM), and have an ongoing drug
discovery project designed to identify a dual inhibitor of PDK-1 and EGFR.

IGF-1R is a receptor tyrosine kinase that stimulates proliferation, enables
oncogenic transformation, and suppresses apoptosis. It is an excellent strategic
fit within our core strategy. Inhibitors of IGF-1R are expected to have broad
utility in oncology since the over-expression of IGF-IR and/or its ligands
(IGF-I and IGF-II) or the down-regulation of ligand binding proteins, or IGFBP,
occurs in numerous human malignancies including lung, colon, breast, prostate,
brain and skin cancers. Correlations with increased risk and poor prognosis have
been established. In addition, signaling through the IGF system has also been
implicated in protecting tumor cells from apoptosis induced by a number of
anti-cancer treatments such as EGFR inhibitors (e.g., Tarceva(TM), the
anti-HER2/erbB2 antibody Herceptin(R)) and cytotoxic agents. To be competitive
in the IGF-1R space, we have initiated a research collaboration that uses
structure based design as an enabling technology to identify proprietary IGF-1R
inhibitors for us. The collaboration has significantly improved our
understanding of the structure activity relationship within our lead chemical
series and we anticipate identifying a development candidate in the first
quarter of calendar 2005. We believe that an IGF-1R inhibitor should be useful
both as a single agent, and in the potentiation of other molecularly targeted
therapeutic agents and cytotoxic agents.

Our approach to discovering drugs 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) signal
transduction, protein kinases, gene transcription and other assay systems, (ii)
automated high throughput screening, (iii) an extensive library of proprietary
small
13

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 117 scientists in our pre-clinical research
activities.

In order to be competitive in the oncology drug discovery field we have
endeavored to build a network of alliances designed to fill gaps in our
expertise as well as enhance our existing understanding of the drug discovery
process. This is based upon a philosophy that we should access complementary
technology and expertise on the outside where and when this is appropriate. We
have made external investments in three key areas: (i) target identification and
validation, (ii) lead optimization, and (iii) surrogate biomarkers translational
research.

Target Identification and Validation

Early in fiscal 2003 we established a research collaboration with Cold
Spring Harbor Laboratory to utilize RNA interference to identify and validate
new drug targets. Cold Spring Harbor Laboratory has a patent application
covering the use of viral delivery of RNA hairpins into cells. An extensive gene
library has been generated with the expectation that the size of this library
will cover the entire genome. The entire gene library will be screened against
genetically defined cancer cell lines and will identify those specific gene
products that may modulate apoptosis and/or drive tumor cell proliferation.
Additional research within OSI will help define potential drug targets.

We also initiated a research collaboration with EiRX Therapeutics plc of
Cork, Ireland in June 2003. Using appropriate growth factors and reagents, EiRX
is able to manipulate and test the apoptosis process in primary cells associated
with normal and disease conditions. EiRX has been able to demonstrate that
several of the genes they have identified are present in cancer cells, and are
functional in blocking cell death. We entered into our agreement with EiRX to
evaluate a set of 12 genes, whose use as cancer targets is covered within a
filed patent application. We have selected four new targets for entry into our
drug discovery efforts.

Lead Optimization

We have approached lead optimization in two ways. First, we have enhanced
the quality of our chemical library through two major deals in the last year. We
have acquired 130,000 new compounds from Array BioPharma, Inc. which are of high
purity, are well characterized and are considered highly "drug-like." Second, we
became a subscriber to a library of structures available from Albany Molecular
Research, Inc. representing a variety of chemical building blocks. These
transactions have improved the diversity of our chemical library and, as a
result, we are confident that our high throughput screening efforts are more
likely to identify promising drug-like leads for our ongoing project teams.

We have also enhanced our capabilities in lead optimization through
investments in structure based drug design. We have an ongoing alliance with
Structural Genomix, Inc., or SGX, in which SGX will provide and will continue to
provide crystal structures of up to 12 of our drug targets over a collaboration
period ending February 1, 2005, unless extended. SGX has received milestone
payments for successfully co-crystallizing target with inhibitor. To date, we
have made significant progress in a number of our projects and we view this
collaboration as being a successful entry for OSI into the field of structure
based drug design.

Surrogate Biomarkers and Translational Research

The optimal clinical development of novel targeted therapies requires
assays and reagents (surrogate markers) that are capable of identifying whether
a specific patient tumor will respond to the therapy under investigation. Going
forward, we intend to invest in this area in order to:

- identify surrogate biomarkers that predict cellular sensitivity and tumor
response to OSI compounds of interest; and

- determine the pathways that are influenced/impacted through RNA
interference of select OSI drug targets.

14

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 will enable and support our
future clinical development. This process ensures that our lead compounds have
retained their anticipated mechanism of action in vivo.

Translational research is designed to bridge our research knowledge base
into the clinic and the marketplace. The current emphasis of our translational
research programs is on Tarceva(TM) and a series of collaborations and studies
are ongoing (including, for example, our Phase II dose-to-rash study in NSCLC)
designed to improve our understanding of how best to use Tarceva(TM) clinically.

ONCOLOGY DRUG DEVELOPMENT

After identifying a suitable drug candidate, a molecule is advanced toward
clinical trials and enters the investigational new drug, or IND, track phase, in
which toxicological, scale-up synthesis and clinical development strategy are
addressed. The IND track phase typically takes up to one year. An IND
application is reviewed by the FDA or its foreign equivalent prior to the
commencement of clinical studies. A drug is typically first assessed for its
safety and pharmacokinetic properties. 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 101 physicians, scientists and clinical
operations 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 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

We currently rely on third-party manufacturers to manufacture all of our
marketed products and late stage product candidates. Under our collaboration
agreement with Genentech, we are responsible for the manufacture and supply of
erlotinib, the active pharmaceutical ingredient, or API, and Tarceva(TM) tablets
for pre-clinical and clinical trials and for the supply of commercial quantities
of Tarceva(TM) tablets for sales within the United States. We entered into a
Manufacturing and Supply Agreement with Genentech, effective as of June 4, 2004,
to define each party's rights and responsibilities in connection with such
supply. Under our collaboration agreement with Roche, Roche has elected to take
responsibility for the supply of tablets for sales outside of the United States.

Erlotinib is manufactured in a three-step process with high yield. Sumitomo
Chemical Co., Ltd. (formerly known as Sumika Fine Chemicals Co. Ltd.) and
Dinamite Dipharma S.p.A are our manufacturers of erlotinib used for commercial
supplies. Both of these manufacturers have manufactured API for Tarceva(TM)
clinical trials. We contracted with Schwarz Pharma AG to manufacture Tarceva(TM)
tablets and placebo product for clinical supplies and are engaging Schwarz to
manufacture Tarceva(TM) tablets for commercial supplies. We are also evaluating
the capability of another manufacturer to serve as an alternative (i.e., back-
up) provider of Tarceva(TM) tablets. Clinical supplies of Tarceva(TM) tablets
are currently stored, labeled, packaged and distributed by Cardinal Health
Clinical Services, and we are engaging Cardinal Health Packaging Services for
labeling and secondary packaging services for commercial supplies of Tarceva(TM)
tablets before their subsequent distribution to Genentech or a storage facility
designated by Genentech. We expect to enter into long term supply agreements
with our API and tablet manufacturers. All manufacturers of erlotinib and
Tarceva(TM) tablets are required to comply with current good manufacturing
practices. We have produced sufficient quantities of Tarceva(TM) tablets to
conduct our ongoing clinical trials, and we believe we have a supply chain in
place with inventory on hand to support launch.

15

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 are held by Helsinn.

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 drug product. We have
transitioned the manufacture of the API to new manufacturers. Gilead will
produce for us liposomal formulations of OSI-7904L at its manufacturing facility
in San Dimas, California to support our ongoing clinical trial activities.

PROSIDION

In 2002, we made the decision to focus our initial research and development
efforts into the oncology area and to either shut down or divest research
programs in other areas with the exception of our research assets in the
diabetes and obesity arena. These programs were transferred to a newly created
U.K. based subsidiary, Prosidion, in January 2003. Prosidion is registered in
England and Wales under registered number 4600121 and is a majority-owned
subsidiary.

As part of the formation of Prosidion, we transferred and/or licensed our
diabetes assets to Prosidion and we also transferred our employees who were
focusing on diabetes research. In 2003, we hired Anker Lundemose, M.D., Ph.D. as
Chief Executive Officer of Prosidion, established a separate board of directors
and committed approximately $10 million in funding to support Prosidion's
operations. In August 2003, Prosidion completed a transaction with H. Lundbeck
A/S's subsidiary, Synaptic Pharmaceutical Corporation, to license co-exclusive
rights to a novel G-protein coupled receptor, or GPCR, target for the treatment
of diabetes and obesity. In March 2004, Prosidion signed an agreement with
Tanabe Seiyaku Co., Ltd. in order to obtain U.S. and European rights to the
OSI/Tanabe joint technology in glucokinase activators and to gain freedom to
operate in all other areas previously covered by the OSI/Tanabe alliance. Both
Tanabe and Synaptic are minority shareholders of Prosidion as a result of these
transactions.

On July 26, 2004, Prosidion acquired a platform of DP-IV technology from
Probiodrug for approximately $35 million in cash plus future milestones. The
milestone payments are payable upon the successful development of PSN9301, the
lead DP-IV inhibitor acquired from Probiodrug, which is in Phase II clinical
trials for the treatment of type 2 diabetes. These milestone payments are
payable in January 2007 and/or January 2010, or on such earlier dates upon which
the criteria are met unless the development of PSN9301 is terminated prior to
such dates due to safety, efficacy or regulatory issues in which event the
obligation to make the milestone payments will lapse. Probiodrug, based in Halle
(Saale), Germany, had pioneered much of the research and development that has
led to the characterization of DP-IV as one of the most important targets in
diabetes drug development today. Included in the assets acquired by Prosidion is
a portfolio of medical use patents around the target. This portfolio includes
issued and pending patents with claims covering DP-IV as a target for
anti-diabetic therapy and licensed rights to patent applications claiming
combinations of DP-IV inhibitors with other oral anti-diabetes drugs such as
Metformin(TM). Merck, Novartis and Ferring B.V. are all non-exclusive licensees
to the estate. Future potential milestones and royalties arising from this
intellectual property have been transferred to Prosidion. Prosidion also entered
into a research agreement with Probiodrug under which Prosidion will provide
funding of certain research aimed at discovering backup compounds to PSN9301 and
discovering the potential therapeutic use of the related target
glucose-dependent insulinotropic peptide receptor in metabolic diseases.

DP-IV cleaves and inactivates GLP-1, an important mediator of blood glucose
levels. Inhibition of DP-IV leads to prolonged GLP-1 activity and inhibitors of
DP-IV have demonstrated significant effects on mean blood glucose and
post-prandial blood glucose and HbA(1C) levels, a reference marker widely used
in the monitoring of diabetes patients, in pre-clinical and clinical trials. The
field is competitive with the Novartis DP-IV inhibitor, LAF237, currently in
Phase III trials and compounds from Merck and BMS are entering Phase III trials.
PSN9301 is an orally active, competitive inhibitor of DP-IV that is designed as
a shorter acting inhibitor. PSN9301 has been shown to lower glucose in type 2
diabetics in early clinical trials.

16

In addition to PSN9301, Prosidion has two molecules in the late stages of
pre-clinical development which are scheduled to enter clinical trials in the
first half of calendar 2005. PSN105 is an oral, small molecule activator of
glucokinase and PSN357 is an oral, small molecule inhibitor of glycogen
phosphorylase. Both glucokinase and glycogen phosphorylase are targets for
therapeutic intervention in diabetes. The molecules have demonstrated efficacy
in animal models and successfully completed acute toxicological profiling.

In April 2004, we announced that our board of directors approved an
investment of up to an additional $40 million in Prosidion. The first
installment of $10 million was invested at a cost of $10 per share. In order to
finance the Probiodrug transaction and fund the current ongoing research and
development efforts at Prosidion, we increased our investment commitment in
Prosidion. Following the closing of the Probiodrug acquisition and our increased
investment in Prosidion to finance the transaction, our ownership of Prosidion
increased to approximately 97%.

ROCHE AND GENENTECH ALLIANCE

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 a portion of which have been received. We have entered
into separate agreements with both Genentech and Roche with respect to the
alliance, as well as a Tripartite Agreement.

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) 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 collaboration agreement or the OSI/
Roche agreement terminates.

Under the OSI/Genentech collaboration 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 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 own and filed, and the first
supplemental NDA, which we 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 under the OSI/Genentech collaboration
agreement which were defined in an amendment to the agreement effective as of
June 4, 2004. Pursuant to this amendment, we co-promote Tarceva(TM) using a
sales force that is equal to or greater than 25% of the combined OSI/Genentech
sales force. We will share equally in the operating profits or losses on
products resulting from the collaboration. Under the OSI/Genentech collaboration
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

17

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.

In connection with our collaboration with Genentech, Genentech will
recognize all U.S. sales of Tarceva(TM). We will recognize revenues from our
alliance with Genentech, which will consist of our share of the pretax profits
(loss) generated from the sales of Tarceva(TM) in the United States. We also
will recognize manufacturing revenue from the sale of inventory to Genentech for
commercial sales of Tarceva(TM) in the United States, partial reimbursement from
Genentech of our Tarceva(TM) -related commercial expenses. We will receive
royalties on sales of Tarceva(TM) outside of the United States by Roche and up
to $92 million in non-refundable milestone payments from Genentech and Roche,
upon the achievement of certain milestones relating to regulatory submissions
and approval, certain of which have already been received.

The OSI/Genentech collaboration 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 its early termination rights. The
OSI/Genentech collaboration agreement is subject to early termination in the
event of certain customary defaults, such as material breach of the agreement
and bankruptcy. The provisions of the amendment allowing us to co-promote are
also subject to termination by Genentech upon a material breach by us of the
amendment which remains uncured or upon a pattern of nonmaterial breaches which
remains uncured. In addition, since January 8, 2003, Genentech has had the right
to terminate the OSI/Genentech collaboration agreement with six months' prior
written notice.

Effective June 4, 2004, we entered into a Manufacturing and Supply
Agreement with Genentech that defined each party's responsibilities with respect
to the manufacture and supply of clinical and commercial quantities of
Tarceva(TM). Under certain circumstances, if we fail to supply such clinical and
commercial quantities, Genentech has the right, but not the obligation, to
assume responsibility for such supply. The Manufacturing and Supply Agreement
will terminate upon the termination of the OSI/Genentech collaboration
agreement.

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) worldwide, other than the territories covered by the
OSI/Genentech collaboration 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 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 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.

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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% to 30% of all women with metastatic breast cancer
over-express HER2/erbB2.

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, Europe, Japan, and 20 other countries
cover composition of matter for erlotinib (the API for Tarceva(TM)), processes
for its preparation, and pharmaceutical compositions containing erlotinib. These
patents expire in 2015. Patent applications are being pursued, seeking
protection in and outside the United States, for polymorphic, anhydrous,
hydrate, and certain salt forms of erlotinib, as well as for processes and
important intermediate chemicals in the manufacture of erlotinib. The
polymorphic patent, when it issues, should provide patent exclusivity for
erlotinib through 2020. Further, patent protection for methods of use of
Tarceva(TM) are being sought.

Patents directed to the OSI-7904L compound have issued in the United
States, Japan, and Europe. Patent protection is also being sought, with a
composition of matter and method-of-use patent issuing earlier this year in the
United States, for liposomal formulations of OSI-7904L. From our acquisition of
Cell Pathways, we have a patent estate to methods of identifying compounds that
participate in a specific apoptotic pathway. Aptosyn(R) and OSI-461 are each
covered by U.S. and foreign patents to methods of treatment using the compounds.
We have rights to a U.S. patent covering a method-of-use of Novantrone(R) for
solid tumors, expiring April 11, 2006. A patent application has been allowed in
the United States covering the composition of Gelclair(R).

We have assembled a strong gene transcription patent portfolio and 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 Corporation, R.W.
Johnson Pharmaceutical Research Institute, Wyeth, BASF Corporation and Merck. We
also have non-exclusive licenses from Cadus Corporation (seven U.S. patents and
additional U.S. and foreign applications) and Wyeth (four U.S. patents and
additional foreign applications) to a portfolio of patents and applications
covering yeast cells engineered to express heterologous GPCRs and G-protein
polypeptides, methods of use thereof in screening assays, and DNAs encoding
biologically active yeast-mammalian hybrid GPCRs.

Prosidion has acquired rights to U.S. patents and foreign patents and
patent applications covering methods of treatment of diabetes through the
administration of a DP-IV inhibitor, as well as patents and patent applications
covering composition of matter for specific small molecule DP-IV inhibitors
including the clinical candidate PSN9301, which is in Phase II clinical trials,
as part of its asset acquisition from Probiodrug. Merck and Novartis, among
others, have taken licenses to some of these method-of-use patents

19

and patent applications, from which Prosidion may accrue certain milestone
payments and royalties. One of these patents has been challenged in Europe and,
in May 2004, in a ruling by the European Patent Office in Munich, one of the
DP-IV method-of-use patents was revoked. Prosidion has appealed this decision.

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 in oncology and diabetes, 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 and larger overall research and development staff and facilities than
we do in drug research and development, regulatory affairs 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. At least three competitors,
AstraZeneca plc, BMS/ImClone/Merck KGaA and Amgen/Abgenix, Inc., also have
substantial clinical development programs for the same target as our flagship
product, Tarceva(TM). AstraZeneca has received approval for its anti-EGFR, small
molecule drug in the United States (accelerated approval, contingent studies
required by FDA), Switzerland, Japan and other territories. However,
AstraZeneca's drug has not yet demonstrated a survival benefit. AstraZeneca has
recently announced that the survival data from their ongoing Iressa(R) study
will be available by the end of the year. BMS/ImClone/Merck KGaA's anti-EGFR
antibody, Erbitux(TM), has been approved (as single agent or in combination with
irinotecan) in the United States and in the EU and Switzerland for the treatment
of metastatic colon carcinoma in patients who are refractory or have developed
intolerance to irinotecan based chemotherapy. In addition to agents that target
EGFR, Taxotere(R) and Alimta(R) are chemotherapy agents that are approved for
use in second-line NSCLC. Taxotere(R) and Alimta(R) are manufactured and
distributed by Aventis and Eli Lilly and Company, respectively.

With the acquisition of the co-promotion rights 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), which
the FDA approved for use in combination with prednisone in May 2004 for HRPC
based on a survival benefit for Taxotere(R)-based regimens compared to the
better tolerated Novantrone(R) plus prednisone. 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), marketed by Genentech/IDEC Pharmaceuticals, Inc., 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 the relief of pain associated
with oral mucositis. Key competitors include a myriad of products often blended
in the dispensing pharmacy, none of which have been specifically approved for
this indication, such as Xylocaine(R), Benadryl(R) Elixir(R), Carafate(R),
Orabase(R), and over-the-counter and prescription analgesics.

OSI-7904L, our next-generation cytotoxic drug candidate, is designed to
improve upon products of similar mechanism already in the market and available
generically. We must therefore clearly differentiate the activity or safety of
our molecule if we are to successfully register this drug and compete in the
marketplace.

20

OSI-7904L, which is currently in Phase II trials, is a TSI designed to compete
with generic 5-FU, as well as Xeloda(R) by Roche, an oral TSI.

Companies with related research and development activities also present
significant competition for us. 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.

With respect to Prosidion's drug discovery and development programs for
diabetes and obesity, 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. At
least three competitors, Merck, Novartis and BMS, have advanced clinical
development programs directly competitive with Prosidion's lead clinical
candidate, PSN9301, an inhibitor of DP-IV for treating diabetes which is in
Phase II clinical trials. DP-IV inhibitors are designed to prevent cleaving and
inactivation of GLP-1, an important mediator of blood glucose levels. There are
no DP-IV inhibitors that are currently marketed, although Amylin
Pharmaceuticals, Inc. has filed an application with the FDA to market a GLP-1
product, Exenatide(TM), for the treatment of diabetes. Prosidion must therefore
clearly distinguish the profile of PSN9301 if we are to successfully register
this product and compete in the marketplace. Prosidion's other clinical
candidates for diabetes, a glucokinase activator, PSN105, and a glycogen
phosphorylase inhibitor, PSN357, are currently in late pre-clinical development
and anticipated to enter clinical development in the first half of calendar
2005. At least two competitors, Roche and Pfizer, have, at various times,
announced similar research and development activities.

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 on a profitable basis.

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, quality, labeling, distribution,
marketing, export, storage, record keeping, advertising and promotion of
pharmaceutical and diagnostic products.

The FDA Process

The process required by the FDA before a new drug (pharmaceutical product)
or a new route of administration of a pharmaceutical product 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);

- FDA compliance inspection and/or clearance of all manufacturers;

21

- 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, 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, the EU 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 an 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.

There is an NDA review process referred to as the Fast Track program which
is designed to expedite the approval of new drugs that are intended to treat
serious or life-threatening conditions and that demonstrate the potential to
address unmet medical needs. Applicants that meet the relevant acceptance
criteria may receive Fast Track designation. The benefits of a Fast Track
designation include the ability to schedule meetings to seek FDA input into
development plans, the option of submitting an NDA in sections on a rolling
basis rather than submitting all components simultaneously, and the option of
requesting evaluation of studies using surrogate endpoints (accelerated
approval). Tarceva(TM) was granted a Fast Track designation for the advanced
NSCLC indication.

In addition, the FDA has recently instituted a new trial program, the Pilot
1 program, which provides for the review of a limited number of pre-submitted
portions, or reviewable units, of an applicant's marketing

22

application before submitting the complete application. The Pilot 1 program only
applies to certain new drug or biological products that have received Fast Track
designation, have been the subject of an end-of-Phase II and/or a pre-NDA
meeting, and have demonstrated significant promise as a therapeutic advance in
clinical trials. As part of the Pilot 1 program, the FDA agrees to complete
reviews of an applicant's reviewable units within six months of the date of the
submission of such reviewable unit or from granting of Pilot 1 status, whichever
is later, and to provide early feedback in the form of information requests and
discipline review letters. Tarceva(TM) was granted Pilot 1 status and is one of
the first drugs to be entered into the program.

Among the conditions for NDA approval is the requirement that the
prospective manufacturer's procedures conform to current good manufacturing
practices, 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, among other things, compliance with current good manufacturing
practices. To supply products for use in the United States, foreign
manufacturing establishments also must comply with current good manufacturing
practices and are subject to periodic inspection by the FDA or by regulatory
authorities in certain countries under reciprocal agreements with the FDA.

An sNDA is a submission to an existing NDA that provides for changes to the
NDA and therefore requires FDA approval. Changes to the NDA that require FDA
approval are the subject of either the active ingredients, the drug product
and/or the labeling. A supplement is required to fully describe the change.
There are two types of sNDAs depending on the content and extent of the change.
These two types are (i) supplements requiring FDA approval before the change is
made and (ii) supplements for changes that may be made before FDA approval.
Supplements to the labeling that change the Indication Section require prior FDA
approval before the change can be made to the labeling, e.g. a new indication.

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

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. For example, sales,
marketing and scientific/educational grant programs must comply with the
Medicare-Medicaid Anti-Fraud and Abuse Act, as amended, the False Claims Act,
also as amended, the privacy provisions of the Health Insurance Portability and
Accountability Act, and similar state laws. Pricing and rebate programs must
comply with the Medicaid rebate requirements of the Omnibus Budget
Reconciliation Act of 1990, as amended, and the Medicare Prescription Drug
Improvement and Modernization Act of 2003. If products are made available to
authorized users of the Federal Supply Schedule of the General Services
administration, additional laws and requirements may apply. All of these
activities are also potentially subject to federal and state consumer protection
and unfair competition laws. In addition, our research and development
activities involve the controlled use of hazardous materials, chemicals and
various radioactive compounds the handling and disposal of which are governed by
various state and federal regulations.

In addition to regulations in the United States, we are subject to various
foreign regulations governing clinical trials and the commercial sales and
distribution of our products, including Tarceva(TM.) We must obtain approval of
a product by the comparable regulatory authorities of foreign countries before
we can commence clinical trials or marketing of the product in those countries.
The requirements governing the conduct of

23

clinical trials, product licensing, pricing and reimbursement and the regulatory
approval process all vary greatly from country to country. Additionally, the
time it takes to complete the approval process in foreign countries may be
longer or shorter than that required for FDA approval. Foreign regulatory
approvals of our products are necessary whether or not we obtain FDA approval
for such products. Finally, 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.

Under European Union regulatory systems, we are permitted to submit
marketing authorizations under either a centralized or decentralized procedure.
The centralized procedure provides for the grant of a single marketing
authorization that is valid for all member states of the European Union. The
decentralized procedure provides for mutual recognition of national approval
decisions by permitting the holder of a national marketing authorization to
submit an application to the remaining member states. Within 90 days of
receiving the applications and assessment report, each member state must decide
whether to recognize approval.

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 December 1, 2004, we, including Prosidion, have 452 employees worldwide,
363 of whom are in the United States. Of the 452 employees, 154 are primarily
involved in research activities, 105 are primarily involved in development and
manufacturing activities, 81 are primarily involved 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, we intend to
add personnel with specialized 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.

24

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.

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

We have had net operating losses since our inception in 1983. We expect to
continue to incur operating losses over the next several years as a result of
our expenses for the continued development of Tarceva(TM) and our other clinical
products and research programs and the expansion of our commercial operations.
We cannot predict when our business will become profitable. We do not expect to
achieve profitability for at least three years following the launch of
Tarceva(TM).

At September 30, 2004, our accumulated deficit was $766.0 million. Our net
losses were $260.4 million, $181.4 million and $218.5 million for fiscal years
2004, 2003 and 2002, respectively. Our net loss for fiscal 2004 included an
in-process research and development charge of $32.8 million related to the
acquisition of certain assets from Probiodrug AG in July 2004 and a charge of
$24.6 million related to an impairment of an intangible asset. Our 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. Our net
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.

WE, TOGETHER WITH OUR ALLIANCE PARTNERS GENENTECH, INC. AND ROCHE, MAY NOT BE
ABLE TO MARKET OR GENERATE SALES OF TARCEVA(TM) TO THE EXTENT ANTICIPATED.

Our ability to successfully penetrate the market and generate sales of
Tarceva(TM) may be limited by a number of factors, including the following:

- Certain of our competitors in the HER1/EGFR field, namely AstraZeneca plc
and Bristol-Myers Squibb Company/ImClone Systems Incorporated, have
already received regulatory approvals for and have begun marketing
similar products in the United States, the EU, Japan and other
territories, which may result in greater physician awareness of their
products as compared to Tarceva(TM).

- Information from our competitors or the academic community indicating
that current products or new products are more effective than Tarceva(TM)
could, if and when it is generated, impede our market penetration or
decrease our existing market share.

- Physicians may be reluctant to switch from existing treatment methods,
including traditional chemotherapy agents, to Tarceva(TM).

- The price for Tarceva(TM), which is set by Genentech in the United States
after consultation with us and will be set by Roche outside of the United
States, as well as pricing decisions by our competitors, may have an
effect on our Tarceva(TM)-derived revenues.

25

- Our Tarceva(TM)-derived revenues may diminish if third-party payors,
including private health coverage insurers and health maintenance
organizations, do not provide adequate coverage or reimbursement for
Tarceva(TM).

IF GOVERNMENT AGENCIES DO NOT GRANT US OR OUR COLLABORATIVE PARTNERS REQUIRED
APPROVALS FOR ANY OF OUR POTENTIAL PRODUCTS IN A TIMELY MANNER OR AT ALL, WE OR
OUR COLLABORATIVE PARTNERS WILL NOT BE ABLE TO DISTRIBUTE OR SELL OUR PRODUCTS
CURRENTLY UNDER DEVELOPMENT.

All of our potential products must undergo extensive regulatory approval
processes in the United States and other countries. These regulatory processes,
which include pre-clinical testing and clinical trials of each compound to
establish safety and efficacy, can take many years and require the expenditure
of substantial resources. The FDA and the other regulatory agencies in
additional markets which are material to us and our collaborative partners,
including the European Agency for the Evaluation of Medicinal Products, or EMEA,
and the Japanese Ministry of Health, may delay or deny the approval of our
potential products. Although we have been successful in gaining regulatory
approval for Tarceva(TM) in the United States for the NSCLC indication, there
can be no guarantee of subsequent approvals either for Tarceva(TM)in other
territories (including the EU) or for other indications in the United States or
for other products in the United States and other territories.

Delays or rejections may be encountered during any stage of the regulatory
process based upon the failure of the clinical data to demonstrate compliance
with, or upon the failure of the product to meet, a regulatory agency's
requirements for safety, efficacy and quality. Any such delay could have a
negative effect on our business. A drug candidate cannot be marketed in the
United States until it has been approved by the FDA. Once approved, drugs, as
well as their manufacturers, are subject to continuing and ongoing review, and
discovery of previously unknown problems with these products or the failure to
adhere to manufacturing or quality control requirements may result in
restrictions on their distribution, sale or use, or their withdrawal from the
market. The FDA also has the authority, when approving a product, to impose
significant limitations on the product in the nature of warnings, precautions
and contra-indications that could negatively affect the profitability of a drug.

Furthermore, once a drug is approved, the drug can only be marketed for the
indications and claims approved by the FDA. If we fail to comply with the FDA
regulations prohibiting promotion of off-label uses and the promotion of
products for which marketing clearance has not been obtained, the FDA, or the
Office of the Inspector General of the U.S. Department of Health and Human
Services, or state Attorneys General could bring an enforcement action against
us that would inhibit our marketing capabilities as well as result in
significant penalties. The ability to market and sell a drug product outside of
the United States is also subject to stringent and, in some cases, equally
complex regulatory processes that vary depending on the jurisdiction.

WE ARE RESPONSIBLE FOR THE SUPPLY OF TARCEVA(TM) IN THE UNITED STATES. SINCE WE
HAVE NO COMMERCIAL MANUFACTURING FACILITIES, WE ARE DEPENDENT ON TWO SUPPLIERS
FOR THE ACTIVE PHARMACEUTICAL INGREDIENT, OR API, FOR TARCEVA(TM) AND A SINGLE
SUPPLIER FOR THE TABLETING OF TARCEVA(TM) IN THE UNITED STATES.

We are responsible for manufacturing and supplying Tarceva(TM) in the
United States under the terms of a Manufacturing and Supply Agreement entered
into with Genentech in 2004. We rely on two third-party suppliers to manufacture
the API, erlotinib, for Tarceva(TM). We also currently rely on a single
manufacturer to formulate the Tarceva(TM) tablets. We are presently seeking
another manufacturer to serve as an alternative (i.e. back-up) provider of
Tarceva(TM) tablets. If our relationships with any of these manufacturers
terminate or if they are unable to meet their obligations, we will need to find
other sources of supply. Such alternative sources of supply may be difficult to
find on terms acceptable to us or in a timely manner, and, if found, would
require FDA approval which could cause delays in the availability of erlotinib
and ultimately Tarceva(TM) tablets, which, in turn, could negatively impact our
Tarceva(TM)-derived revenues.

Furthermore, the manufacturing of our products is, and will continue to be,
subject to current good manufacturing practices regulations prescribed by the
FDA or other standards prescribed by the appropriate regulatory agency in the
country of use. If our manufacturers, including the current manufacturers of
erlotinib

26

and Tarceva(TM) tablets, do not comply with all applicable regulatory standards,
they may not be permitted to manufacture Tarceva(TM) or any other product for
commercial sale. If this occurs, we might not be able to identify another
third-party manufacturer on terms acceptable to us or in a timely manner, or
such other third-party manufacturer may not receive FDA approval in a timely
manner or at all. Any of the foregoing could cause delays in the availability of
our products, including erlotinib and/or Tarceva(TM) tablets, which would
negatively impact our revenues. If we fail to meet our manufacturing
obligations, our partner, Genentech, also has the right to take over supply of
Tarceva(TM) in the United States.

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

Tarceva(TM) is being developed and commercialized in an alliance under
co-development and marketing agreements with Genentech and Roche. The
development program is managed by us, Genentech and Roche under a global
development committee. Under the alliance, Genentech leads the marketing efforts
in the United States and Roche will market the drug in the rest of the world.
Recently, we signed an amendment to our collaboration agreement with Genentech
to provide us with the right to co-promote Tarceva(TM) in the United States and
signed a Manufacturing and Supply Agreement with Genentech that clarified our
role in supplying Tarceva(TM) for the U.S. market.

The OSI/Genentech collaboration 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 collaboration, that is, until the
date that we and Genentech mutually agree to terminate the collaboration or
until either party exercises its early termination rights as described as
follows. The OSI/ Genentech collaboration agreement is subject to early
termination in the event of certain customary defaults, such as material breach
of the agreement and bankruptcy. Since January 8, 2003, Genentech has had the
right to terminate the OSI/Genentech collaboration agreement with six months'
prior written notice. The provisions of the amendment allowing us to co-promote
are also subject to termination by Genentech upon a material breach of the
amendment by us which remains uncured or upon a pattern of nonmaterial breaches
which remains uncured.

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. Since July 31,
2003, 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 would
require greater financial resources and would result in us incurring greater
expenses and may cause a delay in market penetration while we continue to build
our own commercial operation or seek alternative collaborative partners.

IF ANY OF OUR CURRENT OR FUTURE MARKETED PRODUCTS, INCLUDING NOVANTRONE(R) OR
TARCEVA(TM), WERE TO BECOME THE SUBJECT OF PROBLEMS RELATED TO THEIR EFFICACY,
SAFETY, OR OTHERWISE, OR IF NEW, MORE EFFECTIVE TREATMENTS WERE TO BE
INTRODUCED, OUR REVENUES FROM SUCH MARKETED PRODUCTS COULD DECREASE.

If Novantrone(R) or Tarceva(TM) or any of our other current or future
marketed products become the subject of problems, including those related to,
among others:

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

- unexpected side-effects;

27

- regulatory proceedings subjecting the products to potential recall;

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

- pressure from competitive products; or

- introduction of more effective treatments;

our revenues from such marketed products could decrease. For example, efficacy
or safety concerns may arise, whether or not justified, that could lead to the
recall or withdrawal of such marketed products. In the event of a recall or
withdrawal of a product such as Novantrone(R) or Tarceva(TM), our revenues would
significantly decline.

IF WE DO NOT RECEIVE ADEQUATE THIRD-PARTY REIMBURSEMENT FOR THE SALES OF OUR
PRODUCTS, WE MAY NOT BE ABLE TO SELL SUCH PRODUCTS ON A PROFITABLE BASIS.

Sales of our products will depend, in part, upon the extent to which the
costs of our products will be paid by health maintenance, managed care, pharmacy
benefit and similar reimbursement sources, or reimbursed by government health
administration authorities, private health coverage insurers and other
third-party payors. Such third-party payors continue to aggressively challenge
the prices charged for healthcare products and services. Additionally, federal
and state governments have prioritized the containment of healthcare costs, and
drug prices have been targeted in this effort. If these organizations and
third-party payors do not consider our products to be cost-effective, they may
not reimburse providers of our products, or the level of reimbursement may not
be sufficient to allow us to sell our products on a profitable basis.

THE MEDICARE PRESCRIPTION DRUG IMPROVEMENT AND MODERNIZATION ACT OF 2003
MATERIALLY CHANGES THE MEDICARE REIMBURSEMENT GUIDELINES FOR INTRAVENOUS AND
ORAL ONCOLOGY PRODUCTS. SUCH CHANGES MAY NEGATIVELY IMPACT OUR REVENUES FOR
NOVANTRONE(R).

After a Congressional debate regarding the formula by which Medicare
reimbursement for intravenous oncology products is rendered to oncologists, the
levels of reimbursement to oncologists for intravenous oncology products like
Novantrone(R) were lowered, effective January 2004. Under the Medicare
Prescription Drug Improvement and Modernization Act of 2003, Medicare benefits
will be primarily provided through private entities that will attempt to
negotiate price concessions from pharmaceutical manufacturers, which may
increase pressure to lower prescription drug prices. The Act also includes other
cost containment measures for Medicare in the event Medicare cost increases
exceed a certain level, which may also impose limitations on prescription drug
prices. These changes in Medicare reimbursement could have a negative impact on
our revenues derived from sales of Novantrone(R).

IF SERONO S.A. DOES NOT FULFILL ITS OBLIGATIONS FOR MANUFACTURING AND SUPPLYING
NOVANTRONE(R), WE MAY NOT BE ABLE TO CONTINUE THE MARKETING AND DISTRIBUTION OF
THE PRODUCT WHICH COULD CAUSE OUR REVENUES TO DECREASE.

Serono is responsible for the manufacture and supply of Novantrone(R).
Under our agreement with Serono, we do not have the obligation nor the right to
manufacture Novantrone(R). These obligations and rights are held solely by
Serono. If Serono is delayed in or restricted from supplying the product, we
would be directly affected in that any such delay or restriction would impede us
from selling the product. Without the sales of Novantrone(R), our revenues would
decrease.

ONE ASPECT OF OUR BUSINESS STRATEGY DEPENDS ON OUR ABILITY TO IDENTIFY AND
ACQUIRE PRODUCT CANDIDATES AND MARKETED PRODUCTS, WHICH IF NOT MET, MAY PREVENT
US FROM ACHIEVING EXPECTED FUTURE PERFORMANCE.

As part of our business strategy, we plan to identify and acquire product
candidates and approved products for markets that we can reach through our
commercial operations. We may not be able to acquire rights to additional
products or product candidates on acceptable terms, if at all. If we fail to
obtain, develop and successfully commercialize such additional product
candidates and approved products, we may not achieve expectations of our future
performance.

28

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

Successful research and development of pharmaceutical products is high
risk. Most products 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 and diabetes and obesity products
may never reach the market for a number of reasons. They may be found
ineffective or may 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 product candidates in
various stages of development and do not expect them to be commercially
available for a number of years, if at all. Our candidates that are in clinical
trials will still require significant research and development and regulatory
approvals before we or our collaborative partners will be able to market them.

IF OUR COMPETITORS SUCCEED IN DEVELOPING PRODUCTS AND TECHNOLOGIES THAT ARE MORE
EFFECTIVE THAN OUR OWN, OR IF SCIENTIFIC DEVELOPMENTS CHANGE OUR UNDERSTANDING
OF THE POTENTIAL SCOPE AND UTILITY OF OUR PRODUCTS, THEN OUR PRODUCTS AND
TECHNOLOGIES MAY BE RENDERED LESS COMPETITIVE.

We face significant competition from industry participants that are
pursuing similar products and technologies that we are pursuing and are
developing pharmaceutical products that are competitive with our products and
potential products. Some of our industry competitors have greater capital
resources, larger overall research and development staffs and facilities, and a
longer history in drug discovery and development, obtaining regulatory approval
and pharmaceutical product manufacturing and marketing than we do. 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, as well as new scientific
developments, may result in our compounds, products or processes becoming
obsolete before we can recover any of the expenses incurred to develop them. For
example, changes in our understanding of the appropriate population of patients
who should be treated with a targeted therapy like Tarceva(TM) may limit the
drug's market potential if it is subsequently demonstrated that only certain
subsets of patients should be treated with the targeted therapy.

OUR RELIANCE ON THIRD PARTIES, SUCH AS 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.

In the course of product development, we engage CROs to conduct and manage
clinical studies and to assist us in guiding our products through the FDA review
and approval process. For example, we collaborated with the National Cancer
Institute of Canada's Clinical Trial Group based at Queens University, Ontario,
in connection with our Tarceva(TM) Phase III trials. Because we have engaged and
intend to continue to engage 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 CROs fail to perform their obligations under our
agreements with them or fail to perform clinical trials in a satisfactory
manner, we may face delays in completing our clinical trials, as well as
commercialization of one or more drug candidates. 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.

THE USE OF ANY OF OUR POTENTIAL PRODUCTS IN CLINICAL TRIALS AND THE SALE OF ANY
APPROVED PRODUCTS EXPOSES US TO LIABILITY CLAIMS.

The nature of our business exposes us to potential liability risks inherent
in the testing, manufacturing and marketing of drug candidates and products. If
any of our drug candidates in clinical trials or our marketed products harm
people or allegedly harm people, we may be subject to costly and damaging
product liability claims. A number of patients who participate in trials are
already critically ill when they enter a trial. The waivers we obtain may not be
enforceable and may not protect us from liability or the costs of product
liability

29

litigation. While we currently maintain product liability insurance that we
believe is adequate, we are subject to the risk that our insurance will not be
sufficient to cover claims. There is also a risk that adequate insurance
coverage will not be available in the future on commercially reasonable terms,
if at all. The successful assertion of an uninsured product liability or other
claim against us could cause us to incur significant expenses to pay such a
claim, could adversely affect our product development and could cause a decline
in our product revenues. Even a successfully defended product liability claim
could cause us to incur significant expenses to defend such a claim, could
adversely affect our product development and could cause a decline in our
product revenues.

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, which 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.

We hold numerous U.S. and foreign patents and have many pending
applications for additional patents. 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 and maintain 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 sizeable
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 publishes or 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 receive patent protection for
additional proprietary technologies that we develop, 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.

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

30

not be available to us on acceptable terms, if at all. Any litigation,
regardless of the outcome, could be extremely costly to us.

OUR ABILITY TO RAISE CAPITAL IN THE FUTURE MAY BE LIMITED, WHICH COULD ADVERSELY
IMPACT OUR GROWTH.

Changes in our operating plans, increased expenses or other events
described in this "Risk Factors" section may require us to seek additional debt
or equity financing. Such financing may not be available on acceptable terms, or
at all, and our failure to raise capital when needed could negatively impact our
growth, financial condition and results of operations. Additional financing
would most likely be dilutive to the holders of our common stock, and debt
financing, if available, may involve significant cash payment obligations and
covenants that restrict our ability to operate our business.

WE HAVE OUTSTANDING OPTIONS, CONVERTIBLE DEBT, CONTINGENT VALUE RIGHTS AND
WARRANTS, THE EXERCISE, CONVERSION OR EXCHANGE OF WHICH COULD DILUTE STOCKHOLDER
VALUE AND CAUSE OUR STOCK PRICE TO DECLINE.

We grant stock options to our employees and other individuals as part of
our overall compensation plan which, upon vesting, are exercisable for common
stock. In addition, we have issued convertible debt which may be converted into
common stock as well as contingent value rights which, upon the occurrence of
certain events, may be exchanged for common stock. We are not able to estimate
when, if ever, the stock options or convertible debt will be exercised or
converted into common stock or when, if ever, shares will be issued in
connection with the contingent value rights, but any such conversion or issuance
would almost certainly dilute stockholder value.

Further, if some or all of such shares are registered and sold into the
public market over a short time period, the price of our stock is likely to
decline, as the market may not be able to absorb those shares at the prevailing
market prices.

OUR OUTSTANDING INDEBTEDNESS INCREASED SUBSTANTIALLY WITH THE ISSUANCE OF
CONVERTIBLE SENIOR SUBORDINATED NOTES IN SEPTEMBER 2003, OR THE 2023 NOTES, AND
WE MAY NOT BE ABLE TO MAKE THE REQUIRED PAYMENTS ON THESE NOTES WHEN DUE AND
THEREFORE MAY FACE LIQUIDITY PROBLEMS.

As a result of the issuance of our 2023 Notes, our long-term debt
represented by these notes was $150.0 million as of September 30, 2004. Our 2023
Notes significantly increased our interest expense and related debt service
costs. Interest on these notes accrues at the rate of 3.25% per annum. This
amounts to interest payments of $2.4 million due and payable on the 2023 Notes
semi-annually on March 8 and September 8 of each year on the outstanding amount
of the notes. Total interest payments of $92.6 million are scheduled to be paid
between March 8, 2005 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 downturn in our business.

We currently are not generating sufficient net cash flow to satisfy the
annual debt service payments on the notes. If we are unable to satisfy our debt
service requirements, we will default on our 2023 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 stock price of biotechnology
and pharmaceutical companies, including our stock price, has been volatile and
may remain volatile for the foreseeable future. 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

31

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. From October 1, 2003
through September 30, 2004, the range of our stock price was between $98.70 and
$24.47, and the range of the Nasdaq Biotechnology Index was between 851.44 and
622.01. 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;

- unanticipated clinical efficacy or safety results from our competitors'
products;

- changes in government regulation, including pricing controls;

- delays with the FDA in the approval process for 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.

In addition, historically, our stock price has been affected by
technological, clinical and regulatory developments in the HER1/EGFR field,
including developments with respect to the products of our main competitors in
the field. It is possible that future developments concerning our competitors'
products as well as further research and clinical results of targeted therapies
in general and the HER1/EGFR field in particular could have an impact on our
stock price due to Tarceva(TM)'s classification as a targeted therapy in the
HER1/ EGFR field.

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, 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

32

- 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.

ITEM 2. PROPERTIES

We currently lease three facilities in New York, one located at 58 South
Service Road, Melville, New York, consisting of approximately 27,000 square
feet, one located at One Bioscience Park Drive, Farmingdale, New York,
consisting of approximately 53,000 square feet, and one located at 106 Charles
Lindbergh Boulevard, Uniondale, New York, consisting of approximately 30,000
square feet. The Melville facility houses our principal executive, commercial,
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 Boulder, Colorado, one located at
2860 Wilderness Place, consisting of approximately 60,000 square feet, one
located at 2900 Center Green Court South, consisting of approximately 10,000
square feet, and one located at 2970 Wilderness Place, consisting of
approximately 26,000 square feet. The Boulder facilities house our clinical
research, regulatory affairs and drug development personnel. The lease for the
facility at 2900 Center Green Court South, expires in February 2005 and we do
not expect to renew the lease.

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. In May 2004, we subleased our rights under the
lease agreement for this facility.

Our wholly-owned subsidiary, OSI Pharmaceuticals (UK) Limited, currently
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. In August 2004, we announced a plan to consolidate our U.K. based
oncology research and development activities into our New York locations.
Following the consolidation, the only operations remaining at the Oxford
facilities are those related to our international clinical trials group and our
diabetes and obesity subsidiary, Prosidion Limited. We expect to vacate the
facility at Isis House by January 2005 and attempt to assign or sublease our
rights under the related lease agreement.

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 2004.

33

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, 2002 through September 30, 2004 as reported on the NASDAQ National
Market:

HOLDERS AND DIVIDENDS

As of December 1, 2004, there were approximately 3,641 holders of record of
our common stock. We have not paid any cash dividends since inception and we do
not intend to pay any cash dividends in the foreseeable future. Declaration of
dividends will depend, among other things, upon future earnings, our operating
and financial condition, our capital requirements and general business
conditions.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

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

(a) Consists of five plans: 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 the Amended and Restated Stock Incentive 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 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.
34

(c) Includes options established for certain outside consultants related to
clinical trial operations.

(d) Includes 776,428 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.

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, 2004.
The information below should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this report.

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

(a) The fiscal 2004 consolidated financial statements include the acquisition of
certain assets from Probiodrug AG for approximately $36.4 million in cash;
the impairment of the Gelclair(R) intangible asset of $24.6 million; the
conversion of $160.0 million aggregate principle amount of convertible
senior subordinated notes into 3.2 million shares of our common stock; the
charge of $8.6 million relating to excess Gelclair(R) inventory; and the
recognition of $3.0 million of Tarceva(TM)-related milestone revenues. (See
notes 1(b), 1(l),3(a),5(a), 8, and 10(b) to the accompanying consolidated
financial statements.)

(b) 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(b) and 10(a) to the
accompanying consolidated financial statements.)

(c) 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(c),
5(b) and 10(b) to the accompanying consolidated financial statements.)

(d) 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 5(a),
17(d) and 17(e) to the accompanying consolidated financial statements.)

(e) 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 Bayer Corporation; and a charge to operations of
$700,000 representing the cost of a license to use and practice certain of
Cadus Corporation's technology and patents.

36

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

OVERVIEW

We are a leading biotechnology company primarily focused on the discovery,
development and commercialization of high quality oncology products that both
extend life and improve the quality-of-life for cancer patients worldwide. Our
flagship product, Tarceva(TM) (erlotinib), is an oral, once-a-day, small
molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR.
Tarceva(TM) is the first EGFR inhibitor, and the first non-chemotherapy agent,
to demonstrate a survival benefit in advanced non-small cell lung cancer, or
NSCLC, and also in pancreatic cancer, two forms of cancer widely recognized as
amongst the toughest treatment challenges facing oncologists. On November 18,
2004, after a review lasting only three and a half months, the U.S. Food and
Drug Administration, or FDA, approved our New Drug Application, or NDA, for
monotherapy Tarceva(TM) use in the treatment of all NSCLC patients who have
failed prior chemotherapy. We, along with our partner Genentech, Inc. launched
Tarceva(TM) on November 22, 2004, two business days following approval, shortly
prior to which we and Genentech announced pricing for the drug in the United
States. We intend to file a supplemental NDA, or sNDA, for the treatment of
front-line pancreatic cancer patients (in combination with gemcitabine) in
fiscal 2005. In addition, our partner, Roche, has completed a regulatory filing
under the centralized process in the European Union, or EU, for Tarceva(TM) in
NSCLC. We anticipate that Roche will gain approval for the drug in the second
half of calendar 2005. Beyond Tarceva(TM), we have a balanced pipeline of
oncology drug candidates that includes signal transduction inhibitors, apoptosis
(also know as programmed cell death) inducers and a next-generation cytotoxic
chemotherapy agent. We have established a core commercial organization, which
includes approximately 50 sales representatives and managers covering the major
territories in the United States. We market and promote Novantrone(R)
(mitoxantrone concentrate for injection) for approved oncology indications in
the United States, and we market and distribute Gelclair(R) in North America, a
bioadherent oral gel for the relief of pain associated with oral mucositis, a
frequent side-effect of chemotherapy. We also have a diabetes and obesity
subsidiary, Prosidion Limited, which is based in the United Kingdom. Prosidion's
lead clinical candidate, PSN9301, an inhibitor of dipeptidyl peptidase IV, or
DP-IV, is in Phase II clinical trials for the treatment of type 2 diabetes.
PSN9301 was acquired by Prosidion from Probiodrug AG, a German company, in a
transaction which closed in July 2004. Behind PSN9301, Prosidion has an emerging
pipeline of diabetes and obesity drug candidates.

Our objective going forward is to build upon Tarceva(TM)'s significant
market potential and to capitalize on the experienced management team and the
comprehensive set of capabilities from discovery to commercialization that we
have established over the last several years in order to create a premier
biotechnology organization and drive value creation for our stockholders. To
accomplish this, we intend to:

- maximize Tarceva(TM)'s value by supporting an effective launch in the
United States, a timely registration and effective launch in the EU and
Japan and an effective product growth strategy;

- establish our position as a premier oncology franchise by advancing our
pipeline, reinforcing our commercial presence, validating our research
capabilities and actively pursuing in-licensing and acquisition
opportunities; and

- diversify our business through continued investment in Prosidion to grow
a second business unit focused on diabetes and obesity in order to help
drive long-term growth.

SIGNIFICANT EVENTS

Tarceva(TM)

On November 18, 2004, we announced that the FDA approved our NDA for
monotherapy Tarceva(TM) use in the treatment of all NSCLC patients who have
failed at least one prior chemotherapy regimen. Tarceva(TM) met its primary
endpoint of improving overall survival and its key secondary endpoints of
progression-free survival and objective tumor response rate in a 731-patient
randomized, double-blinded placebo controlled Phase III trial, or the BR.21
study. The study compared Tarceva(TM) to placebo in the treatment of patients
with advanced NSCLC following the failure of first or second-line chemotherapy.
The data demonstrates a 42%

37

improvement in median survival and a 45% improvement in the one-year survival
rate relative to placebo. The results revealed a survival benefit in essentially
all subsets of patients examined, including males, smokers and patients with
squamous cell carcinoma histology (subsets that, consistent with previous
studies with EGFR inhibitors, had a relatively low rate of tumor response in our
study), as well as females, non-smokers and patients with adenocarcinoma
(subsets with higher rates of tumor response). We believe that these results are
particularly noteworthy in that they demonstrate a meaningful, broad-based
clinical benefit in a very advanced population of lung cancer patients and that
these results form the basis for our recent approval.

The safety profile observed in the BR.21 study was relatively benign
compared to cytotoxic chemotherapy and was consistent with that seen in prior
Tarceva(TM) studies with 75% of patients receiving Tarceva(TM) exhibiting rash
versus 17% in the placebo group and 54% of patients receiving Tarceva(TM)
experiencing diarrhea versus 18% for placebo. In this large placebo controlled
study, severe pulmonary events, including potential cases of interstitial lung
disease, were infrequent and generally equally distributed between the
Tarceva(TM) and placebo arms. We believe that this combination of survival
benefit with a relatively benign side-effect profile positions Tarceva(TM) as a
potentially important treatment option for oncologists treating advanced NSCLC
patients who have failed front-line chemotherapy.

In September 2004, we announced that Tarceva(TM) also met its primary
endpoint of improving overall survival in a 569-patient randomized, double-blind
placebo controlled Phase III trial in front-line pancreatic cancer patients with
locally advanced or metastatic disease. The trial compared a combination of
Tarceva(TM) and the chemotherapy agent gemcitabine with gemcitabine plus
placebo. The data demonstrates a 23.5% improvement in overall survival (a hazard
ratio of 0.81 and p-value of 0.025) for the Tarceva(TM) arm compared to the
placebo arm. The results were noteworthy in that Tarceva(TM) was used at a lower
dose (100mg) than was used in our BR.21 study for the majority of patients
treated in the study and Tarceva(TM) was used in combination with a chemotherapy
agent. We believe that the data demonstrates that Tarceva(TM) is likely to have
broad utility beyond the initial lung cancer indication.

In connection with the further development and commercialization of
Tarceva(TM), we recently entered into agreements with Genentech with respect to
promotion, marketing and manufacturing responsibilities for Tarceva(TM) in the
U.S. market. Genentech will have the lead responsibility for the marketing and
promotion of Tarceva(TM) in the United States. However, we will co-promote the
product in the field by providing at least 25% of the combined U.S. sales force.
We also have responsibility for the manufacturing and supply of Tarceva(TM) in
the United States, and we believe we have a supply chain in place with inventory
on hand to support launch of the product. We, along with our supply chain of
third-party providers, have sufficient inventory for the launch of the product.
Tarceva(TM) is priced to wholesalers at $2,026 per 30-day supply of the 150mg
tablets, and is also available in 100mg and 25mg tablet strengths. With the
Iressa(R) price increase effective November 18, 2004 Tarceva(TM) is priced at
less than a 20% premium to the competitor's product.

The successful execution of a strategy to expand Tarceva(TM) indications
and grow the product post-launch is our clear priority. We intend to broaden the
use of Tarceva(TM) to earlier stage lung cancer patients, both in the first-line
and adjuvant settings. The first part of this strategy has been initiated with
an ongoing randomized Phase II trial evaluating monotherapy Tarceva(TM) against
chemotherapy in patients who have received no prior chemotherapy and have poor
performance status.

Public Offering

On November 12, 2004, subsequent to the end of fiscal 2004, we concluded a
public offering of 6.0 million shares of common stock at a price of $64.50 per
share. Gross proceeds totaled $387.0 million with net proceeds of approximately
$365.0 million after all related fees. In addition, on November 17, 2004,
underwriters associated with this offering exercised their over-allotment option
to purchase an additional 900,000 shares of our common stock at a price of
$64.50 per share. Gross proceeds from the exercise of the over-allotment option
totaled $58.1 million with net proceeds of approximately $54.9 million. We
believe that the proceeds from this offering together with existing cash
resources and projected cashflows from Tarceva(TM) will be sufficient to execute
our strategy going forward.

38

Redemption of 4% Convertible Senior Subordinated Notes

On June 18, 2004, we exercised the redemption option for our 4% senior
convertible subordinated notes due 2009 that we issued in February 2002 and
called for the full redemption of the outstanding $160.0 million of the notes.
As expected, all of the noteholders converted their notes into shares of our
common stock prior to the redemption date of July 19, 2004. As a result of these
conversions, in July 2004, we reduced our long-term debt by $160.0 million and
issued 3.2 million shares of our common stock. We also paid the remaining
portion of the guaranteed interest of $6.4 million to the noteholders. (See note
10(b) to the accompanying consolidated financial statements.)

Impairment of Intangible Asset

In October 2004, we announced that it will be necessary to record an
impairment charge as of September 30, 2004 related to our intangible asset for
the exclusive distribution rights to the marketed product, Gelclair(R), in North
America. We determined that an impairment charge of approximately $24.6 million,
which represented the full unamortized balance of the Gelclair(R) intangible
asset, was necessary as of September 30, 2004. The impairment charge resulted
from both the recent discontinuance of discussions with a replacement dental
partner and slower than originally expected sales growth in the oncology
marketplace following the re-launch of the product in October 2003.

Prosidion's Asset Acquisition

We consider expansion into a second disease area to be an important part of
our strategy for long-term value creation. To this end, on July 26, 2004,
Prosidion acquired from Probiodrug, its Type 2 diabetes Phase II clinical
candidate, PSN9301 (formerly P93/01), and its associated intellectual property
estate. PSN9301 is an oral, small molecule inhibitor of DP-IV, which is
recognized as an important target in diabetes. In addition to composition of
matter claims for PSN9301, the acquired intellectual property estate includes
issued U.S. method-of-use claims that have been non-exclusively licensed to
Novartis Pharma AG and Merck & Co., Inc., among others, for milestones and
royalties. Prosidion also anticipates initiating clinical trials for two
diabetes candidates, PSN105 (a glucokinase activator) and PSN357 (a glycogen
phosphorylase inhibitor), in the first half of calendar 2005. (See note 3(a) to
the accompanying consolidated financial statements.)

Consolidation of Our Oncology Operations

On August 5, 2004, we announced to our employees a plan to consolidate our
U.K. based oncology research and development activities into our New York
locations by November 30, 2004. This decision was based on the need to
prioritize the expansion of our commercial operation infrastructure and increase
our level of investment in both translational research and our diabetes and
obesity subsidiary, Prosidion. This consolidation primarily affects our Oxford
facility where the consolidation has resulted in the layoff of 82 employees.
Upon the consolidation, the only operations remaining at the Oxford facility are
those related to our international clinical trials group and Prosidion. As a
result of this decision, we recorded a charge of $5.7 million during the fourth
quarter of fiscal 2004 related to termination benefits and the acceleration of
depreciation on certain leasehold improvements at the Oxford facility. (See note
17(b) to the accompanying consolidated financial statements.)

Aptosyn(R)

On June 11, 2004, we announced that, as we had expected, the Phase III
study of Aptosyn(R) (exislund) in combination with Taxotere(R) (docetaxal) did
not meet its primary endpoint of improving overall survival in patients with
advanced NSCLC. The trial also did not meet its secondary endpoints of
improvement in one-year survival, progression-free survival and response rate.
Survival in the Aptosyn(R) plus Taxotere(R) arm of the study was essentially
indistinguishable from the Taxotere(R) plus placebo arm. Although the further
development of Aptosyn(R) is unlikely, we believe that the more potent follow-on
molecule, OSI-461, warrants continued development. We acquired both Aptosyn(R)
and OSI-461 in June 2003 as part of the acquisition of Cell Pathways, Inc.

39

Provision for Excess Gelclair(R) Inventory

During fiscal 2004, we recorded total charges of $8.6 million relating to
obsolete Gelclair(R) inventory that we deemed in excess of forecasted demand.
This excess inventory relates to the substantial inventory obtained from the
Cell Pathways acquisition, the required purchase commitments that we assumed in
the Cell Pathways acquisition and the current low demand for the product. We
purchased an additional $2.0 million of inventory during the fourth quarter of
fiscal 2004 based upon the required purchase commitments. We are required to
purchase another $1.0 million of inventory by December 31, 2004 and will be
required to purchase an additional $5.0 million in 2005. As of September 30,
2004, we have accrued a charge of $4.9 million related to the remaining 2004 and
2005 purchase commitments that we have determined to be in excess of forecasted
demand. In addition, we recorded a charge of $3.7 million for excess inventory
on hand during fiscal 2004. In late October 2004, we exercised our right to
terminate our agreement with Helsinn Healthcare S.A., the supplier of the
product. Under the terms of the agreement, Helsinn has the option to purchase
any and all of our inventory at cost plus 5% and if Helsinn does not elect to
purchase our inventory, we are permitted to continue to sell such inventory. We
are currently negotiating a new agreement with Helsinn.

FINANCIAL EXPECTATIONS FOR FISCAL 2005

In terms of fiscal 2005 guidance, we are not currently providing
Tarceva(TM) specific revenue guidance as per our agreement with Genentech.
Tarceva(TM) was launched in late November and therefore we will only have ten
months of sales for our fiscal 2005. In order to maximize Tarceva(TM)'s value
with an effective launch and product growth strategy in the United States, we,
along with our partner, Genentech, expect to incur significant costs related to
the launch of Tarceva(TM). As a result of the significant investment required
with a product launch, we believe that our share of the co-promotion split from
the sale of Tarceva(TM) in the United States may not be profitable in the near
term.

We currently estimate that our total fiscal 2005 sales commissions and
Gelclair(R) product sales will be between $33 million and $35 million. In terms
of operating expenses, we expect our selling, general and administrative
expenses to decrease and be in the range of $80 million to $90 million,
primarily due to our share of the fiscal 2005 commercial costs associated with
Tarceva(TM) that are expected to be offset against Tarceva(TM)-derived revenue
in the co-promotion split. We expect to maintain our current level of R&D
between $110 million to $120 million. We expect that amortization expense will
decrease to approximately $15.0 million as a result of the impairment of the
Gelclair(R) asset in the fourth quarter of fiscal 2004. We expect total
operating expenses to be approximately $220 million in fiscal 2005. Further we
expect interest expense to decrease to approximately $5.0 million as a result of
the conversion in July 2004 of the 4% senior subordinated convertible notes.

Actual results could differ materially and will depend on, among other
things, the continuing growth of our currently marketed products; developments
with competitive products; the timing and scope of regulatory approvals and the
success of our new product launches; foreign exchange rates; possible regulatory
actions; and the impact of state, federal, and foreign government pricing and
reimbursement measures. This guidance excludes material unusual items and
in-process research and development charges that we may report. We currently
expect to record a charge in either the first or second quarter of fiscal 2005
for rental obligations relating to the portion of our U.K. facilities that we
will vacate as a result of our decision to consolidate our U.K. based oncology
research and development activities into our New York facilities. We are
currently not aware of any other material unusual charges that will occur in
fiscal 2005. Except for our ongoing obligations to disclose material information
under the federal securities laws, we undertake no duty to update these
forward-looking statements.

CRITICAL ACCOUNTING POLICIES

We prepare our consolidated financial statements in accordance with U.S.
generally accepted accounting principles. 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

40

our estimates and the estimated amounts could differ significantly 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 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, 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 the parties final review in the
subsequent quarter. Based on past experience, we do not believe these
adjustments, if any, will be significant to the consolidated financial
statements.

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
customers' reorder history based on data from an external third party.

Our revenue recognition policies for all nonrefundable upfront license fees
and milestone arrangements are 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 by SEC Staff Accounting
Bulletin No. 104, "Revenue Recognition." In addition, we follow the provisions
of Emerging Issues Task Force Issue 00-21, "Revenue Arrangements with Multiple
Deliverables" for multiple element revenue arrangements entered into or
materially amended after June 30, 2003. Our most significant application of
these policies, 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. A change in the expected
term impacts the period over which the remaining deferred revenue is 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 a review of the research data available, developments in the HER1/EGFR
targeted therapy market and the involved parties' revised projections for the
clinical development plan. Further, as a result of the amendment to the
OSI/Genentech agreement in June 2004, the remaining unearned upfront fee from
Genentech of approximately $1.8 million will be recognized in accordance with
EITF 00-21, as discussed below. As the Roche agreement was not modified or
amended subsequent to its original execution, the unearned upfront fee from
Roche continues to be recognized over the revised term and will be fully
recognized as of December 31, 2004.

In connection with our collaboration with Genentech, Genentech will
recognize all U.S. sales of Tarceva(TM). We will recognize revenues and losses
from our alliance with Genentech, which will consist of our share of the pretax
profits (loss) generated from the sales of Tarceva(TM) in the United States. We
also will recognize manufacturing revenue from the sale of inventory to
Genentech for commercial sales of Tarceva(TM) in the United States and partial
reimbursement from Genentech of our Tarceva(TM)-related commercial expenses. We
will receive royalties on sales of Tarceva(TM) outside of the United States by
Roche and up to $92 million in non-refundable milestone payments from Genentech
and Roche upon the achievement of certain milestones relating to regulatory
submissions and approval, of which $10 million has been received. In the fourth
quarter of fiscal 2004, we recognized $3.0 million in milestone revenues from
our partner Roche based upon the EMEA's notice of acceptance for filing and
review of our NDA for the use of Tarceva(TM) as a monotherapy for the treatment
of patients with advanced NSCLC patients who have failed at least one
chemotherapy regimen. Milestone payments from Roche are accounted for such that
revenue related to each payment be recognized over the entire contract
performance period, but not prior to the removal of the contingencies for each
milestone. Once a contingency is removed and the customer is obligated to make a

41

payment, the costs of the effort that has been incurred to date is divided by
the total expected research and development costs and revenue is recognized for
that milestone to the extent of the ratio of performance to date, less revenue
previously recognized.

In the fourth quarter of fiscal 2004, we also received a $7.0 million
milestone payment from Genentech based upon the FDA's notice of acceptance for
filing and review of our NDA for the use of Tarceva(TM) as a monotherapy for the
treatment of NSCLC patients who have failed at least one chemotherapy regimen.
As a result of the amendment to the OSI/Genentech agreement in June 2004, we
were required to account for the Genentech milestone received and the remaining
unearned upfront fee of approximately $1.8 million, in accordance with EITF
00-21. Milestones received from Genentech and the remaining unearned upfront fee
will be recognized over the term of the Manufacturing and Supply Agreement
between Genentech and us. This accounting resulted from the inability to
determine the fair value of the undelivered items in the arrangement as required
by EITF 00-21. As a result, the milestones are attributed to the last item
delivered under the Manufacturing and Supply Agreement. We will recognize such
deferred revenue over the term of the Manufacturing and Supply Agreement based
on the lesser of the ratio of units sold by Genentech to total expected units or
the cumulative straight-line basis. This estimate of expected unit sales will be
adjusted periodically and whenever events or changes in circumstances indicate
that there could be a significant change in such estimate.

Inventory

Our current inventory consists solely of Gelclair(R) inventory and is
stated at the lower of cost or market value, and our inventory costs are
determined by the first-in, first-out method. We analyze our inventory levels
quarterly and write down inventory that has become obsolete, inventory that has
a cost basis in excess of its expected net realizable value, and inventory in
excess of expected requirements. Expired inventory is disposed of and the
related costs are written off. Provisions for excess or expired inventory are
primarily based on our estimates of forecasted sales levels. During the quarter
ended March 31, 2004, we recorded a provision of $2.0 million for obsolete
inventory that we considered to be in excess of forecasted future demand based
on the expiration date of the product on hand. During the fourth quarter of
fiscal 2004, we recorded an additional provision of $6.6 million in relation to
inventory on-hand and 2004 and 2005 purchase commitments with Helsinn that we
deemed in excess of forecasted demand, based on the expiration date of the
product. This additional provision related to $1.7 million of inventory on hand
and $4.9 million of purchase commitments. This excess inventory relates to the
inventory obtained from Cell Pathways and the required purchase commitments that
we assumed in the Cell Pathways acquisition and the current low demand for the
product. If actual market conditions are less favorable than those projected by
us, additional inventory write-downs may be required.

To date, all costs associated with the manufacturing of Tarceva(TM) have
been included in research and development expenses when incurred. Effective
November 18, 2004, the date on which we received approval from the FDA for
Tarceva(TM), we began to capitalize in inventory the cost of manufacturing
Tarceva(TM) for commercial sale and will expense such cost as cost of goods sold
at the time of sale. However, as we sell existing inventory that was previously
expensed, we will reflect product sales with no corresponding cost of goods sold
for a period of time. Although it is currently impossible to project demand for
Tarceva(TM) due to lack of historical experience, we believe we have sufficient
inventory to supply our partner, Genentech, with the product for a significant
period. As we began to package our bulk inventory, we capitalized the cost of
packaging and labeling such inventory. Therefore, we anticipate that our cost of
sales of Tarceva(TM) to our partner, Genentech, will fluctuate in fiscal 2005
from quarter to quarter.

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.

42

Goodwill and Other Long-Lived Assets

SFAS No. 142, "Goodwill and Other Intangible Assets," 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 annual impairment review of
goodwill during the first quarter of fiscal 2004 and determined that no
impairment charge was required.

Our identifiable intangible assets are subject to amortization. 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. 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.
We review our intangibles with determinable lives and other long-lived assets
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. Our two most significant intangible assets are our rights to
Novantrone(R) and Gelclair(R), and therefore, we continually monitor sales
activity and market and regulatory conditions for these products for the
existence of any impairment indicators. In October 2004, we determined that it
was necessary to record an impairment charge as of September 30, 2004 related to
our intangible asset for exclusive distribution rights to the marketed product,
Gelclair(R), in North America. The impairment charge resulted from both the
recent discontinuance of discussions with a replacement dental partner and
slower than originally expected sales growth in the oncology marketplace
following the re-launch of the product in October 2003. In accordance with SFAS
No. 144, these events indicated that the carrying value of the Gelclair(R)
intangible should be tested for recoverability. The revised forecast indicated a
period of continuing losses associated with the sales and distribution of
Gelclair(R). In performing such recoverability test we determined that the total
of the expected future undiscounted cash flows directly related to the
Gelclair(R) asset was less than the carrying value of the Gelclair(R) asset. As
a result, an impairment charge was required. The amount of the impairment charge
represents the difference between the fair value of the intangible asset and its
associated carrying value. We calculated the fair value of the intangible asset
using discounted cash flows. The discounted cash flows calculation was made
utilizing various assumptions and estimates regarding future revenues and
expenses, cash flow and discount rates. Based on these calculations, we
determined that an impairment charge of $24.6 million, which represented the
full unamortized balance of the Gelclair(R) intangible asset, was necessary as
of September 30, 2004. In the future, events could cause us to conclude that
impairment indicators exist and that certain other 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.

COMPARISON OF FISCAL 2004 AND FISCAL 2003

Results of Operations

Our fiscal 2004 net loss of $260.4 million increased $79.0 million compared
to our fiscal 2003 net loss of $181.4 million. The fiscal 2004 net loss included
an in-process R&D charge of $32.8 million in connection with the acquisition of
certain assets of Probiodrug by Prosidion, a charge of $24.6 million related to
the impairment of the Gelclair(R) intangible asset and a charge of $8.6 million
for excess inventory. The fiscal 2003 net loss included an in-process R&D charge
of $31.5 million in connection with the acquisition of Cell Pathways.

43

Revenues

Revenues for fiscal 2004 were primarily comprised of sales commissions as
compared to sales commissions and collaborative revenues for fiscal 2003. This
shift reflects our transition from a business centered on funded collaborative
programs to one of generating our own product revenues in conjunction with the
launch of Tarceva(TM).

Sales Commissions and Product Sales

We began recording Novantrone(R) sales commissions upon the execution of
our Co-Promotion Agreement with an affiliate of Serono, S.A. in March 2003.
Sales commissions for fiscal 2004 of $34.3 million were $18.0 million higher
than the fiscal 2003 sales commissions of $16.3 million. The increase was
primarily due to a full 12 months of sales commissions in fiscal 2004 compared
to six and a half months of sales commissions in fiscal 2003. The increase was
also due in part to net oncology sales exceeding a contractual threshold limit
in both the first and fourth quarters of fiscal 2004, thus resulting in higher
effective commissions. The commission rate will revert back to the base
commission rate effective with the new calendar year.

We began recording Gelclair(R) product sales upon the close of our
acquisition of Cell Pathways in June 2003. Net product sales for fiscal 2004
were $1.2 million compared to $437,000 for fiscal 2003. The increase was due to
a full 12 months of sales in fiscal 2004 compared to three and a half months of
sales in fiscal 2003. We previously had a marketing agreement with John O.
Butler Company, under which Butler marketed Gelclair(R) to the dental market. In
April 2004, we agreed with Butler to terminate this agreement. In late October
2004, we exercised our right to terminate our distribution agreement with
Helsinn upon 90 days notice. Under the terms of the agreement, Helsinn has the
option to purchase any and all of our inventory at cost plus 5% following
termination and if Helsinn does not elect to purchase our inventory, we are
permitted to continue to sell such inventory. We are currently negotiating a new
agreement with Helsinn.

License, Milestone and Other Revenues

License revenues consist principally of the recognition of the $25.0
million upfront fees from Genentech and Roche over the expected term of the
collaboration. We recognized $4.0 million and $5.0 million in license revenue in
fiscal 2004 and 2003, respectively, relating to these upfront fees. License fees
in fiscal 2003 also included recognition of the remaining $875,000 of the $3.5
million upfront fee received from Tanabe Seiyaku Co., Ltd. relating to the
research collaboration that expired on October 1, 2003.

In the fourth quarter of fiscal 2004, we recognized $3.0 million in
milestone revenues from our partner Roche based upon the EMEA's notice of
acceptance for filing and review of our NDA for the use of Tarceva(TM) as a
monotherapy for the treatment of patients with advanced NSCLC patients who have
failed at least one chemotherapy regimen. Milestone payments from Roche are
accounted for such that revenue related to each payment be recognized over the
entire contract performance period, but not prior to the removal of the
contingencies for each milestone. Once a contingency is removed and the customer
is obligated to make a payment, the costs of the effort that has been incurred
to date is divided by the total expected research and development costs and
revenue is recognized for that milestone to the extent of the ratio of
performance to date, less revenue previously recognized.

In the fourth quarter of fiscal 2004, we also received a $7.0 million
milestone payment from Genentech based upon the FDA's notice of acceptance for
filing and review of our NDA for the use of Tarceva(TM) as a

44

monotherapy for the treatment of NSCLC patients who have failed at least one
chemotherapy regimen. As a result of the amendment to the OSI/Genentech
agreement in June 2004, we were required to account for the Genentech milestone
received and the remaining unearned upfront fee of approximately $1.8 million,
in accordance with EITF 00-21, Revenue Arrangements with Multiple Deliverables.
Milestones received from Genentech and the remaining unearned upfront fee will
be recognized over the term of the Manufacturing and Supply Agreement between
Genentech and us. This accounting resulted from the inability to determine the
fair value of the undelivered items in the arrangement as required by EITF
00-21. As a result, the milestones are attributed to the last item delivered
under the Manufacturing and Supply Agreement. We will recognize such deferred
revenue over the term of the Manufacturing and Supply Agreement based on the
lesser of the ratio of units sold by Genentech to total expected units or the
cumulative straight-line basis. This estimate of expected unit sales will be
adjusted periodically and whenever events or changes in circumstances indicate
that there could be a significant change in such estimate. Additional milestone
payments will be paid by Genentech and Roche upon registration of Tarceva(TM) in
the United States and the European Union, respectively, and upon successful
filing and registration of Tarceva(TM) in Japan. Further milestones are also due
upon the successful filing and approval of Tarceva(TM) in a second oncology
indication and upon the approval of the first two adjuvant oncology indications
in the United States, European Union and Japan.

Collaborative Revenues

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. There were no collaborative program revenues in fiscal
2004 due to the completion of our remaining collaborations with Anaderm Research
Corporation in March 2003 and Tanabe in October 2003.

Expenses

Cost of Product Sales

Cost of product sales relate to sales of Gelclair(R) and also includes a
provision for obsolete inventory of $8.6 million. During the fourth quarter of
fiscal 2004, we purchased $2.0 million of Gelclair(R) inventory based upon the
purchase commitments for Gelclair(R) under our agreement with Helsinn that we
assumed in the Cell Pathways acquisition. We are obligated to purchase an
additional $1.0 million of inventory by December 31, 2004 and an additional $5.0
million in 2005. During the second quarter of fiscal 2004, we recorded a
provision of $2.0 million for obsolete inventory that we considered to be in
excess of forecasted future demand based on the expiration date of the product
on hand. During the fourth quarter of fiscal 2004, we recorded an additional
provision of $6.6 million in relation to inventory on-hand and 2004 and 2005
purchase commitments with Helsinn that we deemed in forecasted demand, based on
the expiration date of the product. This additional provision related to $1.7
million of inventory on hand and $4.9 million of purchase commitments. This
excess inventory relates to the inventory obtained from the Cell Pathways
acquisition and the required purchase commitments that we assumed in the Cell
Pathways acquisition and the current low demand for the product.

45

Excluding the provision for obsolete inventory, cost of product sales were
$420,000 and $157,000 in fiscal 2004 and 2003, respectively, or approximately
one-third of product sales.

Research & Development

On November 18, 2004, our flagship product, Tarceva(TM), was approved by
the FDA as a monotherapy for the treatment of all NSCLC patients who have failed
at least one prior chemotherapy regimen and has successfully completed a Phase
III trial for pancreatic cancer. Tarceva(TM) is also the subject of an extensive
collaborative clinical program encompassing over 100 additional clinical trials.
We also have additional drug candidates in various stages of clinical
development. OSI-930 is a tyrosine kinase inhibitor that acts as a potent
co-inhibitor of the receptor tyrosine kinases c-kit and VEGFR, and is designed
to target both cancer cell proliferation and blood vessel growth (angiogenesis)
in selected tumors. OSI-930 is currently in pre-clinical development and we
anticipate initiating a clinical program in the first half of calendar 2005.
OSI-7904L is a liposomal formulation of TSI, which was licensed from
GlaxoSmithKline plc and acquired by us as part of the acquisition of Gilead's
Sciences, Inc.'s oncology business. We are developing OSI-7904L primarily for
gastrointestinal tract cancers. The SAANDs platform that we acquired from Cell
Pathways in June 2003 consisted of two clinical candidates, Aptosyn(R) and
OSI-461. The Phase III study of Aptosyn(R) (exislund) in combination with
Taxotere(R), did not meet its primary endpoint of improving overall survival in
patients with advanced NSCLC. The trial also did not meet its secondary
endpoints of improvement in one-year survival, progression-free survival and
response rate. Although we have halted the further development of Aptosyn(R), we
believe that the more potent follow-on molecule, OSI-461, warrants continued
development. In February 2004, we expanded an ongoing Phase I dose escalating
and pharmacokinetic trial of OSI-461 in patients with advanced solid tumors. In
July 2002, Cell Pathways commenced a Phase II trial of OSI-461 in the
non-cancerous area of inflammatory bowel disease at doses we consider to be
sub-optimal. We recently received inconclusive results from this study, which we
need to further analyze in order to determine how best to proceed with this
compound in this indication. The lead clinical candidate of our diabetes and
obesity subsidiary, Prosidion is PSN9301, an inhibitor of DP-IV, which is in
Phase II clinical trials for the treatment of type 2 diabetes. PSN9301 was
acquired by Prosidion from Probiodrug in a transaction which closed in July
2004. Behind PSN9301, Prosidion has an emerging pipeline of diabetes and obesity
drug candidates. Three other oncology candidates (CP-547,632, CP-724,714 and
CP-868,596) for which we are entitled to royalties, are gene-targeted therapies
currently being developed by Pfizer Inc. 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 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

46

Phase III stage of development, or to the future cash inflows from these
programs. For fiscal 2004, we invested a total of $52.4 million in research and
$58.0 million in pre-clinical and clinical development. For fiscal 2003, we
invested a total of $46.5 million in research and $56.1 million in pre-clinical
and clinical development. We consider this level of investment suitable to
sustain one major late stage clinical program and two to four earlier stage
clinical programs at any time and we manage our overall research and development
investments toward this level of activity.

The marginal increase in the research and development expense for fiscal
2004 was primarily due to costs associated with the clinical development of our
pipeline, including increases in OSI-7904L, OSI-930, OSI-461 and Aptosyn(R) of
$12.1 million, as well as an increased investment in Prosidion of $5.6 million.
Prosidion's research and development expenses for fiscal 2004 were $12.7 million
compared to expenses of $7.1 million in fiscal 2003. Included in Prosidion's
research and development expenses in fiscal 2004 is a $2.0 million termination
fee (paid in cash and Prosidion stock) to Tanabe relating to a termination
agreement with Tanabe, whereby Prosidion obtained the rights to certain patents
developed under the collaboration. Tanabe retained the rights to develop and
commercialize, in certain Asian territories, compounds covered by such patents.
Prosidion is also required to make payments to Tanabe upon the achievement of
certain milestones. Also included in research and development expense for fiscal
2004 is $3.0 million relating to termination benefits paid to employees and $1.7
million relating to the acceleration of certain leasehold improvements, in
connection with our decision to consolidate our U.K.-based oncology research and
development activities into our New York locations. These increases to research
and development expense in fiscal 2004 were offset by a decrease in the
development expense of Tarceva(TM) of $8.2 million due to the completion of the
Phase III trials in NSCLC and pancreatic cancer, as well as decreased investment
in the OSI-211 and OSI-7836 programs of approximately $6.1 million. In fiscal
2004, we decided to halt the further development of OSI-211, since we were
unable to differentiate the program from a current competitor's product, and
OSI-7836, since we were unable to overcome certain toxicity issues.

The significant perceived market potential for Tarceva(TM) resulted in the
OSI/Genentech/Roche alliance committing to a large and comprehensive global
development plan for the candidate. The global development plan has included
major Phase III clinical trials in lung and pancreatic cancers and a large
number of earlier stage trials in a variety of disease settings. The alliance
partners have initially committed to invest a combined $300 million in the
global development plan to be shared equally by the three parties. We have made
additional research and development investments outside of the global
development plan with the consent of the other parties. As of September 30,
2004, we have invested in excess of $100 million in the development of
Tarceva(TM) since the return of the full rights to the product from Pfizer in
June 2000, 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 2004
were $27.7 million compared to $35.9 million for fiscal 2003. To date we have
spent approximately 90% of our commitment under the plan; we expect to continue
our investment in Tarceva(TM), along with our partners, to support its continued
development and commercial growth beyond the original commitment.

Acquired In-Process Research and Development

In connection with the acquisition of certain assets from Probiodrug by
Prosidion in July 2004, we recorded an in-process R&D charge of $32.8 million in
fiscal 2004, 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 development project,
PSN9301, an oral, small molecule inhibitor of DP-IV, which is recognized as an
important target in diabetes.

In connection with the acquisition of Cell Pathways in June 2003, we
recorded an in-process R&D charge of $31.5 million during fiscal 2003,
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 charge was assigned to the two development projects and related
technology platform and patent estate, Aptosyn(R) ($3.7 million) and OSI-461
($27.8 million) based on their value on the date of the acquisition.
47

Selling, General and Administrative

The increase in selling, general and administrative expenses of $28.4
million during fiscal 2004 reflects increased investment in our commercial
infrastructure as we prepared for the launch of our flagship product,
Tarceva(TM), as well as our continued investment in supporting our other
commercial and pipeline programs. For fiscal 2004, our commercial operation
expenses increased approximately $17.9 million compared to fiscal 2003. The most
significant component of our investment has been commercialization and marketing
costs relating to Tarceva(TM) which are shared with Genentech in accordance with
the terms of our collaboration. The increase in commercial cost was also due to
additional management and personnel relating to the establishment of commercial
operations to support Tarceva(TM), Gelclair(R) and Novantrone(R), as well as an
additional two quarters of maintenance fees paid to Serono relating to
Novantrone(R). Also included in selling, general and administrative expenses for
fiscal 2004 were exit costs of $4.8 million relating to remaining rental
obligations for our Horsham, Pennsylvania and Uniondale, New York facilities,
termination benefits relating to the consolidation of our U.K.-based oncology
research and development activities and the acceleration of depreciation of
certain equipment and leasehold improvements at our Oxford and Uniondale
facilities. Included in selling, general and administrative expenses for fiscal
2003 were fees paid to Serono for transition services provided by them after our
acquisition of the Novatrone(R) rights, fees paid to Celgene Corporation in
connection with our recovery of the full rights to market and distribute
Gelclair(TM) in North America, and subcontracting expenses related to our
transitional arrangement with a contract sales organization as we were building
our commercial infrastructure. Our sales and marketing infrastructure is
currently comprised of approximately 80 sales, marketing, medical affairs,
commercial planning and support personnel, which includes approximately 50 sales
representative and managers covering the major territories in the United States.

Impairment of Intangible Asset

In connection with our acquisition of Cell Pathways, we assumed the
exclusive rights to market and distribute Gelclair(R) in North America. We
recorded an identifiable intangible asset of $29.0 million which was being
amortized over eight and a half years, the remaining term of the agreement. We
assess the potential impairment of our long-lived assets, under the provisions
of SFAS No. 144. In performing such recoverability test we determined that the
total of the expected future undiscounted cash flows directly related to the
Gelclair(R) asset was less than the carrying value of the Gelclair(R) asset. As
a result an impairment charge was required. The amount of the impairment charge
represents the difference between the fair value of the intangible asset and its
associated carrying value. We calculated the fair value of the intangible asset
using discounted cash flows. The discounted cash flows calculation was made
utilizing various assumptions and estimates regarding future revenues and
expenses, cash flow and discount rates. Based on these calculations, we
determined that an impairment charge of $24.6 million, which represented the
full unamortized balance of the Gelclair(R) intangible asset, was necessary as
of September 30, 2004. The impairment charge is non-cash and will not result in
future cash expenditures. The impairment charge resulted from both the recent
discontinuance of discussions with a replacement dental partner, and slower than
originally expected sales growth in the oncology marketplace following the
re-launch of the product in October 2003.

Amortization of Intangibles

The increase of $9.3 million is primarily related to amortization expense
related to our rights to Novantrone(R) acquired in March 2003 and to Gelclair(R)
acquired in June 2003. As noted above, in the fourth quarter of fiscal 2004, we
recorded an impairment charge for the remaining carrying value of the
Gelclair(R) rights as of September 30, 2004. As a result of the impairment
charge, amortization expense will decrease to approximately $15.0 million in
fiscal 2005.

48

OTHER INCOME AND EXPENSE

The decrease in investment income in fiscal 2004 was primarily due to a
decrease in the funds available for investment and a decrease in the average
rate of return on our investments during the respective years. The increase in
interest expense resulted from interest on the $150.0 million of 3.25%
convertible senior subordinated notes that we issued in September 2003, as well
as the guaranteed interest on the 4% convertible senior subordinated notes that
were converted into common stock in July 2004. Under the terms of the 4%
convertible senior subordinated notes, the note holders were guaranteed the
payment of interest for the first three years through February 1, 2005. The note
holders became fully entitled to the remainder of this guaranteed interest on
June 18, 2004, the date we called the notes for redemption. As a result of the
conversions, we issued 3.2 million shares of our common stock in July 2004 and
paid the remaining portion of the guaranteed interest of $6.4 million. This
resulted in an additional interest charge of $2.1 million in fiscal 2004
representing the portion of the guaranteed interest from October 1, 2004 to
February 1, 2005. We expect interest expense to decrease to approximately $5.0
million in fiscal 2005, as a result of the conversion of the 4% convertible
senior subordinated notes. Included in other expenses-net for fiscal 2004 and
2003, were amortization of debt issuance costs of $1.7 million and $834,000,
respectively, related to the convertible senior subordinated notes. The increase
in the amortization of debt issuance costs related to the 3.25% convertible
senior subordinated notes issued in September 2003. The debt issuance costs are
being amortized over a period of five years, which represents the earliest date
that we may redeem the notes. Upon the conversion of the 4% convertible senior
subordinated notes, the unamortized balance of the debt issuance costs of $3.7
million was reclassified to additional paid in capital. Also included in other
expenses-net for fiscal 2004 is minority interest in the net losses of Prosidion
of $907,000. As of September 30, 2004, the minority interests represent
approximately 3% ownership of Prosidion.

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's oncology assets.

Revenues

49

Sales Commissions and Product Sales

On March 11, 2003, we began recording Novantrone(R) sales commissions, upon
the execution of our Co-Promotion Agreement with an affiliate of 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 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.

License and Other Revenues

The decrease in license and other revenues in fiscal 2003 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 in January 2001 (see note
5(a) to the accompanying consolidated financial statements). In accordance with
the provisions of SAB No. 101, we were recognizing the $25.0 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 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.

Collaborative Revenues

The decrease in collaborative program revenues in fiscal 2003 was primarily
due to the phase-down of our collaboration in cosmeceuticals with Anaderm. 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, 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 revenue from research alliances going
forward.

Expenses

50

Cost of Product Sales

Cost of product sales related to sales of Gelclair(R) for the period June
12, 2003 to September 30, 2003, were $157,000 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.

Research and Development

Research and development expenses marginally increased during fiscal 2003
due to costs associated with the clinical development of Tarceva(TM) and
transition costs associated with the assimilation of Cell Pathways which were
offset by a shift from non-oncology and collaborative programs to oncology
programs. As of September 30, 2003, we 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
as compared to $30.8 million for fiscal 2002. 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.

Acquired In-Process Research and Development

In connection with the acquisition of Cell Pathways, 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(b) 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(c) 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.

Selling, General and Administrative

Selling, general and administrative expenses increased in fiscal 2003 due
to our significant investment in commercial operations during fiscal 2003. As a
result of our acquisition of the Novantrone(R) and Gelclair(R) rights in fiscal
2003, as well as our preparation for the launch of Tarceva(TM), expenses related
to commercial
51

operations increased approximately $38.6 million. This 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 built our commercial
operations; (iii) increased commercialization and marketing costs relating to
Tarceva(TM) which were 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 was a severance charge of $249,000 relating to a
reduction in our headcount in October 2002.

Amortization of Intangibles

The increase in amortization in fiscal 2003 was primarily due 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 was $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

The decrease to investment income-net in fiscal 2003 was primarily
attributable to a decrease in the average rate of return on our investments and
to less funds available for investment during the period. The increase in
interest expense 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 bore interest at 4% per annum, payable semi-annually, and were to mature
in February 2009. In August and September 2002, we retired a total of $40.0
million in principal amount of these notes. In July 2004, all of the outstanding
notes were converted into common stock. 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. The decrease in other expense-net was primarily due to the
amortization of debt issuance costs of $834,000, offset by realized gains from
the sale of investments of $347,000 in fiscal 2003 compared to 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) in fiscal
2002. With respect to the early retirement of the 4% 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 a $1.0 million contingent payment received
from The

52

Bayer Corporation in December 2001, in connection with the sale of the
diagnostic business in November 1999.

LIQUIDITY AND CAPITAL RESOURCES

General

At September 30, 2004, working capital, representing primarily cash, cash
equivalents, and restricted and unrestricted short-term investments, aggregated
$228.2 million compared to $379.6 million at September 30, 2003. This decrease
of $151.4 million was primarily due to net cash used in operating activities of
$144.9 million and the acquisition of certain assets from Probiodrug of $36.4
million, offset by proceeds from the exercise of options of $38.7 million.

We expect to incur continued losses over the three years following the
launch of Tarceva(TM) as we continue our investment in the commercialization and
development of Tarceva(TM) and other product candidates in our pipeline as well
as our research programs and our commercial operations. While we have
established a goal of achieving profitability and positive cash flow within 3
years of our launch of Tarceva(TM), the time required to reach profitability is
uncertain. 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 successfully manufacture, introduce
and market such technologies and products.

In the past, we have funded our research, development, commercial and
administrative support efforts through public and private sales of our
securities, including debt and equity securities. On November 12, 2004,
subsequent to the end of fiscal 2004, we concluded a public offering of 6.0
million shares of common stock at a price of $64.50 per share. Gross proceeds
totaled $387.0 million with net proceeds of approximately $365.0 million after
all related fees. In addition, on November 17, 2004, underwriters associated
with this offering exercised their over-allotment option to purchase an
additional 900,000 shares of our common stock at a price of $64.50 per share.
Gross proceeds from the exercise of the over-allotment option totaled $58.1
million with net proceeds of approximately $54.9 million. We believe that the
proceeds from this offering together with existing cash resources and projected
cash flows from Tarceva(TM) will be sufficient to execute our strategy going
forward as well as providing a solid financial base from which to fund our
existing operations. In September 2003, we issued a total of $150.0 million
aggregate principal amount of convertible senior subordinated notes due
September 8, 2023, or the 2023 Notes, in a private placement for net proceeds of
$144.8 million. The 2023 Notes bear interest at 3.25% per annum, payable
semi-annually, and mature on September 8, 2023. The 2023 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. The related debt issuance costs of $5.3 million were
deferred and are being amortized on a straight-line basis over a five-year term,
which represents the earliest date that we may redeem the 2023 Notes. In
connection with the issuance of the 2023 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 2023 Notes, we pledged $14.2 million of U.S. government 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. The aggregate fair value and
amortized cost of the restricted investment securities at September 30, 2004 was
$9.5 million. If all or any portion of the 2023 Notes have not been converted
into common stock prior to their maturity date, 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.

On February 1, 2002, we issued $200.0 million aggregate principal amount of
convertible senior subordinated notes due February 1, 2009, or the 2009 Notes,
in a private placement for net proceeds to us of approximately $192.9 million.
The 2009 Notes were convertible into shares of our common stock at a

53

conversion price of $50 per share, subject to normal and customary adjustments
such as stock dividends. The 2009 Notes were redeemable, in whole or in part, at
any time before February 1, 2005 if the closing price of our common stock
exceeded 150% of the conversion price then in effect for a specified period of
time, or the Provisional Redemption. The related debt issuance costs of $7.1
million were deferred and were being amortized on a straight-line basis over the
seven-year term of the 2009 Notes. In August and September 2002, we retired a
total of $40.0 million in principal amount of the 2009 Notes for an aggregate
purchase price of $26.2 million, including accrued interest of $133,000. In June
2004, we exercised our Provisional Redemption option and called for the full
redemption of the outstanding $160.0 million of the 2009 Notes. All of the
holders of the 2009 Notes converted their notes into shares of our common stock
prior to the redemption date of July 19, 2004. As a result of these conversions,
we issued 3.2 million shares of our common stock and paid the remaining portion
of the guaranteed interest of $6.4 million. Upon conversion, the $3.7 million
unamortized balance of the debt issuance costs was reclassified to additional
paid in capital.

Summary of Cash Flows

The following table summarizes our cash flows for fiscal years 2004, 2003
and 2002 (in thousands):

The fluctuations in cash used in operating activities are due to our
increased investments in our commercial operations and research and development
activities, as well as the timing of cash disbursements and receipts. Included
in cash provided by (used in) investing activities are net payments for
acquisitions in fiscal 2004, 2003 and 2002 of $36.4 million (Probiodrug), $46.0
million (Novantrone(R) rights) and $135.7 million (Gilead oncology assets),
respectively. Included in cash provided by financing activities in fiscal 2004
is $39.3 million relating primarily to the exercise of stock options. Included
in cash provided by financing activities in fiscal 2003 and 2002 are $131.0
million (net of purchase of treasury stock) and $173.9 million (net of
retirements), relating to the issuance convertible senior subordinated notes,
respectively.

COMMITMENTS AND CONTINGENCIES

Our major outstanding contractual obligations relate to our senior
subordinated convertible notes and our facility leases. The following table
summarizes our significant contractual obligations at September 30, 2004 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 3.25% per annum relating to our 2023
Notes.

(b) Purchase obligations include inventory commitments, commercial and research
commitments and other significant purchase commitments.
54

(c) Includes payments for termination benefits and facility refurbishments.

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, 2004, we have spent approximately 90% of our commitment
under the agreement. We, along with our partners, expect to continue our
investment in the further development of Tarceva(TM), beyond the
originally committed $300 million. We are also committed to share certain
commercialization costs relating to Tarceva(TM) with Genentech. Under the
terms of our agreement, there are no contractually determined amounts for
future commercial and development costs. However, we are in the process
of determining, together with Genentech and Roche, a development plan for
2005 and, together with Genentech, a commercial plan for the United
States for 2005. These costs will be shared by the parties pursuant to
the terms of our agreement with our partners.

- Under agreements with external CROs we will continue to incur expenses
relating to clinical trials of Tarceva(TM) and other clinical candidates.
The timing and amount of these disbursements can be based upon the
achievement of certain milestones, patient enrollment, services rendered
or as expenses are incurred by the CROs and therefore we cannot
reasonably estimate the potential timing of these payments.

- We have outstanding letters of credit issued by a commercial bank
totaling $3.0 million of which the full amounts were available on June
30, 2004. One is an irrevocable letter of credit related to our Oxford,
England facility which expires and is renewed annually with a final
expiration date of September 27, 2007. 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 and
is renewed annually with a final expiration date of September 22, 2008.

- We have a retirement plan which provides post-retirement 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 $3.9 million at September
30, 2004.

- In connection with the acquisition of Cell Pathways, 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).

- Under certain license and collaboration agreements with pharmaceutical
companies and educational institutions, we are required to pay royalties
and/or milestone payments upon the successful development and
commercialization of products. However, successful research and
development of pharmaceutical products is high risk, and most products
fail to reach the market. Therefore, at this time the amount and timing
of the payments, if any, are not known.

- Under certain license and other agreements, we are required to pay
license fees for the use of technologies and products in our research and
development activities or milestone payments upon the achievement of
certain predetermined conditions. These license fees are not deemed
material to our consolidated financial statements and the amount and
timing of the milestone payments, if any, are not known due to the
uncertainty surrounding the successful research, development and
commercialization of the products.

- We are negotiating the potential purchase of a 60,000 square foot
building, for our Corporate Headquarters. We estimate the total cost of
the building and required renovations, if acquired, to be approximately
$14.0 million, which we would finance from our existing cash.

55

ACCOUNTING PRONOUNCEMENTS

In December 2003, President Bush signed into law the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. The Act introduced both a
Medicare prescription drug benefit and a federal subsidy to sponsors of retiree
health care plans that provide a benefit at least "actuarially equivalent" to
the Medicare benefit. These provisions of the new law will affect accounting
measurements. In May 2004, the FASB issued FASB Staff Position, or FSP, No. FAS
106-2, "Accounting and Disclosure Requirements Related to the Improvement and
Modernization Act of 2003." FSP No. FAS 106-2 provides guidance on the
accounting for the effects of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, or the Act, for employers that sponsor
post-retirement health care plans that provide prescription drug benefits. It
requires those employers to provide certain disclosures regarding the effect of
the Federal subsidy provided by the Act. The accumulated post-retirement
benefits obligation or net post-retirement benefits cost in the consolidated
financial statements or accompanying notes do not reflect the effects of the Act
on our post-retirement benefit plan. We are in the process of determining the
impact of the Act on the accumulated post-retirement benefits obligation and net
post-retirement benefits cost.

ISSUED EXPOSURE DRAFT

On March 31, 2004, the FASB issued a proposed Statement, "Share-Based
Payment," that addresses the accounting for share-based awards to employees,
including employee-stock-purchase-plans, or ESPPs. The FASB formally proposed to
require companies to recognize the fair value of stock options and other stock-
based compensation to employees. The proposed statement would eliminate the
ability to account for share-based compensation transactions using APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and generally would require
instead, that such transactions be accounted for using a fair-value-based
method. The statement is expected to become effective for public companies
during the second half of 2005. We currently account for our stock-based
compensation plans in accordance with APB Opinion No. 25. Therefore, the
eventual adoption of this proposed statement, if issued in final form by the
FASB, will have a material effect 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 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 as defined by SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities," 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
U.S. government securities, or Restricted Investment Securities, with maturities
at various dates through August 2006 and November 2004, respectively. Upon
conversion of the 2009 Notes into our common stock in July 2004, we were
required to pay the remaining part of the guaranteed interest. Therefore, the
restricted investment securities pledged in relation to these notes were
liquidated. Upon maturity, the proceeds of the restricted investment securities
will be sufficient to pay the first six scheduled interest payments of the 2023
Notes when due. We consider our restricted investment securities to be
held-to-maturity
56

as defined by SFAS No. 115. 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.

At September 30, 2004, 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 periods would have
resulted in a $526,000 change in our net loss for fiscal 2004.

In March 2004, we began to enter into forward exchange contracts to reduce
foreign currency fluctuation risks relating to intercompany transactions for the
funding of our research activities in the United Kingdom. We account for these
derivative financial instruments in accordance with SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," which was amended by SFAS
No. 137 and SFAS No. 138. Changes in the fair value of a derivative that is
designated and documented as a cash flow hedge and is highly effective, are
recorded in other comprehensive income until the underlying transaction affects
earnings, and then are later reclassified to earnings. We formally assess, both
at the inception and at each financial quarter thereafter, the effectiveness of
the derivative instrument hedging the underlying forecasted cash flow
transaction. Any ineffectiveness related to the derivative financial
instruments' change in fair value will be recognized in the period in which the
ineffectiveness was calculated. As of September 30, 2004, the notional and fair
value of the foreign exchange contracts for British pounds was $1.6 million. The
contracts will mature over the next two months.

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.

Our long-term debt totaled $150.0 million at September 30, 2004 and was
comprised of our 2023 Notes which bear interest at a fixed rate of 3.25%. In
June 2004, we exercised our provisional redemption right and called for the full
redemption of the outstanding $160.0 million of the 2009 Notes which we issued
in February 2002. All of the holders of these notes converted their notes into
shares of our common stock prior to the redemption date of July 19, 2004. As a
result of these conversions, in July 2004, we issued 3.2 million shares of our
common stock and paid the remaining portion of the guaranteed interest of $6.4
million.

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.

57

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS

Index to Consolidated Financial Statements:

58

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2004
and 2003, 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, 2004. 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 the standards of the Public
Company Accounting Oversight Board (United States). 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, 2004 and 2003, and
the results of their operations and their cash flows for each of the years in
the three-year period ended September 30, 2004, in conformity with U.S.
generally accepted accounting principles.

As discussed in note 1(b) to the consolidated financial statements, the
Company adopted EITF 00-21 "Revenue Arrangements with Multiple Deliverables" in
2004.

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.

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 29, 2004

59

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004 AND 2003
(IN THOUSANDS EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements.
60

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

See accompanying notes to consolidated financial statements.
61

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002
(IN THOUSANDS)

See accompanying notes to consolidated financial statements.
62

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

See accompanying notes to consolidated financial statements.
63

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 subsidiary, OSI Pharmaceuticals (UK)
Limited, or OSI-UK and our majority-owned subsidiary, Prosidion Limited. During
fiscal 2003, we created Prosidion, into which we transferred our diabetes and
obesity research programs. As of September 30, 2004, we held an approximately
97% ownership interest in Prosidion. All intercompany balances and transactions
have been eliminated in consolidation. We operate in one segment. We are
primarily focused on the discovery, development and commercialization of
high-quality oncology products that both extend life and improve the
quality-of-life for cancer patients worldwide.

(b) Revenue Recognition

Sales Commissions and Product Sales

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., an affiliate of Serono, S.A. (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 by an external third
party. The split between oncology and multiple sclerosis sales is subject to
further adjustment based upon the parties' final review, in the subsequent
quarter. Based on past experience, we do not believe these adjustments, if any,
will be significant to the consolidated financial statements.

Product sales represent sales of Gelclair(R) Bioadherent Oral Gel in
accordance with an exclusive distribution agreement with Helsinn Healthcare
S.A., which allowed us to market and distribute Gelclair(R) in North America.
Gelclair(R) was acquired as part of our acquisition of Cell Pathways, Inc. (see
note 3(b)) and launched by us to the oncology market in the fourth quarter of
calendar 2003. In late October 2004, we exercised our right to terminate the
agreement with Helsinn. Under the terms of the agreement, Helsinn has the option
to purchase any and all of our inventory at cost plus 5% and if Helsinn does not
elect to purchase our inventory, we are permitted to continue to sell such
inventory. We are currently negotiating a new agreement with Helsinn. 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
estimated 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 $574,000 and $779,000 as of September 30, 2004 and 2003,
respectively, and is included in unearned revenue-current on the accompanying
consolidated balance sheets.

Licenses, Milestones and Other Revenues

Our revenue recognition policies for all nonrefundable upfront license fees
and milestone arrangements are in accordance with the guidance provided in the
Securities and Exchange Commission's Staff Accounting
64

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Bulletin No. 101, "Revenue Recognition in Financial Statements," as amended by
SEC Staff Accounting Bulletin No. 104, "Revenue Recognition." In addition, we
follow the provisions of Emerging Issues Task Force Issue 00-21, "Revenue
Arrangements with Multiple Deliverables" for multiple element revenue
arrangements entered into or materially amended after June 30, 2003. We received
a total of $25.0 million in upfront fees from Genentech, Inc. and Roche in
January 2001 which was originally being recognized on a straight-line basis 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 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 Principles Board Opinion No. 20, "Accounting
Changes," the remaining unearned revenue is being recognized prospectively over
the revised term. Further, as a result of the amendment to the OSI/ Genentech
agreement in June 2004, the remaining unearned upfront fee from Genentech of
approximately $1.8 million will be recognized in accordance with EITF 00-21, as
discussed below. As the Roche agreement was not modified or amended subsequent
to its original execution, the unearned upfront fee from Roche continues to be
recognized over the revised term and will be fully recognized as of December 31,
2004.

In the fourth quarter of fiscal 2004 we recognized $3.0 million in
milestone revenues from our partner Roche based upon the EMEA's notice of
acceptance for filing and review of our NDA for the use of Tarceva(TM) as a
monotherapy for the treatment of patients with advanced NSCLC who have failed at
least one chemotherapy regimen. Milestone payments from Roche are accounted for
such that revenue related to each payment be recognized over the entire contract
performance period, but not prior to the removal of the contingencies for each
milestone. Once a contingency is removed and the customer is obligated to make a
payment, the costs of the effort that has been incurred to date is divided by
the total expected research and development costs and revenue is recognized for
that milestone to the extent of the ratio of performance to date, less revenue
previously recognized.

In the fourth quarter of fiscal 2004, we also received a $7.0 million
milestone payment from Genentech, Inc. based upon the FDA's notice of acceptance
for filing and review of our NDA for the use of Tarceva(TM) as a monotherapy for
the treatment of NSCLC patients who have failed at least one chemotherapy
regimen. As a result of the amendment to the OSI/Genentech agreement in June
2004, we were required to account for the Genentech milestone received and the
remaining unearned upfront fee of approximately $1.8 million, in accordance with
EITF 00-21; Revenue Arrangements with Multiple Deliverables. Milestones received
from Genentech and the remaining unearned upfront fee will be recognized over
the term of the Manufacturing and Supply Agreement between Genentech and us.
This accounting resulted from the inability to determine the fair value of the
undelivered items in the arrangement as required by EITF 00-21. As a result, the
milestones are attributed to the last item delivered under the Manufacturing and
Supply Agreement. We will recognize such deferred revenue over the term of the
Manufacturing and Supply Agreement based on the lesser of the ratio of units
sold by Genentech to total expected units or the cumulative straight-line basis.
This estimate of expected unit sales will be adjusted periodically and whenever
events or changes in circumstances indicate that there could be a significant
change in such estimate.

Collaborative Program Revenues

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.

65

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

(c) Research and Development Costs

Research and development, or R&D, 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 2004, 2003 and 2002, R&D activities included $110.4
million, $99.8 million, and $95.1 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)). The
balance of R&D in fiscal years 2003 and 2002 represented 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 note 3).

(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 Opinion 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 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.

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. During fiscal 2004, Prosidion granted a fixed number of
stock options to employees at a price equal to the estimated value of Prosidion
common stock on the grant date. Therefore, under the principles of APB Opinion
No. 25, we do not recognize compensation expense associated with the grant of
stock options. 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.

66

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

The fair value of the options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:

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 2004, 2003 and 2002 is as follows (in thousands, except
per share information):

On March 31, 2004, the FASB issued a proposed Statement, "Share-Based
Payment," that addresses the accounting for share-based awards to employees,
including employee-stock-purchase-plans, or ESPPs. The FASB formally proposed to
require companies to recognize the fair value of stock options and other stock-
based compensation to employees. The proposed statement would eliminate the
ability to account for share-based compensation transactions using APB Opinion
No. 25 and generally would require instead, that such transactions be accounted
for using a fair-value-based method. The statement is expected to become
effective for public companies during the second half of 2005. Therefore, the
eventual adoption of this proposed statement, if issued in final form by the
FASB, will have a material effect on our consolidated financial statements.

(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
respective period. Common share equivalents (convertible senior subordinated
notes, stock options and warrants) are not included since their effect would be
anti-dilutive. The contingent shares pursuant to the contingent value rights are
not included since the contingency condition has not been satisfied.

67

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Such common share equivalents (convertible senior subordinated notes, stock
options and warrants) and contingent shares for fiscal 2004, 2003 and 2002
amounted to (in thousands):

If fiscal 2004, 2003 and 2002 had resulted in net income and had the common
share equivalents for our convertible senior subordinated notes due 2009
(3,200,000 shares) and our convertible senior subordinated notes due 2023
(2,998,800 shares) been dilutive, interest expense related to the notes would
have been added back to net income to calculate diluted earnings per share. The
related interest expense of these notes for fiscal 2004, 2003 and 2002 totaled
$13.4 million, $6.7 million and $5.2 million, respectively. As discussed in note
10(b), the convertible senior subordinated notes due 2009 were fully converted
into shares of our common stock in the fourth quarter of fiscal 2004.

(g) Comprehensive Income (Loss)

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

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 $34.7 million and $192.8
million as of September 30, 2004 and 2003, respectively.

(i) Investments

Investment securities at September 30, 2004 and 2003 consist of U.S.
government securities, municipal obligations and debt and equity securities of
financial institutions and corporations with strong credit ratings. 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.

68

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

In September 2003, in connection with the issuance of 3.25% convertible
senior subordinated notes (see note 10(a)), we pledged $14.2 million of U.S.
government securities, or Restricted Investment Securities, with maturities at
various dates through August 2006. In February 2002, in connection with the
issuance of 4.00% convertible senior subordinated notes (see note 10(b)), we
pledged $22.9 million of Restricted Investment Securities with maturities at
various dates through November 2004. We consider our Restricted Investment
Securities to be held-to-maturity, as defined by SFAS No. 115. 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 balance of Restricted Investment
Securities decreases as scheduled interest payments are made. The aggregate fair
value and amortized cost of the Restricted Investment Securities at September
30, 2004 were $9.5 million, of which $4.8 million was classified as short-term
and the balance of $4.7 million was classified as long-term. The aggregate fair
value and amortized costs of the Restricted Investment Securities at September
30, 2003 were $27.8 million and $27.6 million, respectively, of which $12.8
million was classified as short-term and the balance of $14.8 million as
long-term. As further discussed in note 10(b), all of the convertible senior
subordinated notes issued in February 2002 were converted into our common stock
in July 2004. In connection with the conversion, we paid the note holders the
remaining portion of the guaranteed interest of $6.4 million.

With respect to our facility leases for Horsham, Pennsylvania and Oxford,
England, we have outstanding letters of credit issued by a commercial bank. The
irrevocable letter of credit for our Horsham, Pennsylvania facility expires
annually with a final expiration date of September 22, 2008. This letter of
credit is for $400,000, of which the full amount was available at September 30,
2004. The irrevocable letter of credit for our Oxford, England facility expires
annually with a final expiration date of September 27, 2007. This letter of
credit is for $2.6 million, of which the full amount was available on September
30, 2004. 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, 2004 is $132,000 and $3.4 million,
respectively, relating to restricted cash and investments to secure these
letters of credit. Included in cash and cash equivalents and investment
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.

As further discussed in note 4(b), 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

We account for goodwill and other intangible assets in accordance with 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 business combinations. It specifies the criteria which
intangible assets acquired in a business combination must meet in order to be
recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill
and intangible assets 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).

69

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 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. In the fourth quarter of fiscal 2004, we
determined it was necessary to record an impairment charge as of September 30,
2004 related to our intangible asset for exclusive distribution rights to the
marketed product, Gelclair(R) in North America (see note 8).

(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. During the
second quarter of fiscal 2004, we recorded a provision of $2.0 million for
excess inventory that we considered to be in excess of forecasted future demand
based on the expiration date of the product on hand. During the fourth quarter
of fiscal 2004, we recorded an additional provision of $6.6 million in relation
to inventory on-hand and 2004 and 2005 purchase commitments with Helsinn that we
determined to be in excess of forecasted demand. This additional provision
related to $1.7 million of inventory on-hand and $4.9 million of purchase
commitments. The provision in connection with the purchase commitments is
accrued in accounts payable and accrued expenses on the accompanying
consolidated balance sheet. This excess inventory relates to the substantial
inventory obtained from the Cell Pathways acquisition, the required purchase
commitments that we assumed in the Cell Pathways acquisition and the current low
demand for the product. In late October 2004, we exercised our right to
terminate the agreement with Helsinn. Under the terms of the agreement, Helsinn
has the option to purchase any and all of our inventory at cost plus 5% and if
Helsinn does not elect to purchase our inventory, we are permitted to continue
to sell such inventory. We are currently negotiating a new agreement with
Helsinn. These inventory provisions are included in cost of product sales in the
accompanying consolidated statement of operations for fiscal 2004. Inventory,
net of the reserve for excess inventory, at September 30, 2004 and 2003,
consisted of the following (in thousands):

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 fixed assets 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) is 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, or 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, 2004 and 2003 were $2.1
million and $5.0 million, respectively.

(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) Accounting for Derivatives

We enter into forward exchange contracts to reduce foreign currency
fluctuation risks relating to intercompany transactions for the funding of our
research activities in the United Kingdom. We account for these derivative
financial instruments in accordance with SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which was amended by SFAS No.
137 and SFAS No. 138. When entered into, we designate and document these
derivative instruments as a cash flow hedge of a specific underlying exposure,
as well as the risk management objectives and strategies for undertaking the
hedge transactions. Changes in the fair value of a derivative that is designated
and documented as a cash flow hedge and is highly effective are recorded in
other comprehensive income until the underlying transaction affects earnings,
and then are later reclassified to earnings. We formally assess, both at the
inception and at each financial quarter thereafter, the effectiveness of the
derivative instrument hedging the underlying forecasted cash flow transaction.
Any ineffectiveness related to the derivative financial instruments' changes in
fair value will be recognized in the period in which the ineffectiveness was
calculated. As of September 30, 2004, the

71

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

notional and fair value of the foreign exchange contracts for British pounds was
approximately $1.6 million. The contracts will mature over the next two months.
There were no foreign exchange contracts as of September 30, 2003.

(r) 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.

(s) Debt Issuance Costs

Costs incurred in issuing the 3.25% convertible senior subordinated notes
are amortized using the straight-line method over a five year term, which
represents the earliest date that we may redeem such notes. Costs incurred in
issuing the 4.0% convertible senior subordinated notes were amortized using the
straight-line method over a seven year term. Upon conversion of the 4.0%
convertible senior subordinated notes, in July 2004, the remaining unamortized
costs of $3.7 million were reclassified to additional paid in capital (see note
10(b)). The amortization of the debt issuance costs is included in other expense
in the accompanying consolidated statements of operations.

(t) 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 U.S. generally accepted
accounting principles. Actual results could differ from those estimates and
assumptions.

(u) 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 a co-promotion agreement with Ares
Trading, an affiliate of Serono, 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 $46.0 million in cash,
including professional fees. The purchase price and related professional fees,
net of related amortization, are included in other intangible assets-net in the
accompanying consolidated balance sheets as of September 30, 2004 and 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
expense in the accompanying consolidated statement of operations for fiscal
2003. Under the terms of the agreement, we are also required to pay quarterly
maintenance fees 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 are expensed as incurred and included in selling, general and
administrative expenses on the accompanying consolidated statements of
operations for fiscal 2004
72

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

and 2003. We receive commissions on net sales of the product in the United
States for oncology indications. Sales commissions totaled $34.3 million and
$16.3 million for fiscal 2004 and 2003, respectively.

(3) ACQUISITIONS

(a) Probiodrug Assets

On July 26, 2004, our subsidiary, Prosidion, which is focused on the
discovery and development of diabetes and obesity therapeutics, completed the
acquisition of certain assets of Probiodrug AG, pursuant to the terms of an
asset purchase agreement dated June 17, 2004. Probiodrug is a development
company engaged in the research and development of drug candidates for various
targets and various indications, including metabolic diseases. The assets
acquired included a platform of dipeptidyl peptidase IV (DP-IV) technology,
which includes PSN9301 (formerly P93/01), a clinical candidate that is in Phase
II clinical trials for the treatment of Type 2 diabetes and issued method-of-use
claims that have been non-exclusively licensed to other companies for future
milestones and royalties payments. Upon the closing of the acquisition, we paid
$36.4 million in cash, including professional fees. The purchase price was
allocated to the assets acquired based on the fair values as of the date of the
acquisition. Of the $36.4 million purchase price, $32.8 million was assigned to
the drug candidate in clinical development, PSN9301, and was expensed at the
date of the acquisition and is included in acquired in-process research and
development expenses in the accompanying consolidated statement of operations
for fiscal 2004. The non-exclusive licenses issued to other companies as well as
the patent estate were valued at $3.6 million and are included in other
intangible assets-net on the accompanying consolidated balance sheet as of
September 30, 2004, and are being amortized on a straight-line basis through the
earliest expiration of the related patents in April 2017. We will also be
required to pay additional contingent milestone payments upon the achievement of
certain milestones related to the development of PSN9301.

The value assigned to the acquired in-process R&D was determined by
identifying the 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 $32.8
million and was assigned entirely to PSN9301. The value of the acquired
in-process R&D and the other identifiable intangible assets was determined by
estimating the projected net cash flows, based upon the future revenues to be
earned upon commercialization. In determining the value of the in-process R&D,
the assumed commercialization date for the product was 2010. Given the risks
associated with the development of new drugs, the revenue and expense forecast
was probability-adjusted to reflect the risk of advancement through the approval
process. The risk adjustments applied were based on the compound's stage of
development at the time of assessment and the historical probability of
successful advancement for compounds at that stage. The modeled cash flow was
discounted back to the net present value. The projected net cash flows from such
project were based on management's estimates of revenues and operating profits
related to such project. The value of the in-process R&D was based on the income
approach that focuses on the income-producing capability of the asset. 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 the project; future revenues; growth rates; 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 26% to reflect present value.

Prosidion also entered into a research agreement with Probiodrug whereby
Probiodrug would provide services directed to the research and development of
new lead molecules in the area of glucose-dependent insulinotropic peptide
receptor, or GIP, agonism and antagonism and DP-IV modulation and/or inhibition.

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Prosidion agreed to fund the research and development services to be performed,
up to $5.0 million dollars and would also be required to pay Probiodrug
royalties on the net sales of products that arise from the research and
development.

(b) 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
July 14, 2003.

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 entered into consulting agreements with 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. As of September 30, 2003, the full amount of these loans
were 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. As part
of the Cell Pathways transaction, we assumed the rights and obligations under an
exclusive distribution agreement with Helsinn that allowed us to market and
distribute Gelclair(R) in North America (United States, Canada and Mexico)
through January 2012. Cell Pathways previously had entered into a three-year
agreement with Celgene Corporation for the promotion of Gelclair(R), primarily
in the U.S. oncology market. On June 12, 2003, we entered into an agreement with
Celgene whereby we recovered full rights to market and distribute Gelclair(R)in
the oncology setting in North America. Our payment to Celgene under this
agreement for the full return of the rights was expensed in the fourth quarter
of fiscal 2003, upon the return of certain sales and marketing data. We were
also required to make a payment to Celgene on the first anniversary of the
effective date provided the transition services, as defined in the agreement,
had been provided to us. The transition services were expensed ratably over the
transition period from July 2003 through December 2003, and the payment was made
in June 2004. The agreement also provides for a milestone payment to Celgene
upon the achievement of a specified amount of net sales of Gelclair(R). We
previously had a marketing agreement with John O. Butler Company, under which
Butler marketed Gelclair(R) to the dental market. In April 2004, we agreed with
Butler to terminate this agreement. In the fourth quarter of fiscal 2004, we
recorded an impairment charge related to our intangible asset for the exclusive
distribution rights to Gelclair(R) (see note 8). In late October 2004, we
exercised our right to terminate the agreement with Helsinn. Under the terms of
the agreement, Helsinn has the option to purchase any and all of our inventory
at cost plus 5% and if Helsinn does not elect to purchase our inventory, we are
permitted to continue to sell such inventory. We are currently negotiating a new
agreement with Helsinn.

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

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 purchase price paid
represented negative goodwill of approximately $49.2 million. Since a portion of
the negative goodwill was 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 was 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 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 and contingent rights issued and cash paid..... $ 55,005
========

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: Aptosyn(R) ($3.7 million), which was at that time in a
Phase III trial in combination with Taxotere(R) for the treatment of advanced
non-small cell lung cancer, or NSCLC, and OSI-461 ($27.8 million).

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 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

(c) Gilead's Oncology Assets

On December 21, 2001, we acquired certain assets from Gilead Sciences, Inc.
pursuant to the terms of the Asset Purchase Agreement dated as of November 26,
2001. 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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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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.

(d) 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):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 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.

(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):

Our investment securities include mutual funds with a cost basis and fair
market value of $811,000 as of September 30, 2004 and a cost basis and fair
market value of $1.6 million as of September 30, 2003. Net realized gains
(losses) on sales of investments during fiscal 2004, 2003 and 2002 were $41,000,
$347,000, and $(143,000), respectively.

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Maturities of securities classified as available-for-sale, excluding mutual
funds, were as follows at September 30, 2004 (in thousands):

(b) Other Investments

In July 1997, we, together with Cold Spring Harbor Laboratory and Roche,
formed Helicon Therapeutics, Inc., 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, 2004, we owned approximately 4.17% of Helicon common stock. As of
September 30, 2004 and 2003, 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, 2004 and 2003, our investment in the limited
partnership was $1.3 million and $1.2 million, 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 developed and
provided 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 for fiscal 2002, 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 consolidated statement of operations for fiscal 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 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 of which $10.0 million was received as of September
30, 2004. We have entered into separate agreements with both Genentech and Roche
with respect to the alliance, as well as a Tripartite Agreement.

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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) 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 collaboration 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 collaboration 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 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 own and filed, and the first
supplemental NDA, which we will own and for which we will 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 under the OSI/Genentech collaboration
agreement which were defined in an amendment to the agreement effective as of
June 4, 2004. Pursuant to this amendment, we will co-promote Tarceva(TM) using a
sales force that will be equal to or greater than 25% of the combined
OSI/Genentech sales force. We will share equally in the operating profits or
losses on products resulting from the collaboration. Under the OSI/Genentech
collaboration 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.

In connection with our collaboration with Genentech, Genentech will
recognize all U.S. sales of Tarceva(TM). We will recognize revenues and losses
from our alliance with Genentech, which will consist of our 50% share of the
pretax profits (loss) generated from the sales of Tarceva(TM) in the United
States. We also will recognize manufacturing revenue from the sale of inventory
to Genentech for commercial sales of Tarceva(TM) in the United States and
partial reimbursement from Genentech of our Tarceva(TM)-related commercial
expenses. We will receive royalties on sales of Tarceva(TM) outside of the
United States by Roche and up to an aggregate of $92 million in non-refundable
milestone payments from Genentech and Roche upon the achievement of certain
milestones relating to regulatory submissions and approval, certain of which
have already been received.

The OSI/Genentech collaboration 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

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until either party exercises its early termination rights. The OSI/Genentech
collaboration agreement is subject to early termination in the event of certain
customary defaults, such as material breach of the agreement and bankruptcy. The
provisions of the amendment allowing us to co-promote are also subject to
termination by Genentech upon a material breach by us of the amendment which
remains uncured or upon a pattern of nonmaterial breaches which remains uncured.
In addition, since January 8, 2003, Genentech has had the right to terminate the
OSI/Genentech collaboration agreement with six months' prior written notice.

Effective June 4, 2004, we entered into a Manufacturing and Supply
Agreement with Genentech that defined each party's responsibilities with respect
to the manufacture and supply of clinical and commercial quantities of
Tarceva(TM). Under certain circumstances, if we fail to supply such clinical and
commercial quantities, Genentech has the right, but not the obligation, to
assume responsibility for such supply. The Manufacturing and Supply Agreement
will terminate upon the termination of the OSI/Genentech collaboration
agreement.

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) worldwide, other than the territories covered by the
OSI/Genentech collaboration 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 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 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 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 with Pfizer Inc.
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 $8.0 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
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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

and $1.8 million, respectively, of collaborative program revenues in the
accompanying consolidated statement of operations relating to the phase-down.

(c) Tanabe

Effective as of October 1, 1999, we entered into the Collaborative Research
and License Agreement with Tanabe Seiyaku Co. Ltd. focused on discovering and
developing novel pharmaceutical products to treat diabetes. In April 2003, we
assigned our rights and obligations under the collaborative agreement to
Prosidion. The contract period under this agreement expired on October 1, 2003
and was not renewed. Tanabe had the responsibility for further development and
marketing of any lead compound in exchange for milestone and royalty payments to
us. In March 2004, Prosidion entered into a termination agreement with Tanabe,
whereby Prosidion obtained the rights to certain patents developed under the
collaboration, subject to Tanabe's rights to develop and commercialize, in
certain Asian territories, certain compounds covered by such patents. In
consideration of the termination, Prosidion paid Tanabe $1.0 million in cash and
issued $1.0 million of Prosidion preferred stock. This expense of $2.0 million
is included in R&D expenses on the accompanying statement of operations for
fiscal 2004. Prosidion is also required to make certain payments to Tanabe upon
the achievement of certain milestones.

(d) Vanderbilt

Effective as of April 28, 1998, we entered into a Collaborative Research,
Option and Alliance Agreement with Vanderbilt University to conduct a
collaborative research program and seek a corporate partner to fund a technology
collaboration for the discovery and development of drugs to treat diabetes. 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. In April 2003, we assigned our rights and obligation under
the agreement of Prosidion. 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. Prosidion will pay to Vanderbilt a percentage of the revenues
it receives from Tanabe and any other third party which commercializes products
resulting from the OSI/Tanabe research program based on the extent to which
Vanderbilt technology and patents contributed to the product generating the
revenue.

(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, or FTC, 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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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.

We did not record any collaborative program revenues in fiscal 2004 due to
the expiration of these collaborations. Total collaborative program revenues
under our collaborative research agreements for fiscal 2003 and 2002 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 as well as the use of our DP-IV patent estate
acquired from Probiodrug. Licensees may be obligated to pay us 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

(7) PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

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

Depreciation expense relating to these assets for fiscal 2004, 2003 and
2002 was $14.3 million, $11.1 million and $8.7 million, respectively. We
capitalized $3.9 million and $3.4 million of computer software costs as of
September 30, 2004 and 2003, respectively, of which $2.9 million and $2.0
million was amortized as of September 30, 2004 and 2003, respectively.

(8) GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying amount of goodwill was $39.0 million and $38.8 million as of
September 30, 2004 and 2003, respectively. The balance as of September 30, 2004
includes a $206,000 effect from foreign currency exchange rate fluctuations
during fiscal 2004. We completed our annual impairment review of goodwill during
the first quarter of fiscal 2004 and determined that no impairment charge was
required. Amortization expense relating to capitalized workforce for fiscal 2002
was $1.3 million.

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

We acquired the exclusive rights to market and promote Novantrone(R) for
approved oncology indications in the United States from Serono in March 2003.
These rights are being amortized over the life of the underlying patent. 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 Pharma plc in January 2002 for a period of ten years.
These rights were being amortized over eight and a half years, the remaining
term of the agreement. SFAS No. 142 requires that intangible assets with
determinable useful lives

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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. In the fourth quarter of
fiscal 2004, it was determined that the carrying value of the Gelclair(R) rights
exceeded the expected future undiscounted cash flows. The impairment charge
resulted from both the recent discontinuance of discussions with a replacement
dental partner, and slower than originally expected sales growth in the oncology
marketplace following the re-launch of the product in October 2003. The
discounted cash flows calculation was made utilizing various assumptions and
estimates regarding future revenues and expenses, cash flow and discount rates.
Based upon our analysis, we recognized an impairment loss for the remaining
carrying value of the rights as of September 30, 2004. This impairment loss of
$24.6 million is included as impairment of intangible asset expense in the
accompanying consolidated statement of operations for fiscal 2004. In connection
with Prosidion's acquisition of certain assets of Probiodrug, we recorded
intangible assets for the acquired patent estate ($515,000) and two
non-exclusive licenses issued to Merck & Co., Inc. and Novartis Pharma AG ($3.1
million). These intangible assets are being amortized over the shortest life of
the patents in April 2017. In the first quarter of fiscal 2004, we made the
decision not to renew our research agreement with British Biotech plc and as a
result recorded an accelerated amortization relating to the license for compound
libraries of $217,000 which is included in amortization expense in the
accompanying consolidated statement of operations for fiscal 2004.

Amortization expense for these intangible assets for fiscal 2004, 2003 and
2002 was $18.6 million, $9.3 million, and $216,000, respectively. Amortization
expense is estimated to be $15.2 million for fiscal 2005 and $8.4 million for
fiscal 2006 and $283,000 for fiscal 2007 through 2010.

(9) ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses at September 30, 2004 and 2003 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, or the 2023 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 the 2023 Notes, for an additional net
proceeds to us of $14.5 million. The 2023

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Notes bear interest at 3.25% per annum, payable semi-annually, and mature on
September 8, 2023. The 2023 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 2023 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 2023
Notes to be redeemed, plus any accrued and unpaid interest. The holders of the
2023 Notes have the right to require us to purchase all of the 2023 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 2023 Notes plus any
accrued and unpaid interest. Upon a change in control, as defined in the
indenture governing the 2023 Notes, the holders of the 2023 Notes will have the
right to require us to purchase all of the 2023 Notes, or a portion thereof, not
previously called for redemption at a purchase price equal to 100% of the
principal amount of the 2023 Notes purchased, plus accrued and unpaid interest.
Upon the election, by the holders, of the right to require us to purchase the
2023 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 $5.3 million were deferred and are being amortized on a straight-line basis
over a five-year term, which represents the earliest date that we may redeem the
2023 Notes. In connection with the issuance of the 2023 Notes, we used $19.0
million of the net proceeds for the purchase of 503,800 shares of our common
stock (see note 11(h)). At September 30, 2004 and 2003, the fair value of the
outstanding 2023 Notes, was approximately $223.5 million and $147.7 million,
respectively, based on their quoted market value.

(b) 4.00% Convertible Senior Subordinated Notes

On February 1, 2002, we issued $200.0 million aggregate principal amount of
convertible senior subordinated notes, or the 2009 Notes, in a private placement
for net proceeds to us of $192.9 million. The 2009 Notes were 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. The 2009 Notes were
redeemable by us, in whole or in part, at any time before February 1, 2005 if
the closing price of our common stock exceeded 150% of the conversion price then
in effect for a specified period of time. The related debt issuance costs of
$7.1 million were deferred and were being amortized on a straight-line basis
over the seven-year term of the 2009 Notes. In August and September 2002, we
retired a total of $40.0 million in principal amount of the 2009 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 2009 Notes retired and accrued interest, resulted in a net gain on the early
retirement of the 2009 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. In June 2004, we called for the full redemption of the
outstanding $160.0 million of the 2009 Notes. All of the holders of the 2009
Notes converted their notes into shares of our common stock prior to the
redemption date of July 19, 2004. As a result of these conversions, we issued
3.2 million shares of our common stock and paid the remaining portion of the
guaranteed interest of $6.4 million which is included in interest expense on the
accompanying consolidated statement of operations for fiscal 2004. Under the
terms of the 2009 Notes, the note holders were guaranteed the payment of
interest for the first three years through February 1, 2005. Upon conversion of
the 2009 Notes, the remaining balance of the unamortized debt issuance costs of
$3.7 million was reclassified to additional paid in capital.

(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. The plans are administered by the

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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, or the 2001 Stock Option Plan, effective June 13, 2001, which was
approved by the stockholders on March 13, 2002. Under the 2001 Stock Option
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 2001 Stock Option 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 2001 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). On March 17, 2004, at the 2004 Annual Meeting
of Stockholders, our stockholders approved the Amended and Restated Stock
Incentive Plan, which was adopted by the Board of Directors on January 23, 2004.
This plan amends and restates the 2001 Stock Option Plan to permit, in addition
to the grant of options, the grant of restricted stock awards, stock
appreciation rights and stock bonus awards upon such terms and conditions as the
Compensation Committee appointed by the Board of Directors shall determine.

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, options granted to employees of OSI-UK, and options
granted to outside directors during fiscal 2004, 2003 and 2002:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

At September 30, 2004, we have reserved 5.9 million shares of our
authorized common stock for all shares issuable under options. At September 30,
2004, 2003 and 2002, the number of options exercisable were 2.6 million, 2.8
million, and 2.3 million, respectively.

Information regarding stock options outstanding as of September 30, 2004,
is as follows:

(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.

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

(c) Authorized Common and Preferred Stock

We have 200.0 million shares of authorized common stock, with a par value
of $.01 per share, and 5.0 million 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.

(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 2004, 2003 and 2002, approximately
16,000, 26,000, and 19,000 shares, respectively, were issued with approximately
136, 118, and 163 employees participating in the plan, respectively. At
September 30, 2004, we had 566,000 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. As a result of our decision in the fourth quarter of fiscal
2004 to consolidate all of our U.K.-based oncology research and development
activities into our New York locations (see note 17(b)), we did not offer this
plan to employees for fiscal 2004. 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, 2004, there were 45 employees and 75 employees in
the 2003 and 2002 stock purchase plans, respectively. At September 30, 2004, we
had 152,000 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 1996 Annual Meeting of Stockholders, the stockholders
approved the Stock Purchase Plan for Non-Employee Directors, or the Directors'
Stock Purchase Plan.

On December 11, 2002, our Board of Directors approved an amendment to the
Directors' Stock Purchase Plan. Pursuant to the amended Directors' 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 2003
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 Directors' Stock Purchase Plan as well.
At September 30, 2004, we had 58,000 shares of our common stock reserved in
connection with this plan.

(f) Issuance of Common Stock to Gilead

On December 21, 2001, in connection with the acquisition of certain
oncology assets from Gilead, we issued approximately 925,000 shares of common
stock valued at $40.0 million (see note 3(c)).

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

(g) Issuance of Common Stock to Cell Pathways

On June 12, 2003, in connection with the acquisition of Cell Pathways, we
issued approximately 2.2 million shares of our common stock valued at $31.2
million (see note 3(b)).

(h) Convertible Notes

On September 8, 2003, we issued $135.0 million aggregate principal amount
of 2023 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 2023
Notes, for additional net proceeds to us of $14.5 million. The 2023 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 2023 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
2009 Notes in a private placement. In August and September 2002, we retired a
total of $40.0 million in principal amount of the 2009 Notes for an aggregate
purchase price of approximately $26.2 million. The 2009 Notes were 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. In June 2004, we called for the full redemption of the outstanding
$160.0 million of the 2009 Notes. All of the holders of the 2009 Notes converted
their notes into shares of our common stock prior to the redemption date of July
19, 2004. As a result of these conversions, we issued 3.2 million shares of our
common stock. Upon conversion of the 2009 Notes the remaining balance of the
unamortized debt issuance costs of $3.7 million was reclassified to additional
paid in capital (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 -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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

As of September 30, 2004, we have available U.S. federal and foreign net
operating loss carry forwards of approximately $696 million and $53 million,
respectively which will expire in various years from 2005 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 2024. Certain of our net
operating loss carry forwards and research and development tax credits may be
subject to significant limitations under Section 382 of the Internal Revenue
Code.

Of the $415 million valuation allowance at September 30, 2004, $104 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 $8.8 million, $7.4 million, and $6.2 million for
fiscal 2004, 2003 and 2002, respectively. Rent expense for fiscal 2004 includes
the Oxford, England facility leases, the Boulder, Colorado facility leases
(acquired in December 2001), the Farmingdale, New York facility lease, the
Melville, New York facility lease (commenced in June 2001), the Uniondale, New
York facility lease and the Horsham, Pennsylvania facility lease (acquired in
June 2003). As further discussed in note 17, we accrued for the remaining net
lease rental payments for the

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YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Horsham and Uniondale facilities in fiscal 2004 and the remaining net lease
rental payments for the Birmingham, England facility in fiscal 2002.

The following is a schedule of future minimum rental payments for the next
five fiscal years and thereafter required as of September 30, 2004, assuming
expiration of the leases for the Uniondale facility in June 2006, the Boulder
facilities in October 2006, the Horsham facility in June 2008, the Melville
facility in December 2009, the two Oxford facilities in August 2009 and March
2021, and the Farmingdale facility in May 2022. Also included in the amounts
below are commitments for equipment under various operating leases (in
thousands).

2005........................................................ $ 8,188
2006........................................................ 6,589
2007........................................................ 5,208
2008........................................................ 6,168
2009........................................................ 5,794
2010 and thereafter......................................... 48,789
-------
$80,736
=======

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 companies and universities
advising us that various products under research and development by us may be
infringing existing patents of such entities. These matters are reviewed by
management and, if necessary, 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 companies or modify the
conduct of its research. Our future royalties, if any, may be substantially
reduced 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, 2004, we had a line of credit with a commercial bank in
the amount of $10 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, 2004 and 2003.

(14) RELATED PARTY TRANSACTIONS

One member of our Board of Directors is a partner in a law firm which
represents us on our patent and license matters. Fees paid to this firm in
fiscal 2004, 2003 and 2002 were approximately $557,000, $579,000, and $504,000,
respectively. One member of our Board of Directors is a controlling member of
Mehta Partners LLC with which we had a strategic and financial services
arrangement that expired in December 2002. In

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

fiscal 2002, we paid Mehta Partners $175,000 for consulting services. In
addition, we have compensated other directors for services performed pursuant to
consultant arrangements. In fiscal 2004, 2003 and 2002, consulting fees in the
amounts of $139,000, $150,000, and $153,000, respectively, were paid by us
pursuant to these arrangements. One member of our Board of Directors was an
officer of Cold Spring Harbor Laboratory through December 2003, 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. One member of our Board of Directors 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. One member of our Board of Directors 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 has outstanding loans
with us aggregating $200,000 with a carrying amount of $164,000 as of September
30, 2004. 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
2004, 2003 and 2002, our expenses related to the plan were approximately
$625,000, $543,000, and $502,000, respectively.

We also sponsor four pension plans covering the employees of OSI-UK and
Prosidion. 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, 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
invests, we will contribute up to 9% into the funds. For fiscal 2004, 2003, and
2002, our expenses related to the plans were $841,000, $714,000, and $602,000,
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, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" as amended by SFAS No. 132(R),
"Employers' Disclosures About Pensions and Other Postretirement Benefits," to
account for and disclose 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. In May 2004, the FASB issued FASB Staff

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

Position, or FSP, No. FAS 106-2, "Accounting and Disclosure Requirements Related
to the Medicare Prescription Drug, Improvement and Modernization Act of 2003."
FSP No. FAS 106-2 provides guidance on the accounting for the effects of the
Medicare Prescription Drug, Improvement and Modernization Act of 2003, or the
Act, for employers that sponsor postretirement health care plans that provide
prescription drug benefits. It requires those employers to provide certain
disclosures regarding the effect of the federal subsidy provided by the Act. The
accumulated postretirement benefits obligation or net postretirement benefits
cost in the consolidated financial statements accompanying notes do not reflect
the effects of the Act on our postretirement benefit plan. We are in the process
of determining the impact of the Act on the accumulated postretirement benefits
obligation and net postretirement benefits cost to be recorded.

Net postretirement benefit cost for fiscal 2004, 2003 and 2002 includes the
following components (in thousands):

The accrued postretirement benefit cost at September 30, 2004 and 2003 was
as follows (in thousands):

The changes in the accumulated postretirement benefit obligation during
fiscal 2004 and 2003 were as follows (in thousands):

In fiscal 2004, the health care cost trend was increased to an initial
level of 12% (from an initial level of 8% in fiscal 2003), decreasing to an
ultimate rate of 5% by 2011 and thereafter. Increasing the assumed health care
cost trend rates by one percentage point in each year and holding all other
assumptions constant would increase the accumulated postretirement benefit
obligation as of September 30, 2004 by $1.3 million and the fiscal 2005 net
postretirement service and interest cost by $344,000. Decreasing the assumed
health care cost trend rate by one percentage point in each year and holding all
other assumptions constant would decrease the accumulated postretirement benefit
obligation as of September 30, 2004 by $1.0 million and the fiscal

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

2005 net postretirement service and interest cost by $252,000. Benefits paid
during fiscal 2004, 2003 and 2002 were $83,000, $60,000 and $60,000,
respectively.

The weighted average assumptions used in determining benefit obligations
and net periodic benefits costs are as follows:

(17) CONSOLIDATION OF FACILITIES

(a) Uniondale, New York

During the fourth quarter of fiscal 2003, we consolidated operations at our
Uniondale, New York facility with our Farmingdale, New York facility. During the
fourth quarter of 2004, we made the decision not to further utilize our
Uniondale facility. As a result, we have accrued for costs relating to this exit
activity. The estimated exit costs as of September 30, 2004 are $1.9 million,
all of which are included in selling, general and administrative expenses in the
accompanying consolidated statement of operations for fiscal 2004. These exit
costs are comprised of the rental obligations for the remainder of the lease
(through June 2006) of $994,000, offset by previously accrued rent expense of
$180,000, the write down of equipment and leaseholds of $724,000, and costs to
restore the facility to its original condition of $350,000.

(b) Oxford, England

During the fourth quarter of fiscal 2004, we announced the decision to
consolidate all of our U.K.-based oncology research and development activities
into our New York locations by approximately November 30, 2004. As of September
30, 2004, we estimate that the consolidation will result in a reduction in our
U.K.-based oncology workforce by approximately 82 employees. The termination
benefits provided to current employees is estimated at $3.7 million as of
September 30, 2004, of which $3.0 million is included in research and
development expenses and $767,000 is included in selling, general and
administrative expenses in the accompanying consolidated statement of operations
for fiscal 2004. Although our subsidiary, Prosidion, will continue operations at
the Oxford facility, we will recognize a liability for rental obligations
relating to the portion of the facilities vacated by our oncology operations,
currently estimated to occur in either the first or second quarters of fiscal
2005. We did accelerate the useful lives of certain related leasehold
improvements, which resulted in additional depreciation expense of $2.0 million,
of which $1.7 million is included in research and development expenses and
$277,000 is included in selling, general and administrative expenses in the
accompanying consolidated statement of operations for fiscal 2004.

(c) Horsham, Pennsylvania

During the second quarter of fiscal 2004, we committed to and approved an
exit plan for our Horsham, Pennsylvania facility which we acquired in connection
with the acquisition of Cell Pathways in June 2003. We have recognized the rent
obligations for the remainder of the lease (through June 2008), offset by the
sublease rental income. This resulted in a charge of $1.8 million which has been
included in selling, general and administrative expenses in the accompanying
consolidated statement of operations for fiscal 2004. These exit costs are
comprised of the net lease obligations of $2.1 million, offset by previously
accrued rent expense of $338,000. In May 2004, we entered into a sublease
agreement for the Horsham facility. We charge the rental

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

payments less the sublease rental income received against the accrued liability.
The consolidation activity for fiscal 2004 was as follows (in thousands):

(d) Birmingham

During the fourth quarter of fiscal 2001, we announced the decision to
consolidate our Birmingham, England facility with the then newly acquired
Oxford, England facility as a result of the acquisition of the British Biotech
assets. The operations at the Birmingham 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 (R&D expense of $3.8 million and selling, general and
administrative expenses of $511,000). 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 were not being relocated
of $2.1 million, and severance costs of $190,000. The consolidation activity for
fiscal 2003 and 2002 was as follows (in thousands):

(e) 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 our other 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

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

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 consolidated activity for fiscal 2002 was as
follows (in thousands):

(18) QUARTERLY FINANCIAL DATA (UNAUDITED)

The tables below summarize our unaudited quarterly operating results for
fiscal 2004 and 2003.

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.

(19) SUBSEQUENT EVENTS

(a) Public Offering

On November 12, 2004, we concluded a public offering of 6.0 million shares
of common stock at a price of $64.50 per share. Gross proceeds totaled $387.0
million with net proceeds of approximately $365.0 million after all related fees
are included. In addition, on November 17, 2004, underwriters associated with
this offering exercised their over-allotment option to purchase an additional
900,000 shares of our common stock at a price of $64.50 per share. Gross
proceeds from the exercise of the over-allotment option totaled $58.1 million
with net proceeds of approximately $54.9 million.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002

(b) Tarceva(TM) Approval

On November 18, 2004, we announced that the FDA approved our NDA for
monotherapy Tarceva(TM) use in the treatment of all NSCLC patients who have
failed at least one prior chemotherapy regimen. Tarceva(TM) met its primary
endpoint of improving overall survival and its key secondary endpoints of
progression-free survival and objective tumor response rate in a 731-patient
randomized, double-blinded placebo controlled Phase III trial, or the BR.21
study. We launched Tarceva(TM) on November 22, 2004, the second business day
after approval.

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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, despite 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.

99

ITEM 9B. OTHER INFORMATION

Not Applicable.

100

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 2005 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2004.

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 2005 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2004.

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 2005 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2004.

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 2005 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2004.

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 2005 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2004.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(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.

102

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 13, 2004

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.

103

104

INDEX TO EXHIBITS

105

106

107

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

* 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.

108