<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K
(Mark One)
  [ x ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
  Exchange Act of 1934
                  For the Fiscal Year Ended December 31, 2000
                                      or
  [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
  Exchange Act of 1934
                        Commission File Number: 0-19171

                               ICOS CORPORATION
            (Exact name of registrant as specified in its charter)

                      Delaware            91-1463450
                   (State of               (I.R.S.
                   incorporation)          Employer
                                        Identification
                                             No.)

                            22021-20th Avenue S.E.
                           Bothell, Washington 98021
                                (425) 485-1900
  (Address, including zip code, and telephone number, including area code, of
                         principal executive offices)

       Securities registered pursuant to Section 12(b) of the Act: None
          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.01 par value

  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
                                Yes  X  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 ]

State the aggregate market value of voting and non-voting stock held by non-
affiliates of the registrant as of February 12, 2001.
                                $2,355,578,628
  Indicate the number of shares outstanding of each of the registrant's
classes of Common Stock as of February 12, 2001.

<TABLE>
<CAPTION>
                Title of Class                                Number of Shares
                --------------                                ----------------
         <S>                                                  <C>
         Common Stock, $.01 par value                            52,515,007
</TABLE>

                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive Proxy Statement for the annual meeting
of stockholders to be held on May 4, 2001, relating to "Election of
Directors," "Continuing Class 3 Directors (until 2002)," "Continuing Class 1
Directors (until 2003)," "Other Executive Officers," "Section 16(a) Beneficial
Ownership Reporting Compliance," "Compensation of Directors," "Executive
Compensation," "2000 Option Grants," "2000 Option Exercises and Year-end
Option Values," "Compensation Committee Interlocks and Insider Participation,"
"Employment Contracts, Termination of Employment and Change of Control
Arrangements," "Security Ownership of Certain Beneficial Owners and
Management," and "Certain Relationships and Related Transactions" are
incorporated by reference in Part III of this Form 10-K.
<PAGE>

                                ICOS CORPORATION

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
 Part I
 ------
 <C>         <S>                                                           <C>
    Item 1.  Business                                                        3
    Item 2.  Properties                                                     22
    Item 3.  Legal Proceedings                                              22
    Item 4.  Submission of Matters to a Vote of Security Holders            22

<CAPTION>
 Part II
 -------
 <C>         <S>                                                           <C>
    Item 5.  Market for the Registrant's Common Equity and Related
             Stockholder Matters                                            23
    Item 6.  Selected Consolidated Financial Data                           23
    Item 7.  Management's Discussion and Analysis of Financial Condition
             and Results of Operations                                      24
    Item 7A. Quantitative and Qualitative Disclosure about Market Risk      29
    Item 8.  Consolidated Financial Statements and Supplementary Data       29

<CAPTION>
 Part III
 --------
 <C>         <S>                                                           <C>
    Item 10. Directors and Executive Officers of the Registrant             48
    Item 11. Executive Compensation                                         48
    Item 12. Security Ownership of Certain Beneficial Owners and
             Management                                                     48
    Item 13. Certain Relationships and Related Transactions                 48

<CAPTION>
 Part IV
 -------
 <C>         <S>                                                           <C>
    Item 14. Exhibits, Consolidated Financial Statement Schedules, and
             Reports on Form 8-K                                            49
</TABLE>

                                       2
<PAGE>

                                    PART I

Item 1. Business

Overview

ICOS is a product-driven company that has expertise in both protein-based and
small molecule therapeutics. We combine our capabilities in molecular,
cellular and structural biology, high throughput drug screening, medicinal
chemistry and genomics to develop highly innovative products with significant
commercial potential. We apply our integrated approach to specific target
areas where we have expertise. We believe this strategy increases our chances
of successfully developing commercial products.

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

  .  Cialis(TM)(/1/), which is being developed in collaboration with Eli
     Lilly and is in Phase 3 clinical trials for the treatment of erectile
     dysfunction and in Phase 2 clinical trials for the treatment of female
     sexual dysfunction;

  .  Pafase(R)(/2/), which is being developed in collaboration with Suntory
     for the treatment of severe sepsis and is anticipated to enter Phase 3
     clinical trials in the first half of 2001;

  .  Sitaxsentan, which is being developed in collaboration with Texas
     Biotechnology for the treatment of pulmonary arterial hypertension and
     is anticipated to enter Phase 2b/3 clinical trials in the first half of
     2001;

  .  TBC3711, which is being developed in collaboration with Texas
     Biotechnology for the treatment of congestive heart failure and
     essential hypertension, is in Phase 1 clinical trials; and

  .  IC14, which is in Phase 1 clinical trials for the treatment of sepsis.

Business Strategy

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

Obtaining regulatory approval for and successfully commercializing Cialis and
Pafase. We intend to complete clinical trials and obtain regulatory approval
of Cialis and Pafase. These product candidates target significant markets. We
intend to increase awareness of the benefits of these product candidates over
existing therapies through sales and marketing efforts. We plan to continue
working with Eli Lilly with respect to Cialis and Suntory with respect to
Pafase in developing and establishing market awareness of these product
candidates.

Diversifying our portfolio of product candidates. We continue to develop a
broad portfolio of product candidates encompassing a variety of therapeutic
approaches to address both chronic and acute diseases. For example, we are
currently discovering and developing product candidates targeting erectile
dysfunction, sepsis, pulmonary arterial hypertension and other cardiovascular
diseases, female sexual dysfunction, inflammatory diseases, infectious
diseases and cancer. Developing therapeutics to treat these diseases is
difficult and time consuming. In our industry, a large number of product
candidates that enter clinical testing fail to achieve regulatory approval. To
compensate for this risk, we plan to continue developing a number of product
candidates in parallel.

Using our internal capabilities to discover and develop novel product
candidates. Since our inception, we have focused our research and development
efforts on both protein-based and small molecule therapeutics. Using our
capabilities in molecular, cellular and structural biology, high throughput
drug screening, medicinal chemistry and genomics, we have successfully
identified novel product candidates and obtained patents for these candidates.
We believe that proteins and small molecules will be primary areas for
pharmaceutical development for the foreseeable future, particularly as genomic
research identifies novel disease targets. We plan to continue our discovery
and development efforts in these areas, emphasizing diseases and medical
conditions for which current therapies are substandard or unavailable and for
which the market opportunities are large.

Identifying attractive acquisition and in-licensing candidates. In addition to
our own development efforts, we plan to continue to identify opportunities to
acquire or in-license late-stage product candidates. Our IC14, sitaxsentan and
TBC3711 product candidates are the result of such acquisition and in-licensing
efforts. We believe that we are well positioned to attract

-------
(1) A trademark application has been filed on Cialis by Lilly ICOS LLC,
    Wilmington, Delaware, U.S.A.

(2) Pafase is a registered trademark to ICOS Corporation, Bothell, Washington,
    U.S.A.

                                       3
<PAGE>

additional product candidates as a result of our demonstrated experience and
success in negotiating and completing such acquisitions and arrangements.

Forming strategic collaborations. We intend to continue partnering with large
pharmaceutical companies and other biotechnology companies. We have
established corporate collaborations to enhance the development of product
candidates while maintaining substantial rights, thereby offsetting a
substantial portion of the financial risk of developing these product
candidates. For example, we have entered into collaborations with Eli Lilly,
Suntory and Texas Biotechnology. Collaborations such as these generally enable
us to develop a greater number of product candidates than otherwise would be
possible, lower the significant financial investment required to develop these
product candidates, and provide us with domestic and international marketing
and sales expertise for our partnered product candidates if approved. When we
enter into collaborations, we seek to retain strategically important sales and
marketing rights in order to optimize the value of our drug development
opportunities.

Expanding our intellectual property portfolio. We intend to aggressively
pursue protection of our proprietary technology and other intellectual
property. We believe that establishing a strong proprietary position could
provide an important competitive advantage in our target markets. We have
aggressively pursued comprehensive patent protection of our product
candidates. As of December 31, 2000, we owned or exclusively licensed 131
United States patents and we had 118 patent applications pending in the United
States that we filed on our own behalf or on behalf of our joint ventures or
exclusive licensors. When appropriate, we also seek foreign patent protection
and as of December 31, 2000, we owned or exclusively licensed 82 foreign
patents.

Development Pipeline

We are developing several product candidates targeting a variety of serious
diseases and medical conditions. The two charts in this section summarize our
product development programs in which we are conducting clinical trials or are
engaged in preclinical development or research. In the status column of the
charts: "Research" indicates the research phase of the product identification
process for compounds for which activity in target human biological assay
systems has been demonstrated in laboratory tests, but which have not yet been
tested in non-human animal models of specific human diseases; "Preclinical"
indicates evaluation of lead or preferred compounds for safety, pharmacology
and proof of efficacy in non-human animal models; "Phase 1" indicates a
clinical trial for safety, pharmacology and dose-determining drug regimen;
"Phase 2" indicates a clinical trial to determine dosing and efficacy; "Phase
2a" indicates a small clinical trial to determine potential therapeutic doses;
"Phase 2b" indicates a larger clinical trial to determine efficacy of chosen
therapeutic doses; and "Phase 3" indicates a confirmatory clinical trial to
determine efficacy and safety as primary support for regulatory approval. We
expect to enroll patients in the Phase 3 clinical trial of Pafase(R) and in
the Phase 2b/3 clinical trial of sitaxsentan for the treatment of pulmonary
arterial hypertension in the first half of 2001.

We have retained significant marketing rights to each of the product
candidates covered by partnership arrangements. For example, we have retained
co-promotion rights to Cialis(TM) in North America and Europe, have retained
marketing rights to Pafase in the United States and share marketing rights to
Pafase with Suntory outside of Japan and the United States, and share
worldwide marketing rights to sitaxsentan and TBC3711 with Texas
Biotechnology.

                         Clinical Development Pipeline

<TABLE>
<CAPTION>
      Product Candidate    Target Indication               Status       Partner
    ---------------------------------------------------------------------------------------------------

      <S>                  <C>                             <C>          <C>
      Cialis               Erectile dysfunction            Phase 3      Eli Lilly and Company
                           Female sexual dysfunction       Phase 2

      Pafase               Sepsis                          Phase 3 *    Suntory Limited

      Endothelin Receptor
       Antagonists:
        Sitaxsentan        Pulmonary arterial hypertension Phase 2b/3 * Texas Biotechnology Corporation
        TBC3711            Congestive heart failure        Phase 1      Texas Biotechnology Corporation
                           Essential hypertension

      IC14                 Sepsis                          Phase 1
</TABLE>

      *    Expect to enroll patients in the first half of 2001.

Cialis

We are evaluating Cialis, a small molecule compound that inhibits the
phosphodiesterase type 5 enzyme, or PDE5, for the treatment of erectile
dysfunction and female sexual dysfunction. In 1998, we formed a joint venture
entity with Eli Lilly called Lilly ICOS LLC to develop and commercialize
Cialis.

                                       4
<PAGE>

   Erectile Dysfunction Clinical Application

Erectile dysfunction is a condition in which a man is unable to attain or
maintain an erection sufficient for sexual intercourse. Erectile dysfunction
affects an estimated 70 million men in North America and Europe, and it is
increasingly recognized as a serious and treatable medical condition. Erectile
dysfunction is often associated with underlying diseases such as diabetes,
cardiovascular disease and depression, or may be a consequence of prostate
surgery, spinal cord injury or treatment with certain medications. In the
typical erection process, tactile and visual stimuli lead to increased blood
flow into penile tissue, resulting in an erection. As part of this process, a
chemical called cyclic GMP causes penile blood vessels to dilate, allowing
blood flow to increase. PDE5, an enzyme present in penile blood vessels,
removes cyclic GMP from penile tissue, thereby allowing the penile blood
vessels to return to their undilated state. Inhibition of PDE5 can enhance
blood flow to the penis, contributing to an erection.

Current Treatment. Until 1998, treatments for erectile dysfunction were
primarily limited to the use of injectibles, vacuum pumps and prostheses,
which are inconvenient and unpleasant options that have restricted the size of
the treated population. With the introduction in 1998 of Viagra(R), the first
effective oral treatment for erectile dysfunction, millions of men were
motivated for the first time to acknowledge their affliction and seek
treatment. We believe that many men have ceased therapies for erectile
dysfunction due to ineffectiveness, unpleasant side effects or inconvenient
administration. We believe that as few as 10% of the men who could benefit
from orally administered treatment for erectile dysfunction are currently
undergoing treatment.

Potential Treatment by Cialis(TM). Cialis is a small molecule compound that
inhibits PDE5, increasing cyclic GMP levels and consequently increasing blood
flow to the penis. We believe Cialis is a more promising therapy for erectile
dysfunction than current therapies because it has been shown in in vitro
studies to narrowly target PDE5, and therefore may produce a lower risk of
certain side effects associated with currently available therapies. Cialis may
encourage use among the untreated population of erectile dysfunction patients
in addition to those currently using therapies for erectile dysfunction.

Development Status. To date, we have initiated over 50 Phase 1, 2 and 3
clinical trials evaluating Cialis for the treatment of erectile dysfunction.
For example, Cialis has been evaluated in three Phase 2 clinical trials
conducted in an outpatient setting. These trials were multicenter, randomized
and placebo-controlled. One of these trials assessed daily Cialis
administration at doses of 10 mg to 100 mg. In the other two trials, patients
used Cialis as needed at doses of 2 mg to 25 mg. In each of these studies,
questionnaires, patient diaries and partner diaries reported erectile function
in both pre-treatment periods and periods during which the patient was on
treatment. In all three studies, Cialis improved the patients' ability to
attain and maintain an erection sufficient for sexual intercourse and
increased both the percentage of successful sexual attempts reported by
patients in patient diaries as well as the proportion of experiences
satisfying to both patients and partners. The most frequently reported
treatment-related side effects in these studies were headache, back pain,
muscle ache and heartburn-like symptoms. Most of these side effects were mild
to moderate in intensity and decreased with continued treatment.

We are currently conducting a Phase 3 clinical program for Cialis. We plan to
submit a New Drug Application for Cialis to the FDA in the second half of
2001, subject to the successful conclusion of our clinical trials.

   Female Sexual Dysfunction Clinical Application

Female sexual dysfunction is a general term that describes a variety of
conditions, including lack of sexual desire, lack of sexual arousal, inability
to achieve orgasm and pain during intercourse. Female sexual dysfunction has
been reported to affect greater than 40% of adult women in the United States.
Research in female sexual dysfunction is considerably less advanced than that
of erectile dysfunction. In addition, the factors that underlie female sexual
dysfunction are not well understood. At present, treatment for female sexual
dysfunction is primarily limited to counseling, hormonal treatment and vaginal
lubricants. These products may reduce discomfort, but do not directly address
desire, arousal and orgasmic disorders.

We are evaluating Cialis for the treatment of some forms of female sexual
dysfunction. Women were included in Phase 1 clinical trials of Cialis, and a
Phase 2 clinical program is being conducted to further explore the safety and
efficacy of Cialis in women suffering from female sexual dysfunction.

Pafase(R)

We are evaluating Pafase, a recombinant human serum protein, for the treatment
of sepsis and other diseases characterized by increased activity of platelet-
activating factor, or PAF. Pafase breaks down PAF, a chemical produced by the
body that generally acts to induce or increase inflammation. In 1997, we
formed a joint venture entity with Suntory called Suncos to develop and
commercialize Pafase. We have funded the development and commercialization of
Pafase in part through contributions from ICOS Clinical Partners, a limited
partnership composed of private investors.

                                       5
<PAGE>

   Sepsis Clinical Application

Sepsis is a life-threatening condition that can occur when the body's immune
system mounts a systemic inflammatory response to an infection. As part of
this immune response, immune system cells produce inflammatory agents, such as
PAF, which can induce fever, shock and sometimes organ failure. There are
currently over 500,000 reported cases of sepsis each year in the United
States. The number of new cases of sepsis each year is approximately the same
as the combined number of new cases each year of prostate, breast and lung
cancer, the three most common forms of cancer. We believe that approximately
40% of sepsis patients progress to septic shock, a leading cause of death in
hospital intensive care units in the United States. Septic shock accounts for
a higher incidence of mortality than breast cancer and congestive heart
failure combined, with greater than 100,000 deaths per year in the United
States alone.

Current Treatment. After over 25 years of clinical and research investigation
of potential therapies for patients with sepsis, treatment of the condition
still is primarily limited to antimicrobial therapy directed toward the
underlying infection and supportive measures for patients suffering from or at
risk of developing multiple organ dysfunction. Previous clinical trials of
investigational agents in sepsis have targeted various inflammatory mediators
or bacterial components. To date, these strategies have met with only limited
success.

Potential Treatment by Pafase(R). Pafase is a recombinant human serum protein
that inactivates PAF, eliminating its inflammatory effects. PAF is implicated
in sepsis as well as acute respiratory distress syndrome and other
debilitating inflammatory conditions. We have demonstrated the inhibitory
activity of Pafase on PAF-induced inflammation in both in vitro and in vivo
studies.

Development Status. In 1999, we completed patient enrollment in a Phase 2
clinical trial to evaluate the safety and efficacy of Pafase in 240 patients
with either severe sepsis or multiple traumatic injuries who were at risk of
developing acute respiratory distress syndrome. Based on safety and efficacy
data obtained from clinical trials completed to date, we intend to initiate a
pivotal Phase 3 clinical trial of Pafase in severe sepsis patients in the
first half of 2001. This study is expected to consist of approximately 2,500
patients from approximately 150 investigative sites.

Endothelin Receptor Antagonist Program

Sitaxsentan and TBC3711 are small molecules that antagonize, or block, the
action of endothelin, which is a potent mediator of blood vessel constriction
and of the growth of smooth muscle in vascular walls. Endothelin receptor
antagonists are believed to be effective in the treatment of a variety of
diseases where the regulation of vascular constriction and muscle tone is
important. These diseases include pulmonary arterial hypertension, congestive
heart failure and essential hypertension. In addition, endothelin receptor
antagonists may be useful for pain relief therapy for advanced prostate
cancer. In June 2000, we formed a partnership entity with Texas Biotechnology
called ICOS-Texas Biotechnology L.P. to develop and commercialize endothelin
receptor antagonists, including sitaxsentan and TBC3711, both in clinical
development.

Vascular endothelium, which is the innermost lining of the blood vessels,
plays a pivotal role in maintaining normal blood vessel tone, including blood
flow, by producing substances such as endothelin that regulate the delicate
balance between the dilation and constriction of blood vessels. Endothelin
binds to two distinct receptors, ET(A) and ET(B), on cell surfaces. In
general, ET(A) receptors are associated with blood vessel constriction, while
ET(B) receptors are associated with blood vessel dilation and endothelin
clearance.

   Pulmonary Arterial Hypertension Clinical Application

Pulmonary arterial hypertension is a condition that involves excessive
pressure in the pulmonary arteries, which are the blood vessels that connect
the right side of the heart to the lungs. Primary and secondary pulmonary
arterial hypertension is estimated to afflict over 100,000 people worldwide.
The life expectancy of patients with untreated primary pulmonary arterial
hypertension is less than three years after diagnosis.

Currently the only approved pharmaceutical therapy for severe pulmonary
arterial hypertension is an intravenously administered form of prostacyclin.
No oral drug is currently approved for the treatment of pulmonary arterial
hypertension. Patients currently using prostacyclin must receive continuous
infusion of the drug through an in-dwelling catheter, necessitating that they
carry an infusion pump with them at all times.

We believe an oral, highly targeted ET(A) receptor antagonist may be a more
effective treatment for patients suffering from pulmonary arterial
hypertension. ICOS-Texas Biotechnology has completed an open-label Phase 2a
clinical trial evaluating sitaxsentan for the treatment of pulmonary arterial
hypertension. Preliminary analysis of patient data from this trial suggests
that sitaxsentan may provide clinical benefit to patients diagnosed with some
types of pulmonary arterial hypertension. However, in a follow-on extension
trial, treatment-related hepatitis was observed in two patients and one of
these patients died. ICOS-Texas Biotechnology intends to begin a pivotal Phase
2b/3 clinical trial of sitaxsentan for the treatment of pulmonary arterial
hypertension in the first half of 2001.

                                       6
<PAGE>

   Additional Clinical Applications

We will continue to explore the utility and effectiveness of endothelin
receptor antagonists in the following clinical applications:

Congestive Heart Failure. Congestive heart failure is a broad term that refers
to the heart's inability to pump blood at a rate consistent with the needs of
the human body. More than 10 million people in North America, Europe and Japan
suffer from this condition. Congestive heart failure represents the only form
of heart disease that is rising in incidence and prevalence. Approximately
half of all congestive heart failure patients die within five years of
diagnosis, a mortality rate that exceeds most cancers. According to the
American Heart Association, more than 1 million patients in the United States
alone are hospitalized annually due to this disease. Congestive heart failure
is currently treated with a combination of drugs depending on the severity of
the disease. Standard medical therapy includes digitalis, diuretics, ACE-
inhibitors, aldosterone antagonists and beta-blockers.

We believe that endothelin receptor antagonists may prove effective in
combating congestive heart failure through their novel therapeutic mechanism
and may provide additional benefit to patients who do not respond to other
therapies. To date, a Phase 2a clinical trial evaluating the acute effects of
sitaxsentan in patients with congestive heart failure has been conducted. This
clinical trial evaluated the effects of a single dose of sitaxsentan and
demonstrated that this product candidate is capable of reducing pulmonary
systolic artery pressure, pulmonary vascular resistance and right atrial
pressure. Specifically, this trial demonstrated that sitaxsentan was able to
decrease endothelin levels and cause selective dilation of blood vessels.

Essential Hypertension. Essential hypertension is a common condition that
refers to high blood pressure with no definable cause. There are over 200
million individuals with essential hypertension in North America, Europe and
Japan. Despite a range of medications available to treat essential
hypertension, many patients do not respond to these therapies and their
condition steadily worsens over time. We believe selective ET(A) receptor
antagonists may become an important option for these patients.

To date, a Phase 2a clinical trial evaluating sitaxsentan for the treatment of
essential hypertension has been conducted. This trial evaluated patients'
blood pressure levels over the course of two weeks, with daily dosing of
sitaxsentan. The trial demonstrated that sitaxsentan is capable of reducing
sitting diastolic and systolic blood pressures to levels comparable with other
anti-hypertensive medications. We are not currently pursuing clinical trials
evaluating sitaxsentan for the treatment of essential hypertension.

IC14

IC14 is a monoclonal antibody that blocks the function of CD14, a receptor
found on the surface of certain white blood cells that plays a unique role in
the development of sepsis.

   Sepsis Clinical Application

We are developing IC14, in addition to Pafase(R), for the treatment of sepsis.
While Pafase is intended to treat sepsis by destroying PAF and eliminating its
inflammatory effects, IC14 is intended to treat sepsis at both early and late
stages in the inflammatory response by blocking the function of CD14. CD14 is
unique in its ability to recognize components from most types of
microorganisms. Once activated by the recognition of these microbial
components, CD14 typically triggers a localized inflammatory response that
removes microorganisms at the site of infection. However, in some cases, CD14
triggers a systemic inflammatory response that may lead to sepsis and multiple
organ failure. In contrast to other potential targets, CD14 does not appear to
be a redundant component of the immune response that leads to sepsis. Not only
does CD14 recognize a diverse array of microbial components, but it is also
directly involved in activating multiple cell types that promote this immune
response, making it an attractive target for the treatment of sepsis. IC14 has
been shown to block CD14 in both in vitro and in vivo models in preclinical
studies.

In 1999, we conducted a bacterial toxin challenge study in 16 healthy
volunteers, which demonstrated that IC14 inhibited the inflammatory response
to specific bacterial toxins, blocking the release of greater than 95% of
tumor necrosis factor alpha (TNF-alpha), and substantially reducing the
development of flu-like symptoms. We also completed a Phase 1 safety study in
30 healthy volunteers in 1999 that indicated IC14 was well tolerated after the
administration of single doses. During the first quarter of 2001, we completed
enrollment in a Phase 1 study initiated in 2000 that was designed to determine
the molecule's safety and pharmacology in sepsis patients.

                                       7
<PAGE>

                       Preclinical and Research Pipeline

<TABLE>
<CAPTION>
      Product
      Candidate/Program         Target Indication                        Status
    --------------------------------------------------------------------------------

      <S>                       <C>                                      <C>
      IC485 (PDE4 inhibitor)    Chronic obstructive pulmonary disease    Preclinical
                                Rheumatoid arthritis                     Preclinical

      IC747 (LFA-1 antagonist)  Psoriasis                                Preclinical

      Cell cycle                Cancer                                   Preclinical
       checkpoint/DNA repair
       inhibitors

      Lipid and protein kinase  Inflammatory diseases                    Preclinical
       inhibitors

      Chemokine receptor        Allergic inflammatory diseases           Research
       antagonists

      Other cell adhesion       Cardiovascular and inflammatory diseases Research
       molecule antagonists

      Other phosphodiesterase   Multiple diseases                        Research
       inhibitors

      Novel antibiotics         Infectious diseases                      Research
</TABLE>


Preclinical Programs

We continuously evaluate new product candidates as part of our discovery
research program. We use an integrated approach to this program that
incorporates genetics, biochemistry and cell biology. Our goal is to introduce
one or more of the following product candidates into clinical trials in 2001.

   IC485 (PDE4 inhibitor)

IC485 is an orally administered, small molecule inhibitor of the
phosphodiesterase type 4 enzyme, or PDE4. Inhibition of PDE4 with IC485 may
reduce the production of TNF-alpha. Clinical benefits in rheumatoid arthritis
and Crohn's disease have been observed in therapies that target TNF-alpha
production. Moreover, clinical efficacy has been observed with PDE4 inhibitors
in patients with asthma and in patients with chronic obstructive pulmonary
disease. Historically, drugs that have targeted PDE4 have induced side effects
such as nausea, vomiting and sedation, which has limited the clinical utility
of these drugs. In preclinical studies of IC485, vomiting and sedation were
not observed over a range of doses that inhibited TNF-alpha production,
demonstrating the potential utility of this product candidate over existing
therapies.

We expect to initiate a Phase 1 clinical trial with IC485 in 2001. Chronic
obstructive pulmonary disease and rheumatoid arthritis are under consideration
as the primary clinical applications for IC485. According to the American Lung
Association, approximately 16 million people in the United States suffered
from chronic obstructive pulmonary disease in 1995, with approximately 14
million cases manifested as chronic bronchitis and approximately 1.8 million
manifested as emphysema. Rheumatoid arthritis is another chronic inflammatory
disease which affects approximately 2.1 million adults in the United States.
Sales of TNF-alpha inhibitors that are administered by injection have
increased since their market launch.

   IC747 (LFA-1 antagonist)

IC747 is an orally administered small molecule antagonist of the cell adhesion
molecule LFA-1, which is expressed by white blood cells. Many chronic
inflammatory diseases are thought to be driven by abnormal activation of T
lymphocytes, a type of white blood cell. In our preclinical studies, we have
demonstrated that IC747 binds to LFA-1 and inhibits T lymphocyte activation.

In June 2000, we acquired exclusive global rights to an LFA-1 program
previously subject to our 1995 collaborative agreement with Abbott
Laboratories. LFA-1 antagonists such as IC747 may be particularly desirable
for the treatment of psoriasis, a chronic T lymphocyte-driven skin disorder
afflicting approximately 3 million people in the United States. There is
currently no effective, well-tolerated approved treatment available for this
disorder. However, Genentech, Inc. and XOMA Corporation have demonstrated the
effectiveness of an LFA-1 antibody in a Phase 2 clinical trial in psoriasis
patients. We expect to initiate a Phase 1 clinical trial with IC747 in 2001
targeting psoriasis. Other chronic diseases for which LFA-1 antagonists may
prove useful are asthma and rheumatoid arthritis. In the United States, an
estimated 17 million people suffer from asthma while approximately 2.1 million
are afflicted with rheumatoid arthritis. LFA-1 antagonists also may help
prevent organ rejection for the 20,000 cases of solid organ transplant
conducted in the United States each year.

   Cell Cycle Checkpoint/DNA Repair Inhibitors

Resistance of tumor cells to radiation or chemotherapy is due in part to
cellular enzymes collectively termed cell cycle checkpoint/DNA repair enzymes.
These enzymes are proteins that recognize and repair potentially lethal
defects in cellular

                                       8
<PAGE>

DNA introduced by radiation or chemotherapeutic agents. In preclinical tests,
we are currently evaluating and optimizing lead compounds that inhibit two key
enzymes involved in this process. We are assessing these compounds for their
ability to selectively increase the sensitivity of tumors versus normal tissue
to radiation or chemotherapeutic agents, thereby enhancing the success and
minimizing the toxic effects of conventional treatments for many different
types of tumors.

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

   Lipid and Protein Kinase Inhibitors

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

Research Programs

Since our inception we have placed a strong emphasis on generating novel drug
candidates from our own internal research activities. Over the past ten years,
we have assembled a highly integrated multidisciplinary research staff of
approximately 150 professionals. Our staff includes:

  .  molecular biologists and biochemists who identify new genes or proteins
     that are either product candidates or targets for product candidates;
     and

  .  medicinal chemists, robotics experts and pharmacologists who create,
     evaluate and optimize new product candidates.

To use our expertise most effectively, we have concentrated our product
discovery efforts on specific gene families, including phosphodiesterases,
cell adhesion molecules and cell cycle checkpoint enzymes. In each case, we
seek first to identify all the members of the family, understand the
distribution of each member within the body and, through multiple functional
tests, determine which are most likely to impact human disease in a manner
that can lead to therapeutic treatment. Once a given target is linked to an
important biological function, such as activation of white blood cells, it is
screened by our robotics group against a complex library of small organic
molecules, from which lead compounds are identified. These lead compounds are
tested against structurally related targets encoded within the same family of
genes and then optimized through repetitive cycles of chemical modification to
yield a final product candidate. During the optimization process our chemists
and pharmacologists work together to build other attractive characteristics
into the product candidate, such as the capacity to be administered orally and
maintained at appropriate levels in the bloodstream. The advantage of this
gene family approach is that the initial efforts that yield a promising
product candidate targeting one family member also provide valuable
information about how to create product candidates that target other members
of the gene family. For example, novel structural information regarding how
IC747 interacts with its target, LFA-1, has been used to identify lead
compounds that selectively block the function of other structurally related
targets. This approach not only provides additional opportunities in other
therapeutic areas, but also markedly reduces the effort required to produce
the next product candidate.

Our current discovery research programs are directed toward the discovery of
new product candidates for the treatment of various diseases, including
allergic and other inflammatory diseases, cardiovascular diseases and
infectious diseases. Compounds in the research phase of the product
identification process are those for which activity in the target human
biological assay systems has been demonstrated in laboratory tests. These
compounds have not yet been tested in non-human animal models of specific
human diseases. These compounds include:

  .  antagonists of a chemokine receptor that promotes the exit of certain
     white blood cells from the bloodstream to sites of inflammation, which
     are potentially important in allergic inflammatory diseases such as
     asthma and skin inflammation;

  .  compounds that block the function of other cell adhesion molecules that
     are potentially important in diseases such as rheumatoid arthritis and
     asthma, and in blood clotting disorders;

  .  lead inhibitors of other members of the PDE family of enzymes, including
     those that may be involved in regulating neurodegenerative diseases such
     as Parkinson's disease; and

  .  molecules that represent lead compounds for new classes of antibiotics.

                                       9
<PAGE>

Collaborations and Licensing Agreements

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

   Eli Lilly and Company

In October 1998, ICOS and Eli Lilly formed Lilly ICOS, a 50/50-owned limited
liability company, to develop and commercialize PDE5 inhibitors. Lilly ICOS is
developing Cialis(TM) as an oral therapeutic agent for the treatment of
erectile dysfunction and female sexual dysfunction. Under the terms of this
arrangement, we received a $75.0 million payment upon formation of the joint
venture and an additional $15.0 million payment in 1999 upon initiation of a
Phase 3 clinical trial program for Cialis. We could receive additional
payments based on the progression of Cialis through development. The joint
venture was initially capitalized by Eli Lilly through cash contributions and
the contribution by us of an exclusive worldwide license to intellectual
property relating to PDE5 inhibitors, including intellectual property
associated with Cialis and its research platform. Both ICOS and Eli Lilly
provide Lilly ICOS with research and development services. The joint venture
will market any products resulting from this collaborative effort in North
America and the countries in the European Union or European Free Trade Area
through the services of ICOS and Eli Lilly. For countries outside North
America and these European countries, in exchange for royalty payments, Lilly
ICOS has granted Eli Lilly an exclusive license to develop, manufacture and
commercialize the PDE5 inhibitors developed in the collaboration.

   Suntory Limited

In February 1997, ICOS and Suntory formed Suncos, a 50/50-owned corporation,
to develop and commercialize Pafase(R) worldwide. Under the terms of this
arrangement, the joint venture was established with a $30 million cash
investment by Suntory to Suncos and subsequent capital contributions have been
made by both Suntory and ICOS in equal amounts. We granted Suncos an exclusive
license to all rights to Pafase on a worldwide basis. Suncos has granted
Suntory exclusive rights to develop and commercialize Pafase in Japan, and
Suncos has granted ICOS exclusive rights to develop and commercialize Pafase
in the United States. Suncos retains the rights to develop and commercialize
Pafase in the rest of the world. Suncos is managed jointly by Suntory and
ICOS. Both Suntory and ICOS provide Suncos with research and development
services. Suntory and ICOS will each pay royalties to Suncos on sales of
Pafase in their respective territories.

   Texas Biotechnology Corporation

In June 2000, ICOS and Texas Biotechnology formed ICOS-Texas Biotechnology, a
50/50-owned limited partnership, to develop and commercialize endothelin
receptor antagonists, such as sitaxsentan and TBC3711. Under the terms of this
arrangement, ICOS and Texas Biotechnology will equally fund the development of
endothelin receptor antagonists and equally share in the profits of the
partnership. We made an initial $2.0 million payment to Texas Biotechnology
and may make further milestone payments of up to $53.5 million. Texas
Biotechnology made an initial contribution to ICOS-Texas Biotechnology of an
exclusive worldwide license to the intellectual property associated with
endothelin receptor antagonists, including patent rights and technical
information. Both parties will provide the partnership with research and
development services. ICOS-Texas Biotechnology will manufacture, market and
sell any products resulting from the collaboration worldwide.

   Abbott Laboratories

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

                                      10
<PAGE>

   Other Collaborations and Licensing Arrangements

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

  .  IC14. We have entered into a sub-licensing arrangement with Johnson &
     Johnson and The Rockefeller University under which technology relating
     to IC14, developed by Dr. Richard Ulevitch at The Scripps Clinic and
     Research Foundation and Dr. Samuel Wright at The Rockefeller University,
     was sub-licensed to us. Under this arrangement, we received a sub-
     license to the intellectual property relating to IC14 in exchange for
     royalty and future milestone payments based on development of this
     product candidate. We have exclusive rights to a portfolio of patents
     for the production and commercialization of IC14.

  .  IC485. We have entered into a research and development arrangement with
     Array BioPharma Inc. relating to IC485. Under this arrangement, we
     funded the medicinal chemistry performed by Array relating to IC485. We
     receive either an assignment of or a license to any and all intellectual
     property developed by Array relating to IC485 in exchange for future
     milestone payments based on development of this product candidate. We
     have exclusive rights to the worldwide production and commercialization
     of IC485.

  .  Cell cycle checkpoint/DNA repair inhibitors. We have entered into a
     research and development arrangement with Array relating to multiple
     research targets, including cell cycle checkpoint/DNA repair inhibitors,
     and a research and development arrangement with DuPont Pharmaceuticals
     Research Laboratories relating to a cell cycle checkpoint/DNA repair
     inhibitor. Under these arrangements, we fund the medicinal chemistry
     performed by Array and DuPont relating to the targets. We receive either
     an assignment of or a license to any and all intellectual property
     developed by Array or DuPont in exchange for future milestone payments
     based on the development of any product candidates that may arise from
     these arrangements. DuPont may also receive royalties on sales relating
     to any product candidates arising from its arrangement with us. We have
     exclusive rights to the worldwide production and commercialization of
     any product candidates developed under these arrangements.

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

We have received approximately $250 million in aggregate milestone payments,
research and development funding and license fees from our collaborations and
licensing agreements from the time we began operations in September 1990
through December 31, 2000. We may receive up to approximately $105 million in
additional aggregate milestone payments, research and development funding and
license fees through the end of 2001, a substantial portion of which will be
received from joint ventures to which we make capital contributions. The
actual amount we receive, however, may differ substantially from this amount
depending primarily on the level of research and development expenditures we
incur that are reimbursed by our joint ventures. We may receive additional
amounts beyond 2001, but cannot reasonably estimate these amounts because they
depend upon several factors, some of which are beyond our control, including
the progression of product candidates through development and the amount and
timing of research and development expenditures by our joint ventures.

Patents and Proprietary Rights

Because of the length of time and expense associated with bringing new
products through development and the governmental approval process to the
marketplace, pharmaceutical and biotechnology companies have traditionally
placed considerable importance on obtaining and maintaining patent protection
for significant new technologies, products and processes. We have applied, and
are applying, for patents for our product candidates and aspects of our
technologies. As of December 31, 2000, we owned or exclusively licensed 131
United States patents and we had 118 patent applications pending in the United
States that we filed on our own behalf or on behalf of our joint ventures or
exclusive licensors. When appropriate, we also seek foreign patent protection
and, as of December 31, 2000, we owned or exclusively licensed 82 foreign
patents. Our ability, however, to obtain patents in a timely manner, if at
all, in foreign countries may be limited by the laws of some of those
countries. For example, many countries, including several European countries,
allow for an opposition period, often lasting many months, after a patent is
granted, providing third parties with the opportunity to submit arguments that
may call for the withdrawal of or limitations on the affected patents.

Even if we are granted patents by government authorities, the enforceability
of patents issued to pharmaceutical and biotechnology companies has proven
highly uncertain. For example, legal considerations surrounding the validity
of patents in the fields of pharmaceuticals and biotechnology are in
transition, and we cannot assure you that the historical legal standards
surrounding questions of validity will continue to be applied or that current
defenses relating to issued patents in

                                      11
<PAGE>

these fields will, in fact, be considered sufficient in the future. In
addition, we cannot assure you as to the degree and range of protections any
of our patents may afford us, whether patents will be issued or the extent to
which we will be successful in avoiding infringement of patents granted to
others. For example, patents which have already been issued to us may be
subjected to further governmental review that may ultimately result in the
reduction of their scope of protection, and pending patent applications may
have their requested breadth of protection significantly limited before being
issued, if issued at all. Furthermore, since publication of discoveries in
scientific or patent literature often lags behind actual discoveries, we
cannot assure you that we were the first creator of inventions covered by our
patents or pending patent applications or that we were the first to file
patent applications for these inventions. Pfizer, the maker of Viagra, has
been granted a patent by the European Patent Office claiming the use of a PDE5
inhibitor for the treatment of erectile dysfunction, and likely has filed a
patent application in the United States seeking the same or similar claims. In
addition, after seeking advice of counsel, we may undertake research and
development with respect to potential products, even when we are aware of
third-party patents that may be relevant to these potential products, on the
basis that such patents may be challenged or licensed by us. If our subsequent
challenges to or attempts to license such patents were to prove unsuccessful,
we may not be able to commercialize our potential products after having
incurred significant expenditures, and may be subject to patent infringement
claims. Under United States federal law, companies are protected against
claims of infringement for using technology patented by others in clinical
trials. Accordingly, we cannot assure you that the absence of litigation with
respect to our product candidates in clinical development is an indication
that our commercially marketed products will not be found to infringe the
patent rights of others.

Many pharmaceutical and biotechnology companies and university and research
institutions have filed patent applications or already have received patents
in our areas of product development. Many of these entities' applications and
patents may be competitive with or conflict with ours, and could prevent us
from obtaining patents or could call into question the validity of our
existing patents. For example, if various patents issued to others are upheld
in the courts or if certain patent applications filed by others are issued as
patents and are upheld, we may be unable to market one or more of our product
candidates, or may be required to obtain a license to market those product
candidates. To contend with these possibilities, we have entered into some
non-exclusive license agreements and anticipate entering into additional
license agreements in the future with third parties for technologies that may
be useful or necessary for the manufacture or commercialization of some of our
product candidates. In addition, we have initiated discussions with commercial
entities that hold United States patents on technology or processes that we
may find necessary in order to engage in some of our activities. However, we
cannot assure you that these licenses, or any others that we may be required
to obtain to market our product candidates, will be available on commercially
reasonable terms, if at all, or that we will be able to develop alternative
technologies if we cannot obtain required licenses.

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

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

Pfizer has been granted a patent by the European Patent Office claiming the
use of the composition of sildenafil citrate, also known as Viagra, and
related compounds for the treatment of erectile dysfunction and the use of a
cyclic GMP PDE inhibitor

                                      12
<PAGE>

and more specifically a PDE5 inhibitor for the treatment of erectile
dysfunction. We, Eli Lilly and eleven other companies have filed opposition
briefs in the European Patent Office opposing this patent. The hearing for
this proceeding is scheduled for July 16-19, 2001. A nonbinding preliminary
opinion was issued by one of the three examiners composing the European Patent
Office tribunal on October 14, 2000. The granted European patent has been
nationalized by Pfizer in most European countries. Lilly ICOS has brought
suits challenging the Pfizer patent in the Netherlands, the United Kingdom and
Belgium. The court in the Netherlands issued a judgment on October 4, 2000
that the proceeding in the District Court of the Hague has been adjourned and
stayed pending the decision in the opposition proceeding before the European
Patent Office. The court in the United Kingdom issued a judgment on November
8, 2000 that the Pfizer patent is invalid for obviousness. Pfizer has appealed
the decision. The court in the United Kingdom has proposed to hear the appeal
during the fourth quarter of 2001. By agreement of the parties and consent of
the court, the case in Belgium has been adjourned until after the written
opinion, relating to the hearing on July 16-19, 2001, of the Opposition
Division of the European Patent Office has been rendered; upon resumption of
the case the court will conduct a full hearing concerning all matters and
issues. It is expected that decisions by the European Patent Office and the
trial courts in the three countries will be appealed by the party that does
not prevail. These appeals could take years. If Pfizer's patent is ultimately
upheld by the European Patent Office or the courts in European countries, we
may be subject to litigation by Pfizer in Europe. We also may be prohibited
from marketing Cialis(TM) for the treatment of erectile dysfunction in some or
all European countries, or may be required to enter into licensing agreements
to market Cialis in Europe. We cannot assure you that such agreements would be
available on commercially reasonable terms, if at all. If Pfizer were to
obtain a comparable patent in the United States, we may be involved in further
litigation to determine whether our manufacture, use, sale or offer for sale
of Cialis infringes such a patent, and to determine the validity and scope of
such a patent.

Government Regulation

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

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

  .  preclinical laboratory tests, animal tests and formulation studies;

  .  the submission to the FDA of an investigational New Drug Application,
     which must become effective before clinical testing may begin;

  .  adequate and well-controlled clinical trials to establish the safety and
     effectiveness of the product candidate for each indication;

  .  the submission of a New Drug Application or Biologics License
     Application, as the case may be, to the FDA; and

  .  FDA review and approval of a New Drug Application or Biologics License
     Application, as the case may be, prior to any commercial sale or
     shipment of the product candidate.

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

Clinical trials are conducted in accordance with Good Clinical Practice
regulations at sponsoring institutions under protocols detailing the
objectives of the trial, the parameters to be used in monitoring safety and
the effectiveness criteria to be evaluated. Typically, clinical evaluation
involves three sequential phases, which may overlap. During Phase 1, clinical
trials

                                      13
<PAGE>

are conducted with a relatively small number of subjects to determine the
early safety profile of a drug, as well as the pattern of drug distribution
and drug metabolism by the subject. In Phase 2, trials are conducted with
groups of patients afflicted by a specific target disease to determine
preliminary efficacy, optimal dosages and dosage tolerance, and to gather
additional safety data. In Phase 3, large-scale, multicenter comparative
trials are conducted with patients afflicted with a specific target disease to
provide data for the statistical proof of efficacy and safety as required by
the FDA and others. The FDA and the clinical trial sponsor may suspend
clinical trials at any time if it is believed that clinical subjects are being
exposed to an unacceptable health risk.

The results of preclinical and clinical testing of a product candidate, as
well as data relating to a product candidate's chemistry, pharmacology and
manufacture, are required to be submitted to the FDA in the form of a New Drug
Application for small molecule products or a Biologics License Application for
biological products in order to seek FDA approval. FDA approval of the New
Drug Application or Biologics License Application is required before marketing
of a product may begin in the United States, and the cost of this process may
be substantial. In response to a New Drug Application or Biologics License
Application, the FDA may grant marketing approval, request additional
information or deny the application if the FDA determines that the application
does not satisfy its regulatory approval criteria, including the pre-approval
of relevant product manufacturing facilities. The failure to obtain timely
permission for clinical testing or timely regulatory approval for product
marketing could materially affect us. Furthermore, the FDA may require testing
and surveillance programs to monitor the effect of a new product or may
prevent or limit future marketing of a product based on the results of these
post-marketing programs.

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

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

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

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

Competition

Competition in the pharmaceutical and biotechnology industries is intense and
characterized by rapid technological development. We expect that our product
candidates will encounter significant competition. A number of pharmaceutical
and biotechnology companies are currently developing products targeting the
same diseases and medical conditions that we target, and some of our
competitors' products have entered clinical trials or are already commercially
available. For example, Pfizer has already successfully commercialized Viagra,
a competitor of our product candidate Cialis(TM), and Bayer AG is

                                      14
<PAGE>

currently conducting Phase 3 studies evaluating a PDE5 inhibitor for the
treatment of erectile dysfunction. Eli Lilly is also currently seeking
regulatory approval for a product for the treatment of sepsis that may compete
with Pafase(R) and IC14. In addition, our potential products, if approved and
commercialized, will compete against well-established existing therapeutic
products that are currently reimbursed by government health administration
authorities, private health insurers and health maintenance organizations.

Our competitors include pharmaceutical companies, biotechnology companies and
chemical companies. Furthermore, significant levels of biotechnology research
now occur in universities, government agencies and other nonprofit research
institutions. These entities have become increasingly active in seeking patent
protection and licensing revenues for their research results, thereby
providing us with additional competition and potential costs to our
operations. In addition, many major pharmaceutical companies have made
commercial arrangements with other biotechnology companies or research
institutions to further their development of products that may compete with
our potential products.

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

  .  develop products that are safer or more effective than our product
     candidates;

  .  obtain FDA and other regulatory approvals or reach the market with their
     products more rapidly than we can, reducing the potential sales of our
     product candidates;

  .  devote greater resources to market or sell their products;

  .  adapt more quickly to new technologies and scientific advances;

  .  initiate or withstand substantial price competition more successfully
     than we can;

  .  have greater success in recruiting skilled scientific workers from the
     limited pool of available talent;

  .  more effectively negotiate third-party collaborative and licensing
     arrangements; and

  .  take advantage of acquisition or other opportunities more readily than
     we can.

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

We believe the principal competitive factors affecting our markets are the
timing and scope of regulatory approvals, safety and effectiveness of
therapeutic products, cost and availability of these products, availability of
alternative treatments, third-party reimbursement programs and patent and
proprietary rights protection. Although we believe that we are well positioned
to compete adequately with respect to these factors in the future, our future
success is currently difficult to predict because all of our product
candidates are still in various stages of development and have yet to undergo
regulatory approval and commercialization.

Manufacturing

Since 1993, we have manufactured recombinant protein-based clinical materials
in our production facilities in Bothell, Washington, a suburb of Seattle, to
support our previous and current clinical trials. Our current facilities are
capable of utilizing both microbial- and mammalian-based production processes
and were designed to meet the FDA requirements for the production of purified
recombinant protein bulk product. We currently produce bulk product for our
product candidates Pafase and IC14 at our production facilities. Vialing and
other finishing steps in the manufacturing processes of Pafase and IC14 are
completed under contracts with Gensia Sicor Pharmaceuticals and several other
companies. We also manufacture purified recombinant protein bulk product for
Seattle Genetics pursuant to an agreement signed in November 2000.

We currently do not have the facilities necessary for the production of small
molecule drugs. Our product candidate Cialis(TM) is currently manufactured by
Eli Lilly. We plan to use Nordic Synthesis AB to manufacture the active
pharmaceutical ingredient of our product candidate sitaxsentan. We have
established relationships with third-party manufacturers to produce the
required materials for our other small molecule programs in preclinical
studies. These manufacturers include Ricerca, LLC and Irix Pharmaceutical. We
cannot assure you that we will be able to maintain our current relationships
with third-party manufacturers and suppliers or establish future arrangements
with third-party manufacturers and suppliers on commercially reasonable terms,
if at all.

                                      15
<PAGE>

Marketing and Sales

We have very limited marketing and sales capabilities. We believe this level
of capacity is appropriate prior to the commercialization of our product
candidates. We anticipate that as we begin to approach our product launch
dates, we will expand our marketing and sales capabilities. We have employees
with significant commercial experience in marketing and sales from major
pharmaceutical companies who will oversee the development of our marketing and
sales infrastructure, including our Vice President of Sales and Marketing, who
was hired in June 2000. In addition to our own marketing and sales workforce,
we anticipate promoting our potential products in collaboration with marketing
partners or relying on relationships with one or more companies with
established distribution systems and direct sales forces to distribute and
sell our potential products, including, to a large degree, our joint venture
partners. For example, we anticipate that Cialis(TM) will be supported by
marketing and sales representatives from both Eli Lilly and ICOS.

Human Resources

As of December 31, 2000, we employed 386 individuals. We consider our employee
relations to be good. We have never had a work stoppage, and none of our
employees is represented under a collective bargaining agreement. We believe
that our future success is dependent in part on our ability to attract,
integrate and retain skilled scientific, sales and marketing, and senior
management personnel. Competition in our industry for these skilled workers is
intense and we cannot assure you that we will be able to attract, integrate
and retain these personnel.

Important Factors Regarding Forward-Looking Statements

This prospectus contains forward-looking statements. These statements relate
to future events or our future financial performance. In some cases, you can
identify forward-looking statements by terminology such as "anticipate,"
"believe," "continue," "could," "estimate," "expect," "intend," "may,"
"might," "plan," "potential," "predict," "should" or "will" or the negative of
such terms or other comparable terminology. These statements are only
predictions and involve known and unknown risks, uncertainties and other
factors that may cause our or our industry's actual results, performance or
achievements to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, performance or
achievements. You should not place undue reliance on these forward-looking
statements.

We have a history of losses and anticipate continued losses.

We have incurred significant operating losses since we began operations in
September 1990. As of December 31, 2000, we had an accumulated deficit of
$222.2 million. We have not yet completed the development of any products and,
consequently, have not generated revenues from the sale of products. Our
operating losses have been increasing during the past several years and will
continue to increase in subsequent years as we attempt to complete development
of our potential products, obtain necessary regulatory approvals and
manufacture and market these product candidates. In particular, we expect to
incur substantial marketing and other costs related to commercializing Cialis
if we are able to complete clinical trials and obtain regulatory approval for
this product candidate. Even if we do successfully develop products that can
be marketed, we will need to generate significant revenues from those products
to achieve and maintain profitability. We currently do not expect to achieve
profitability for at least the next three years. Even if we do become
profitable, we cannot assure you that we would be able to sustain or increase
profitability on a quarterly or annual basis.

Our operating results are subject to fluctuations that may cause our stock
price to decline.

Our operating results have fluctuated in the past and are likely to continue
to do so in the future. Our revenue is unpredictable and may fluctuate due to
the timing of non-recurring licensing fees, reimbursements earned by us for
manufacturing services, and achievement of milestones under new and existing
licensing and collaborative agreements. Revenue historically recognized under
our prior collaborative agreements may not be an indicator of revenue from any
future collaborations. In addition, our expenses are unpredictable and may
fluctuate from quarter to quarter due to the timing of expenses, which may
include payments owed by us under licensing or collaborative arrangements. We
believe that quarter-to-quarter comparisons of our operating results are not a
good indicator of our future performance and should not be relied upon to
predict the future performance of our stock price.

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

                                      16
<PAGE>

Our clinical trials may fail to demonstrate the safety and effectiveness of
our product candidates, which could prevent or significantly delay their
regulatory approval.

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

In addition, larger and later-stage clinical trials may not produce the same
results as early-stage trials. Many companies in the pharmaceutical and
biotechnology industries, including us, have suffered significant setbacks in
clinical trials, even after promising results had been obtained in earlier
trials. For example, our Phase 3 clinical trial of product candidate
LeukArrest(TM) for the treatment of ischemic stroke was stopped after an
interim analysis. Similarly, our trial data for product candidate ICM3 did not
show sufficiently promising results to warrant further study for the treatment
of psoriasis. We may at times elect to use aggressive clinical strategies to
advance product candidates through clinical development as rapidly as
possible. For example, we may commence clinical trials without conducting
preclinical animal testing, or we may conduct later-stage trials based on
limited early-stage data. As a result, we anticipate that only some of our
product candidates may show safety and effectiveness in clinical trials and
many may encounter difficulties or delays during clinical development.

Government regulatory authorities may not approve our product candidates.

We cannot assure you that we will receive the regulatory approvals necessary
to commercialize our product candidates, which could cause our business to
fail. Our product candidates are subject to extensive and rigorous government
regulation. The FDA regulates, among other things, the development, testing,
manufacture, safety, efficacy, record-keeping, labeling, storage, approval,
advertising, promotion, sale and distribution of biopharmaceutical products.
If our potential products are marketed abroad, they will also be subject to
extensive regulation by foreign governments. None of our product candidates
has been approved for sale in the United States or any foreign market. In
addition, we have only limited experience in filing and pursuing applications
necessary to gain regulatory approvals, which may impede our ability to obtain
such approvals.

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

  .  delay marketing of potential products for a considerable period of time;

  .  limit the indicated uses for which potential products may be marketed;

  .  impose costly requirements on our activities; and

  .  provide competitive advantage to other pharmaceutical and biotechnology
     companies.

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

If we are unable to obtain the additional funding we need to develop and
market our potential products, we may be required to delay, scale back or
eliminate expenditures for some of our programs or grant rights to third
parties to develop and market our potential products.

Our business does not currently generate the cash needed to finance our
operations. We will require substantial financial resources to conduct the
time-consuming and costly research, preclinical development, clinical trials
and regulatory approval and marketing activities necessary to commercialize
our potential products. We may need to seek additional funding through public
or private financings, including equity financings, and through other
arrangements, including collaborative

                                      17
<PAGE>

arrangements. Poor financial results, unanticipated expenses or unanticipated
opportunities that require financial commitments could give rise to additional
financing requirements sooner than we expect. However, financing may be
unavailable when we need it or may not be available on acceptable terms. If we
raise additional funds by issuing equity or convertible debt securities, the
percentage ownership of our existing stockholders would be reduced, and these
securities might have rights superior to those of our common stock. If we are
unable to raise additional funds when we need them, we may be required to
delay, scale back or eliminate expenditures for some of our development
programs or grant rights to third parties to develop and market product
candidates that we would prefer to develop and market internally. If we are
required to grant such rights, the ultimate value of these product candidates
to us would be reduced.

If we fail to negotiate or maintain successful collaborative arrangements with
third parties, our development and marketing activities may be delayed or
reduced.

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

Our collaborative agreements can be terminated under certain conditions by our
partners. In addition, our partners may separately pursue competing products,
therapeutic approaches or technologies to develop treatments for the diseases
targeted by us or our collaborative efforts. Even if our partners continue
their contributions to the collaborative arrangements, they may nevertheless
determine not to actively pursue the development or commercialization of any
resulting products. Also, our partners may fail to perform their obligations
under the collaborative arrangements or may be slow in performing their
obligations. In these circumstances, our ability to develop and market
potential products could be severely limited.

If we are unable to protect our intellectual property rights adequately, the
value of our potential products could be diminished.

Our success is dependent in part on obtaining, maintaining and enforcing our
patents and other proprietary rights. Patent law relating to the scope of
claims in the biotechnology field in which we operate is still evolving and
surrounded by a great deal of uncertainty. Accordingly, we cannot assure you
that our pending patent applications will result in issued patents. Because
patent applications in the United States are maintained in secrecy until a
patent issues, we cannot assure you that others have not filed patent
applications for technology covered by our pending applications or that we
were the first to invent the technology. There may be third-party patents or
patent applications relevant to our potential products that may block or
compete with the technologies covered by our patent applications.

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

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

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

                                      18
<PAGE>

We may be subject to substantial costs and liability or be prohibited from
commercializing our potential products as a result of patent infringement
litigation and other proceedings relating to patent rights.

Patent litigation is very common in the biopharmaceutical industry. We cannot
assure you that third parties will not assert patent or other intellectual
property infringement claims against us with respect to our technologies. Any
claims that might be brought against us relating to infringement of patents
may cause us to incur significant expenses and, if successfully asserted
against us, may cause us to pay substantial damages. Even if we were to
prevail, any litigation could be costly and time-consuming and could divert
the attention of our management and key personnel from our business
operations. Furthermore, as a result of a patent infringement suit, we may be
forced to stop or delay developing, manufacturing or selling potential
products that incorporate the challenged intellectual property unless we enter
into royalty or license agreements. We may not be able to obtain royalty or
license agreements on terms acceptable to us, if at all. Even if we were able
to obtain licenses to such technology, some licenses may be non-exclusive,
thereby giving our competitors access to the same technologies licensed to us.
Ultimately we may be unable to commercialize some of our potential products or
may have to cease some of our business operations, which could severely harm
our business.

In addition, we may have to resort to costly and time-consuming proceedings
and litigation to determine the validity and scope of the proprietary rights
of others. For example, we, Eli Lilly and eleven other companies are currently
involved in an opposition proceeding before the European Patent Office in
which we are opposing a patent granted by the European Patent Office to Pfizer
Inc. This patent claims the use of the composition of sildenafil citrate, also
known as Viagra(R), and related compounds for the treatment of erectile
dysfunction and also claims the use of a cyclic GMP PDE inhibitor and more
specifically a PDE5 inhibitor for the treatment of erectile dysfunction.
Viagra targets the same medical conditions that our product candidate
Cialis(TM) targets. This patent has been nationalized by Pfizer in most
European countries, and Lilly ICOS has brought suits challenging the patent in
three European countries. It is expected that decisions by the European Patent
Office and the trial courts in the three countries will be appealed by the
party that does not prevail. These appeals could take years. If Pfizer's
patent is ultimately upheld by the European Patent Office or the courts in
European countries, we may be subject to litigation by Pfizer in Europe. We
also may be prohibited from marketing Cialis for the treatment of erectile
dysfunction in some or all European countries, or may be required to enter
into licensing agreements to market Cialis in Europe. These agreements may not
be available on commercially reasonable terms. If Pfizer were to obtain a
comparable patent in the United States, we may be involved in further
litigation to determine whether our manufacture, use, sale or offer for sale
of Cialis infringes such a patent, and to determine the validity and scope of
such a patent.

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

We may be unable to establish the manufacturing capabilities necessary to
develop and commercialize our potential products.

Currently, we do not have facilities to manufacture small molecule product
candidates, such as Cialis, and we do not have sufficient manufacturing
capacity to manufacture our biological product candidates in quantities
necessary for commercial sale. In addition, our manufacturing capacity may be
inadequate to complete all clinical trials contemplated by us over time. We
intend to rely in part on third-party contract manufacturers to produce large
quantities of drug materials needed for clinical trials and commercialization
of our potential products. Third-party manufacturers may not be able to meet
our needs with respect to timing, quantity or quality of materials. If we are
unable to contract for a sufficient supply of needed materials on acceptable
terms, or if we should encounter delays or difficulties in our relationships
with manufacturers, our clinical trials may be delayed, thereby delaying the
submission of product candidates for regulatory approval and the market
introduction and subsequent commercialization of our potential products. Any
such delays may lower our revenues and potential profitability.

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

                                      19
<PAGE>

clinical development, such as Cialis(TM) and Pafase(R). These manufacturing
changes could result in delays in development or regulatory approval or in
reduction or interruption of commercial sales of our potential products and
could impair our competitive position.

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

We may be unable to establish sales and marketing capabilities necessary to
successfully commercialize our potential products.

We currently have no direct sales capabilities and only limited marketing
capabilities. We anticipate relying on third parties to market and sell some
of our primary product candidates. For example, we have entered into an
agreement with Eli Lilly to co-promote Cialis in North America and Europe. If
we decide to market our potential products through a direct sales force, we
would need to either hire a sales force with expertise in pharmaceutical sales
or contract with a third party to provide a sales force to meet our needs. We
may be unable to establish marketing, sales and distribution capabilities
necessary to commercialize and gain market acceptance for our potential
products. In addition, co-promotion or other marketing arrangements with third
parties to commercialize potential products could significantly limit the
revenues we derive from these potential products, and these third parties may
fail to commercialize our potential products successfully.

We may be unable to compete successfully in the markets for pharmaceutical and
biotechnological products.

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

A number of pharmaceutical and biotechnology companies are currently
developing products targeting the same diseases and medical conditions that we
target, and some of our competitors' products have entered clinical trials or
already are commercially available. For example, Pfizer has already
successfully commercialized Viagra, a competitor of our product candidate
Cialis, and Bayer AG is currently conducting Phase 3 studies evaluating a PDE5
inhibitor for the treatment of erectile disfunction. Eli Lilly is also
currently seeking regulatory approval for a product for the treatment of
sepsis that may compete with Pafase and IC14. In addition, our potential
products, if approved and commercialized, will compete against well-
established existing therapeutic products that are currently reimbursed by
government health administration authorities, private health insurers and
health maintenance organizations.

Our competitors include pharmaceutical companies, biotechnology companies,
chemical companies, academic and research institutions and government
agencies. Many of these organizations have substantially more experience and
more capital, research and development, regulatory, manufacturing, sales,
marketing, human and other resources than we do. As a result, they may:

  .  develop products that are safer or more effective than our product
     candidates;

  .  obtain FDA and other regulatory approvals or reach the market with their
     products more rapidly than we can, reducing the potential sales of our
     product candidates;

  .  devote greater resources to market or sell their products;

  .  adapt more quickly to new technologies and scientific advances;

  .  initiate or withstand substantial price competition more successfully
     than we can;

  .  have greater success in recruiting skilled scientific workers from the
     limited pool of available talent;

  .  more effectively negotiate third-party licensing and collaborative
     arrangements; and

  .  take advantage of acquisition or other opportunities more readily than
     we can.

                                      20
<PAGE>

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

The failure to attract or retain key management and technical personnel could
harm our business.

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

  .  compromise our ability to negotiate additional collaborative
     arrangements;

  .  delay our ongoing discovery research efforts;

  .  delay preclinical or clinical testing of our product candidates;

  .  delay the regulatory approval process; or

  .  prevent us from successfully commercializing our product candidates.

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

Our business may be harmed if we cannot obtain sufficient quantities of raw
materials.

We depend on outside vendors for the timely supply of raw materials used to
conduct preclinical testing and clinical trials of product candidates. Once a
supplier's materials have been selected for use in our manufacturing process,
the supplier in effect becomes a sole or limited source of that raw material
due to regulatory compliance procedures. Our business could be harmed if our
third-party suppliers were to cease production or otherwise fail to supply us
with quality raw materials in a timely manner and we were unable to contract
for these services with alternative suppliers on acceptable terms.

Our product candidates, even if approved by the FDA or foreign regulatory
agencies, may not achieve market acceptance among hospitals, insurers or
patients.

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

Rapid changes in technology and industry standards could render our potential
products unmarketable.

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

We may be required to defend lawsuits or pay damages in connection with the
alleged or actual harm caused by our product candidates.

We face an inherent business risk of exposure to product liability claims in
the event that the use of our product candidates is alleged to have resulted
in harm to others. This risk exists in clinical trials as well as in
commercial distribution. In addition, the pharmaceutical and biotechnology
industries in general have been subject to significant medical malpractice
litigation. We may incur significant liability if product liability or
malpractice lawsuits against us are successful. Although we maintain product
liability insurance, we cannot be sure that this coverage is adequate or that
it will continue to be available to us on acceptable terms.

                                      21
<PAGE>

We may incur substantial environmental liability arising from our activities
involving the use of hazardous materials.

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

Item 2. Properties

We lease or own approximately 220,000 square feet of space in five buildings
located in Bothell, Washington. Our leases expire between May 2002 and
February 2004, with options to renew for additional four- or five-year
periods. Our principal administrative offices, research laboratories and
clinical production facility occupy approximately 190,000 square feet. We
sublease the remaining 30,000 square feet of space under short-term operating
leases expiring in 2001 and 2002, which provide extensions through 2003 and
2004. We also have signed a lease beginning in April 2001 and expiring in
March 2006 for an additional 16,000 square feet, with options to renew for
additional five-year periods. In addition, in December 1992, we purchased
approximately 300,000 square feet of undeveloped land adjacent to our main
facilities. We believe this purchase gives us the flexibility to expand in our
current geographic location as and if our space needs increase in the
foreseeable future. Over the next several years, we plan to lease, acquire or
build additional facilities to accommodate the activities and personnel
necessary to further develop our product candidates.

Item 3. Legal Proceedings

From time to time, we may become involved in litigation relating to claims
arising in the ordinary course of our business. We believe that there are no
claims or actions pending or threatened against us that, if adversely
determined, would have a material adverse effect on us.

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

No matters were submitted to a vote of ICOS' stockholders during the fourth
quarter of its fiscal year ended December 31, 2000.

                                      22
<PAGE>

                                    PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters

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

<TABLE>
<CAPTION>
         2000             High   Low
         ----            ------ ------
         <S>             <C>    <C>
         First Quarter   $68.00 $28.00
         Second Quarter   47.00  26.88
         Third Quarter    60.00  43.06
         Fourth Quarter   56.88  37.81

<CAPTION>
         1999
         ----
         <S>             <C>    <C>
         First Quarter   $38.13 $24.25
         Second Quarter   48.50  30.25
         Third Quarter    42.75  24.00
         Fourth Quarter   34.00  25.19
</TABLE>

As of February 12, 2001, there were approximately 2,458 holders of record of
our common stock. Because many of these shares are held by brokers and other
institutions on behalf of stockholders, we are unable to estimate the total
number of stockholders represented by the record holders.

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

Item 6. Selected Consolidated Financial Data

The following selected consolidated financial data should be read in
conjunction with Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and the consolidated financial statements
and related notes included in this Form 10-K for the year ended December 31,
2000.

<TABLE>
<CAPTION>
                                     (in thousands, except per share data)
                          --------------------------------------------------------------
                                            Year ended December 31,
                          --------------------------------------------------------------
                             2000         1999         1998         1997         1996
                          ----------   ----------   ----------   ----------   ----------
<S>                       <C>          <C>          <C>          <C>          <C>
Statement of Operations
 Data:

Revenue                   $   90,733   $   79,600   $  110,768   $   31,576   $    2,000

Operating expenses            94,017      105,800       81,009       45,520       32,566

Other income (expense)       (31,507)      (6,995)       2,199        1,929        2,071

Income (loss) before
 cumulative effect of
 change in accounting
 principle                   (34,791)     (33,195)      31,310      (12,015)     (28,495)

Cumulative effect of
 change in accounting
 principle                   (63,075)

Net income (loss)            (97,866)     (33,195)      31,310      (12,015)     (28,495)

Per common share -

 Income (loss) before
  cumulative effect of
  change in accounting
  principle

   Basic                  $    (0.75)  $    (0.76)  $     0.78   $    (0.30)  $    (0.77)

   Diluted                     (0.75)       (0.76)        0.67        (0.30)       (0.77)

 Cumulative effect of
  change in accounting
  principle

   Basic                  $    (1.36)

   Diluted                     (1.36)

 Net income (loss)

   Basic                  $    (2.11)  $    (0.76)  $     0.78   $    (0.30)  $    (0.77)

   Diluted                     (2.11)       (0.76)        0.67        (0.30)       (0.77)

Pro forma amounts
 assuming the change in
 accounting principle
 was applied
 retroactively to prior
 years -

 Net loss                              $  (17,309)  $  (39,667)  $  (19,999)  $  (28,495)

 Net loss per common
  share - basic and
  diluted                              $    (0.40)  $    (0.99)  $    (0.51)  $    (0.77)

<CAPTION>
                                                (in thousands)
                          --------------------------------------------------------------
                                                 December 31,
                          --------------------------------------------------------------
                             2000         1999         1998         1997         1996
                          ----------   ----------   ----------   ----------   ----------
<S>                       <C>          <C>          <C>          <C>          <C>
Balance Sheet Data:

Cash and cash
 equivalents, investment
 securities and interest
 receivable               $  229,400   $   69,254   $   78,065   $   25,773   $   41,820

Working capital              194,276       75,035       71,743       24,536       39,575

Total assets                 268,174      112,788      113,347       54,065       58,205

Stockholders' equity         211,095       99,399       98,733       49,872       55,267
</TABLE>

                                      23
<PAGE>

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

The following discussion and analysis should be read in conjunction with our
consolidated financial statements and related notes included elsewhere in this
report. This discussion contains forward-looking statements based on current
expectations that are subject to risks and uncertainties, such as statements
of our plans, objectives, expectations and intentions. In some cases, you can
identify forward-looking statements by terminology such as "anticipate,"
"believe," "continue," "could," "estimate," "expect," "intend," "may,"
"might," "plan," "potential," "predict," "should" or "will" or the negative of
those terms or other comparable terminology. Our actual results and the timing
of events could differ materially from those anticipated or implied by the
forward-looking statements discussed here as a result of various factors,
including, among others, those set forth under "Important Factors Regarding
Forward-Looking Statements" in Item 1, "Business", herein. You should not
place undue reliance on these forward-looking statements, which speak only as
of the date of this report. We undertake no obligation to publicly release the
results of any revisions to these forward-looking statements that may be made
to reflect events or circumstances after the date of this report or to reflect
the occurrence of unanticipated events.

Overview

ICOS Corporation and subsidiary, herein collectively referred to as ICOS, is a
product-driven company that has expertise in both protein-based and small
molecule therapeutics. We combine our capabilities in molecular, cellular and
structural biology, high throughput drug screening, medicinal chemistry and
genomics to develop highly innovative products with significant commercial
potential. We and our partners currently have three product candidates in
late-stage clinical development: Cialis(TM), which is in Phase 3 clinical
trials; Pafase(R), which we anticipate will enter Phase 3 clinical trials in
the first half of 2001; and sitaxsentan, which we anticipate will enter Phase
2b/3 clinical trials in the first half of 2001. We plan to submit a New Drug
Application for Cialis in the second half of 2001, subject to successfully
concluding our clinical trials. To enhance our internal development efforts,
we have established collaborations with other pharmaceutical and biotechnology
companies, including Eli Lilly and Company ("Eli Lilly"), Suntory Limited
("Suntory") and Texas Biotechnology Corporation ("Texas Biotechnology").

Cialis

In collaboration with our partner, Eli Lilly, we are evaluating Cialis for the
treatment of erectile dysfunction and female sexual dysfunction. In Phase 2
clinical trials conducted to date, Cialis has improved patients' ability to
attain and maintain an erection sufficient for sexual intercourse and
increased both the percentage of successful sexual attempts reported by
patients in patient diaries as well as the proportion of experiences
satisfying to both partners. During 2000, we continued our Phase 3 clinical
program. We plan to submit a New Drug Application for Cialis to the Food and
Drug Administration in the second half of 2001, subject to the successful
conclusion of our clinical trials.

Pafase

In collaboration with Suntory, we are evaluating Pafase, a recombinant human
serum protein, for the treatment of severe sepsis. During 2000, we completed
our analysis of a Phase 2 clinical trial evaluating the safety and efficacy of
Pafase in 240 patients with either severe sepsis or multiple traumatic
injuries who were at risk for developing acute respiratory distress syndrome.
The results demonstrated that Pafase produced a statistically significant
decrease in 28-day all cause mortality in patients with severe sepsis. Based
on the results obtained from this and other clinical studies, we intend to
initiate a pivotal multi-national Phase 3 clinical trial of Pafase in severe
sepsis patients in the first half of 2001. This study is expected to consist
of approximately 2,500 patients from approximately 150 investigative sites.

Endothelin Receptor Antagonists

In June 2000, we established ICOS-Texas Biotechnology L.P. ("ICOS-TBC"), a
50/50-owned limited partnership with Texas Biotechnology, to develop and
commercialize endothelin receptor antagonists, including sitaxsentan and
TBC3711. Endothelin receptor antagonists are believed to be effective in the
treatment of a variety of diseases, such as pulmonary arterial hypertension,
congestive heart failure and essential hypertension. During 2000, an open-
label Phase 2a clinical trial was completed that evaluated sitaxsentan for the
treatment of pulmonary arterial hypertension. Preliminary analysis of patient
data from this trial suggest that sitaxsentan was well tolerated and may
provide clinical benefit to patients diagnosed with some types of pulmonary
arterial hypertension. We intend to begin a Phase 2b/3 clinical trial of
sitaxsentan for the treatment of pulmonary arterial hypertension in the first
half of 2001. During 2000, we initiated a Phase 1 single dose study in healthy
volunteers that was designed to determine the safety and tolerability of
TBC3711, our other endothelin receptor antagonist product candidate. This
molecule may be tested in congestive heart failure or essential hypertension.

                                      24
<PAGE>

IC14

IC14 is a monoclonal antibody that we are currently evaluating for the
treatment of sepsis. IC14 is intended to treat sepsis at both early and late
stages in the inflammatory response by blocking the function of CD14, a
receptor found on the surface of certain white blood cells that plays a unique
role in the development of sepsis. During the first quarter of 2001, we
completed enrollment in a Phase 1 study initiated in 2000 that was designed to
determine the molecule's safety and pharmacology in sepsis patients.

Results of Operations

General

We recognize revenue for our contracts for research and development efforts,
including those under collaborative agreements, as the related expenses are
incurred. Payments received that are related to future performance are
deferred and recognized as revenue over the appropriate future performance
periods. Nonrefundable upfront technology license fees, for product candidates
where we are providing continuing services related to product development, are
deferred. We recognize these fees as revenue over the product development
periods, based on estimated total development costs. Milestone payments are
recognized as revenue at the time such payments are due, based on the ratio of
cumulative costs incurred to date, to total estimated development costs. Any
remaining balance is deferred and recognized as revenue over the remaining
product development period.

We recognize our share of the operating results of our collaborations in
proportion to our ownership interest in the collaboration and record it as
equity in income (losses) of affiliates. Losses relating to our collaborations
are recognized only to the extent we have made or are committed to make
capital contributions to the collaboration. Operating results of our
collaborations include expenses related to research and development efforts
that we recognize as revenue. Due to the nature of our collaborative
agreements, cost reimbursement revenue, which is reported as collaborative
research and development revenue from related parties, largely depends on the
continued progression of clinical trial and development activities.

Cost reimbursement revenue includes revenue recognized pursuant to our product
development agreement with ICOS Clinical Partners, L.P. ("ICOS Clinical
Partners"), a limited partnership composed of private investors to fund
development of certain of our product candidates. Proceeds received under this
agreement are apportioned between collaborative research and development
revenue from related parties and additional paid-in capital for the purchase
of warrants. The amount recognized as revenue under this agreement is based on
a relationship between costs incurred and available funding. As of December
31, 2000, there remained approximately $1.8 million available to be recognized
as revenue under this agreement through March 31, 2001.

We have incurred significant operating losses since we began operations in
September 1990. As of December 31, 2000, we had an accumulated deficit of
$222.2 million. We expect that our operating expenses will increase during
2001 and subsequent years as we attempt to complete development of our product
candidates, obtain necessary regulatory approvals and manufacture and market
these product candidates. In particular, we expect to incur substantial
marketing and other costs related to commercializing Cialis(TM) if we are able
to complete clinical trials and obtain regulatory approval for this product
candidate. We may also incur costs and make capital contributions under our
collaborative research and development agreements with Eli Lilly, Suntory and
Texas Biotechnology. A portion of our capital contributions under these
agreements may be used to reimburse us for our clinical and development
activities as well as to fund our share of the development costs of our
affiliate partners. Joint venture activities are subject to the oversight of
both parties. The clinical and development activities of our affiliates are
not entirely within our control. In the future, we intend to pursue our
internal research and development activities more aggressively and, when
beneficial to do so, establish additional collaborations. As a result of these
factors, we expect to incur losses for at least the next three years.

Our results of operations may vary significantly from period to period and
will depend on, among other factors, the timing of expenses, payments received
from collaborations and the progress of our research and development efforts.
We may experience significant fluctuations in both cost reimbursement revenue
and revenue from the license of technology to related parties from one period
to the next. Technology license fee revenue will vary as a result of the
timing of milestone payments and changes in estimated total development costs,
which depend on the success or failure of our clinical trial and development
efforts. In addition, significant changes in joint venture activities could
cause fluctuations in the amount of affiliate losses from period to period.

Securities and Exchange Commission Staff Accounting Bulletin No. 101

In the fourth quarter of 2000, we adopted the provisions of the Securities and
Exchange Commission Staff Accounting Bulletin No. 101, as amended ("SAB 101"),
"Revenue Recognition in Financial Statements." Pursuant to SAB 101,

                                      25
<PAGE>

nonrefundable upfront technology license fees, for product candidates where we
are providing continuing services related to product development, are
deferred. We recognize these fees as revenue over the product development
periods, based on estimated total development costs. Milestone payments are
recognized as revenue at the time such payments are due, based on the ratio of
cumulative costs incurred to date, to total estimated development costs. Any
remaining balance is deferred and recognized as revenue over the remaining
product development period. Previously, those license fees and milestone
payments were recognized as revenue when received. Our results for the year
2000 include a $63.1 million charge ($1.36 per share) representing the
cumulative effect of adopting SAB 101 effective January 1, 2000. This charge
reflects the aggregate amount of license fees and milestone payments that we
reported as revenue in years prior to 2000, that are now being recognized as
revenue in 2000 and future years under SAB 101. In 2000, we recognized $42.9
million of the $63.1 million as revenue, which decreased our loss before the
cumulative effect of the accounting change by $0.93 per share. Accordingly,
adoption of SAB 101 had the effect of increasing our 2000 net loss per share,
from $1.68 to $2.11, an increase in the per share loss of $0.43.

Year Ended December 31, 2000 Compared With Year Ended December 31, 1999

   Revenue

Revenue for the year ended December 31, 2000, increased 14% to $90.7 million
compared to $79.6 million for the year ended December 31, 1999. During 2000,
we recognized $42.9 million in revenue related to technology license fees
which had been recognized in previous years but was required to be deferred
under SAB 101. Excluding the effect of adopting SAB 101, revenue for 2000 was
$47.8 million compared to $79.6 million during the same period in 1999. The
decline reflects a reduction in cost reimbursement revenue to $47.4 million in
2000 compared to $64.1 million during the prior year, as well as the
recognition of $15.0 million in license fee revenue during 1999 related to the
progression of the Cialis(TM) program, prior to the adoption of SAB 101. For
2000, cost reimbursement revenue consisted of $19.9 million from Lilly ICOS
LLC ("Lilly ICOS"), $15.2 million from Suncos Corporation ("Suncos"), $9.5
million from ICOS Clinical Partners, and $2.8 million from ICOS-TBC. For the
year ended December 31, 1999, cost reimbursement revenue consisted of
$19.9 million from Lilly ICOS, $25.1 million from Suncos and $19.1 million
from ICOS Clinical Partners. The decline in cost reimbursement revenue in 2000
reflects a reduction in reimbursable clinical trial and development expenses
primarily associated with Pafase(R) as well as a reduction in available
funding from ICOS Clinical Partners.

   Operating expenses

Research and development. Research and development expense consists primarily
of costs associated with conducting basic research, clinical trials for our
product candidates and other costs incurred in direct support of those
activities. Research and development expense decreased 13% to $87.4 million in
2000 compared to $100.5 million in 1999. This decrease was primarily due to
the discontinuation of clinical activity associated with product candidate
LeukArrest(TM) in 2000, as well as the completion in 2000 of multiple Pafase
clinical studies that were ongoing during 1999. The decrease was partially
offset by increased research and development expense associated with
sitaxsentan and our small molecule product candidates IC485 and IC747.
Research and development expense for 2000 also reflects costs related to the
acquisition of additional technology rights and LFA-1 compounds from Abbott
Laboratories.

General and administrative. General and administrative expense consists
primarily of costs associated with corporate support functions, general
management and other activities not directly related to research and
development efforts. General and administrative expense was $6.6 million in
2000 compared to $5.3 million in 1999. This increase was primarily due to
certain management transition costs incurred during 2000, an increase in
administrative fees related to ICOS Clinical Partners, and pre-marketing costs
associated with our product candidate Cialis.

   Equity in losses of affiliates

Equity in losses of affiliates represents our share of the operating losses of
our collaborations and is primarily related to the continued progression of
our clinical trial activities. Equity in losses of affiliates increased 208%
to $37.0 million in 2000 compared to $12.0 million in 1999. This increase was
primarily due to continued progression of our clinical trial activity for
Cialis as well as our share of losses related to the start-up activities of
ICOS-TBC, partially offset by lower costs associated with clinical trial
activity for Pafase. In the third quarter of 2000, we began to recognize our
share of Lilly ICOS' losses because we will now provide our proportionate
share of the funding of Lilly ICOS' operations pursuant to our collaboration
agreement with Eli Lilly. Under the terms of that agreement, Eli Lilly was
obligated to make scheduled cash contributions to fund the costs of the joint
venture's operations. Costs incurred by the joint venture that exceed Eli
Lilly's scheduled cash contributions are to be funded via additional capital
contributions from each of the joint venture partners. During 2000, Eli
Lilly's scheduled cash contributions were fully committed to fund Lilly ICOS'
existing obligations; consequently, we became

                                      26
<PAGE>

responsible for funding a proportionate share of the joint venture's ongoing
operating activities. Our equity in the losses of Lilly ICOS for 2000 was
$23.6 million.

   Investment income

Investment income for 2000 increased 3% to $4.4 million compared to $4.3
million for 1999. This increase was primarily due to higher yields on
investment balances during the current year as well as an increase in
available cash for investment following our public sale of common stock in the
fourth quarter of 2000.

Year Ended December 31, 1999 Compared With Year Ended December 31, 1998

   Revenue

Revenue for the year ended December 31, 1999 decreased 28% to $79.6 million
compared to $110.8 million for the year ended December 31, 1998. Revenue in
1999 included $15.0 million in license fees from Lilly ICOS as a result of the
initiation of a Phase 3 clinical trial for Cialis(TM). Revenue for 1999 also
included cost reimbursements of $25.1 million from Suncos, $19.9 million from
Lilly ICOS, and $19.1 million from ICOS Clinical Partners, and $0.5 million
received under our research and development agreement with Abbott
Laboratories. Revenue in 1998 consisted of a one-time $75.0 million license
fee payment upon the formation of Lilly ICOS with Eli Lilly, cost
reimbursement revenue of $14.9 million from Suncos, $3.8 million from Lilly
ICOS, and $15.1 million from ICOS Clinical Partners, and $2.0 million received
under our research and development agreement with Abbott Laboratories. The
increase in cost reimbursement revenue in 1999 compared to 1998 was primarily
the result of the progression of our clinical trial and development
activities. Under SAB 101, effective January 1, 2000, the majority of the
$15.0 million and $75.0 million license fee payments previously recognized as
revenue were deferred, to be recognized as revenue over the product
development period.

   Operating expenses

Research and development. Research and development expense increased 31% to
$100.5 million in 1999 compared to $77.0 million in 1998. This increase was
primarily related to the progression of clinical trials for Cialis, Pafase(R),
IC14 and LeukArrest(TM), as well as expansion of other product development
efforts.

General and administrative. General and administrative expense increased 30%
to $5.3 million in 1999 from $4.0 million in 1998. This increase was primarily
due to the addition of management and administrative personnel to support our
product development activities and costs incurred to register Series B
warrants issued pursuant to an agreement with ICOS Clinical Partners.

   Equity in losses of affiliates

Equity in losses of affiliates increased to $12.0 million in 1999 compared to
$0.2 million in 1998. This increase was primarily due to the fact that in 1999
we made an equity investment in Suncos of $15.0 million and recorded
approximately $11.8 million as our share of Suncos' 1999 net loss. Prior to
1999, our equity investment in Suncos had a zero basis for financial reporting
purposes and, accordingly, no loss was recognized. Our investment in Lilly
ICOS had a zero basis for financial reporting purposes at December 31, 1999.

   Investment income

Investment income increased 81% to $4.3 million in 1999 compared to $2.4
million in 1998. This increase was primarily due to higher average cash
available for investment in 1999 compared to 1998.

Liquidity and Capital Resources

As of December 31, 2000, we had cash, cash equivalents, investment securities
available for sale and interest receivable of $229.4 million compared with
$69.3 million as of December 31, 1999.

We used $43.5 million in cash for operating activities during 2000 compared to
$22.2 million during 1999. The primary operating uses of cash during 2000
relate to our clinical trial activities associated with Cialis and Pafase as
well as the expansion of other product development efforts. Current year cash
outflows also reflect costs related to the acquisition of technology rights
and LFA-1 compounds from Abbott Laboratories. The primary operating uses of
cash during 1999 relate to our clinical trial activities associated with
Cialis, Pafase and LeukArrest as well as the expansion of other product
development efforts.

We generated $16.4 million in cash from investing activities during 2000
compared to using $68.2 million in cash during 1999. Significant cash inflows
from investing activities during 2000 included a $21.4 million net decrease in
our short-term

                                      27
<PAGE>

investment portfolio and $7.3 million received upon the repayment of a loan to
ICOS Clinical Partners. Significant cash outflows during 2000 included $9.2
million in capital contributions to our equity affiliates and $3.1 million
invested in capital equipment and leasehold improvements to support our
research and development activities. The primary investing uses of cash during
1999 included a $47.0 million net increase in our short-term investment
portfolio, $15.2 million in equity investments in affiliates and $6.0 million
invested in property, plant and equipment.

We generated $208.9 million in cash from financing activities during 2000
compared to $33.7 million for 1999. The primary cash inflows from financing
activities in 2000 include $181.1 million in net proceeds received from our
public offering of 5.2 million shares of common stock at an offering price of
$37 per share and $27.8 million in proceeds related to stock option and
warrant activity. The primary cash inflows from financing activities during
1999 relate to proceeds received from the exercise of stock options and
warrants.

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

  .  continued progress in our research and development programs;

  .  the results of clinical trials and preclinical studies;

  .  acquisitions of products or technologies, if any;

  .  relationships with research and development collaborators;

  .  capital contributions to our joint ventures, including Lilly ICOS;

  .  royalty payments to ICOS Clinical Partners upon commercialization of
     Pafase(R);

  .  competing technological and market developments;

  .  the time and costs involved in filing and prosecuting patents and
     enforcing and defending patent claims;

  .  the regulatory process; and

  .  the time and costs of manufacturing, scale-up and commercialization
     activities.

We have engaged in collaborations and joint development agreements with other
parties where the work and strategies of the other parties complement ours. In
some instances, these relationships may involve commitments by us to fund some
or all of certain development programs. Although corporate collaborations,
partnerships and joint ventures have provided cost reimbursement revenue to us
in the past, we cannot assure you that this type of revenue will be available
to us in the future.

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

We anticipate that our existing cash and cash equivalents, investment
securities, interest income from our investments, anticipated payments from
Lilly ICOS, Suncos, ICOS-TBC and ICOS Clinical Partners, and cash flow from
other operating activities, will be adequate to satisfy our cash requirements
for at least the next 18 months. However, depending on our product development
efforts, we may need additional financing prior to that time. Additional
financing may not be available when we need it or may be unavailable on
acceptable terms. If we are unable to raise additional funds when we need
them, we may be required to delay, scale back or eliminate expenditures for
some of our development programs or grant rights to third parties to develop
and market product candidates that we would prefer to develop and market
internally.

Recent Accounting Pronouncements

In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, "Accounting for Certain Transactions Involving Stock Compensation: an
Interpretation of APB Opinion No. 25," which became effective on July 1, 2000.
Our adoption of Interpretation No. 44 did not have a material impact on our
consolidated financial statements.

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities," which is effective for fiscal years
beginning after June 15, 2000. The adoption of SFAS 133 will not have a
material impact on our consolidated financial statements as we do not
currently hold any derivative instruments.

                                      28
<PAGE>

Item 7A. Quantitative and Qualitative Disclosure about Market Risk

Our financial instruments currently consist of cash and cash equivalents and
short-term investments. We do not use derivative financial instruments in our
investment portfolio. Our exposure to market risk for changes in interest
rates relates primarily to our short-term investments, thus, interest rate
fluctuations would not be expected to have a material impact on the fair value
of these securities.

Item 8. Consolidated Financial Statements and Supplementary Data

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
     Consolidated Financial Statements                       Page in Form 10-K
     ---------------------------------                       -----------------
     <S>                                                     <C>
     Independent Auditors' Report                                           30

     Consolidated Balance Sheets at December 31, 2000 and
      1999                                                                  31

     Consolidated Statements of Operations for the Years
      Ended December 31, 2000, 1999, and 1998                               32

     Consolidated Statements of Stockholders' Equity and
      Comprehensive Income for the Years Ended December 31,
      2000, 1999, and 1998                                                  33

     Consolidated Statements of Cash Flows for the Years
      Ended December 31, 2000, 1999, and 1998                               34

     Notes to Consolidated Financial Statements                          35-47
</TABLE>

Balance sheets of Lilly ICOS LLC as of December 31, 2000 and 1999, and the
related statements of operations, comprehensive operations, members' equity
(deficit), and cash flows for each of the years in the two-year period ended
December 31, 2000, the period from October 2, 1998 (inception) through
December 31, 1998 and the period from October 2, 1998 (inception) through
December 31, 2000 are included elsewhere in this report.

Balance sheets of Suncos Corporation as of December 31, 2000 and 1999, and the
related statements of operations, stockholders' equity and comprehensive loss,
and cash flows for each of the years in the three-year period ended
December 31, 2000 and the period from February 6, 1997 (inception) through
December 31, 2000 are included elsewhere in this report.

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

                                      29
<PAGE>

                         INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
ICOS Corporation:

We have audited the accompanying consolidated balance sheets of ICOS
Corporation and subsidiary as of December 31, 2000 and 1999 and the related
consolidated statements of operations, stockholders' equity and comprehensive
income, and cash flows for each of the years in the three-year period ended
December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of ICOS
Corporation and subsidiary as of December 31, 2000 and 1999, and the results
of their operations and their cash flows for each of the years in the three-
year period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for nonrefundable technology license fees and
milestone payments in 2000.

/s/ KPMG LLP

Seattle, Washington
January 26, 2001

                                      30
<PAGE>

                                ICOS CORPORATION
                          CONSOLIDATED BALANCE SHEETS

                                     ASSETS

<TABLE>
<CAPTION>
                                           (in thousands, except share data)
                                           ----------------------------------
                                                     December 31,
                                           ----------------------------------
                                                 2000              1999
                                           ----------------  ----------------
<S>                                        <C>               <C>
Current assets:
 Cash and cash equivalents                 $        194,708  $         12,885
 Investment securities, at market value              34,284            55,349
 Interest receivable                                    408             1,020
 Receivables from affiliates                         17,051            17,121
 Other                                                2,007             2,049
                                           ----------------  ----------------
  Total current assets                              248,458            88,424
Net property and equipment, at cost                  19,127            21,042
Investments in affiliates, at equity                    466             3,241
Other assets                                            123                81
                                           ----------------  ----------------
                                           $        268,174  $        112,788
                                           ================  ================

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Accounts payable                          $          3,273  $          4,854
 Accrued payroll and benefits                         1,640             3,565
 Accrued clinical expenses                            3,897             3,409
 Other accrued expenses                               3,070             1,561
 Due to affiliates                                   25,053                 -
 Deferred research and development revenue
  from related parties                               17,249                 -
                                           ----------------  ----------------
  Total current liabilities                          54,182            13,389
Deferred research and development revenue
 from related parties                                 2,897                 -
Stockholders' equity:
 Preferred Stock, $.01 par value.
  Authorized 2,000,000 shares; none issued
 Common Stock, $.01 par value. Authorized
  100,000,000 shares; issued and
  outstanding 52,382,830 at December 31,
  2000 and 44,759,052 at December 31, 1999              524               448
 Additional paid-in capital                         432,665           223,477
 Accumulated other comprehensive income
  (loss)                                                 82              (216)
 Accumulated deficit                               (222,176)         (124,310)
                                           ----------------  ----------------
  Total stockholders' equity                        211,095            99,399
                                           ----------------  ----------------
                                           $        268,174  $        112,788
                                           ================  ================
</TABLE>


          See accompanying notes to consolidated financial statements.

                                       31
<PAGE>

                                ICOS CORPORATION
                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                              (in thousands, except per
                                                     share data)
                                              ----------------------------
                                               Year ended December 31,
                                              ----------------------------
                                                2000      1999      1998
                                              --------  --------  --------
<S>                                           <C>       <C>       <C>
Revenue:
 Collaborative research and development from
  related parties                             $ 47,404  $ 64,100  $ 33,758
 Licenses of technology to related parties      42,929    15,000    75,000
 Other                                             400       500     2,010
                                              --------  --------  --------
   Total revenue                                90,733    79,600   110,768
                                              --------  --------  --------
Operating expenses:
 Research and development                       87,435   100,541    76,978
 General and administrative                      6,582     5,259     4,031
                                              --------  --------  --------
   Total operating expenses                     94,017   105,800    81,009
                                              --------  --------  --------
   Operating income (loss)                      (3,284)  (26,200)   29,759
                                              --------  --------  --------
Other income (expense):
 Equity in losses of affiliates                (37,038)  (12,042)     (191)
 Investment income                               4,419     4,292     2,369
 Other, net                                      1,112       755        21
                                              --------  --------  --------
   Other income (expense)                      (31,507)   (6,995)    2,199
                                              --------  --------  --------
   Income (loss) before income taxes and
    cumulative effect of change in
    accounting principle                       (34,791)  (33,195)   31,958
Income taxes                                         -         -       648
                                              --------  --------  --------
   Income (loss) before cumulative effect of
    change in accounting principle             (34,791)  (33,195)   31,310
Cumulative effect of change in accounting
 principle                                     (63,075)        -         -
                                              --------  --------  --------
   Net income (loss)                          $(97,866) $(33,195) $ 31,310
                                              ========  ========  ========
Per common share:
 Income (loss) before cumulative effect of
  change in accounting principle
   Basic                                      $  (0.75) $  (0.76) $   0.78
   Diluted                                       (0.75)    (0.76)     0.67
 Cumulative effect of change in accounting
  principle
   Basic                                      $  (1.36)
   Diluted                                       (1.36)
 Net income (loss)
   Basic                                      $  (2.11) $  (0.76) $   0.78
   Diluted                                       (2.11)    (0.76)     0.67
Weighted-average common shares outstanding -
  basic                                         46,343    43,449    40,139
Weighted-average common shares outstanding -
  diluted                                       46,343    43,449    46,849
</TABLE>


          See accompanying notes to consolidated financial statements.

                                       32
<PAGE>

                                ICOS CORPORATION
    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME

<TABLE>
<CAPTION>
                           (in thousands, except number of shares and per share
                                                   data)
                         ---------------------------------------------------------
                                            Accumulated
                                Additional     other                     Total
                         Common  paid-in   comprehensive Accumulated stockholders'
                         stock   capital   income (loss)   deficit      equity
                         ------ ---------- ------------- ----------- -------------
<S>                      <C>    <C>        <C>           <C>         <C>
Balances at December
 31, 1997                 $399   $171,879      $  19      $(122,425)   $ 49,872
Comprehensive income
 (loss):
  Net income                 -          -          -         31,310      31,310
  Net unrealized losses
   on investment
   securities                                    (22)             -         (22)
                                               -----      ---------    --------
  Total comprehensive
   income (loss)                                 (22)        31,310      31,288
Issuance of 292,429
 shares of common stock
 from exercise of
 options                     3      1,950          -              -       1,953
Issuance of 1,304,200
 shares of common stock
 from exercise of
 warrants                   13     12,260          -              -      12,273
Value of warrants
 issued to partners of
 ICOS Clinical
 Partners, L.P.              -      3,347          -              -       3,347
                          ----   --------      -----      ---------    --------
Balances at December
 31, 1998                  415    189,436         (3)       (91,115)     98,733
Comprehensive loss:
  Net loss                   -          -          -        (33,195)    (33,195)
  Net unrealized losses
   on investment
   securities                                   (213)             -        (213)
                                               -----      ---------    --------
  Total comprehensive
   loss                                         (213)       (33,195)    (33,408)
Issuance of 860,909
 shares of common stock
 from exercise of
 options                     9      6,953          -              -       6,962
Issuance of 2,416,100
 shares of common stock
 from exercise of
 warrants                   24     22,839          -              -      22,863
Value of warrants
 issued to partners of
 ICOS Clinical
 Partners, L.P.                     4,249          -              -       4,249
                          ----   --------      -----      ---------    --------
Balances at December
 31, 1999                  448    223,477       (216)      (124,310)     99,399
Comprehensive income
 (loss):
  Net loss                   -          -          -        (97,866)    (97,866)
  Net unrealized gains
   on investment
   securities                                    298              -         298
                                               -----      ---------    --------
  Total comprehensive
   income (loss)                                 298        (97,866)    (97,568)
Compensation expense
 related to stock
 options                     -        555          -              -         555
Issuance of 1,224,928
 shares of common stock
 from exercise of
 options                    12     13,624          -              -      13,636
Issuance of 1,223,850
 shares of common stock
 from exercise of
 warrants                   12     11,860          -              -      11,872
Issuance of 5,175,000
 shares of common stock
 at $37.00 per share,
 net of offering costs
 of $10,377                 52    181,046          -              -     181,098
Value of warrants
 issued to partners of
 ICOS Clinical
 Partners, L.P.              -      2,103          -              -       2,103
                          ----   --------      -----      ---------    --------
Balances at December
 31, 2000                 $524   $432,665      $  82      $(222,176)   $211,095
                          ====   ========      =====      =========    ========
</TABLE>



          See accompanying notes to consolidated financial statements.

                                       33
<PAGE>

                                ICOS CORPORATION
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                        (in thousands)
                                                  ----------------------------
                                                   Year ended December 31,
                                                  ----------------------------
   <S>                                            <C>       <C>       <C>
                                                    2000      1999      1998
                                                  --------  --------  --------
   Cash flows from operating activities:
    Net income (loss)                             $(97,866) $(33,195) $ 31,310
    Adjustments to reconcile net income (loss)
     to net cash provided by (used in) operating
     activities:
     Cumulative effect of change in accounting
      principle                                     63,075         -         -
     Amortization of deferred revenue              (42,929)        -         -
     Depreciation and amortization                   4,977     4,037     3,111
     Equity in losses of affiliates                 37,038    12,042       191
     Stock compensation costs                          555         -         -
     Change in operating assets and liabilities:
      Receivables                                   (6,851)   (2,484)   (5,302)
      Other current assets                              43    (1,281)      (82)
      Payables and accruals                         (1,551)   (1,291)   10,592
                                                  --------  --------  --------
       Net cash provided by (used in) operating
        activities                                 (43,509)  (22,172)   39,820
                                                  --------  --------  --------
   Cash flows from investing activities:
    Purchases of investment securities             (33,772)  (80,844)  (17,421)
    Maturities of investment securities             43,823    24,908     7,000
    Sales of investment securities                  11,391     8,966    26,501
    Acquisitions of property and equipment          (3,142)   (6,011)   (5,256)
    Collection of receivable from affiliates         7,341         -         -
    Investments in affiliates                       (9,210)  (15,219)     (218)
                                                  --------  --------  --------
       Net cash provided by (used in) investing
        activities                                  16,431   (68,200)   10,606
                                                  --------  --------  --------
   Cash flows from financing activities:
    Proceeds from exercise of stock options and
     warrants                                       25,508    29,825    14,226
    Proceeds from issuance of warrants               2,295     3,848     3,528
    Proceeds from stock offering, net of related
     costs                                         181,098         -         -
                                                  --------  --------  --------
       Net cash provided by financing activities   208,901    33,673    17,754
                                                  --------  --------  --------
       Net increase (decrease) in cash and cash
        equivalents                                181,823   (56,699)   68,180
   Cash and cash equivalents at beginning of
    year                                            12,885    69,584     1,404
                                                  --------  --------  --------
   Cash and cash equivalents at end of year       $194,708  $ 12,885  $ 69,584
                                                  ========  ========  ========
</TABLE>


          See accompanying notes to consolidated financial statements.

                                       34
<PAGE>

                               ICOS CORPORATION
                  Notes to Consolidated Financial Statements

                          December 31, 2000 and 1999
      (Dollars in thousands, except per share data or as otherwise noted)

(1) Summary of Significant Accounting Policies

  (a)  Nature of Operations

       ICOS Corporation is a product-driven company that has expertise in both
       protein-based and small molecule therapeutics. Our product candidates
       encompass a variety of molecular mechanisms and targets to treat medical
       conditions.

  (b)  Principles of Consolidation

       The consolidated financial statements include the accounts of ICOS
       Corporation and its wholly owned subsidiary, ICOS Development
       Corporation, herein collectively referred to as "ICOS." All significant
       intercompany transactions and balances have been eliminated in
       consolidation.

  (c)  Use of Estimates in the Preparation of Financial Statements

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

  (d)  Financial Instruments

       Our financial instruments consist of cash and cash equivalents, short-
       term investments and, in prior years, a note receivable from an
       affiliate. Our cash and cash equivalents and short-term investments are
       diversified among security types and issuers, and their book value
       approximates fair value. Our financial instruments are short-term and
       therefore are considered to have fair value equal to book value. We do
       not have derivative financial instruments in our investment portfolio.

  (e)  Cash and Cash Equivalents

       All highly liquid short-term investments with a maturity at purchase of
       three months or less are considered to be cash equivalents. Our cash
       equivalents are money market accounts and corporate debt securities.

  (f)  Investment Securities

       Our investment securities are classified as available-for-sale and
       carried at market value, based on quoted market prices, with unrealized
       gains and losses excluded from results of operations and reported as a
       component of total comprehensive income (loss). Realized gains and losses
       on sales of investment securities are determined on the specific
       identification method and included in investment income.

  (g)  Property and Equipment

       Property and equipment are stated at cost. Significant additions and
       improvements to property and equipment are capitalized. Maintenance and
       repair costs are expensed as incurred. Depreciation of furniture and
       equipment is provided on the straight-line method over the assets'
       estimated useful lives of three to five years. We own one building which
       is being depreciated over its estimated useful life of ten years.
       Leasehold improvements are amortized over the shorter of their useful
       lives or the term of the lease. Building improvements are amortized over
       the shorter of their useful lives or the remaining economic life of the
       building.

  (h)  Investments in Affiliates

       Investments in ICOS Clinical Partners, L.P. ("ICOS Clinical Partners"),
       Suncos Corporation ("Suncos"), Lilly ICOS LLC ("Lilly ICOS") and ICOS-
       Texas Biotechnology L.P. ("ICOS-TBC") are accounted for using the equity
       method. Accordingly, the investments are recorded at cost, adjusted for
       our share of income or losses of the entities.

                                      35
<PAGE>

  (i)  Revenue Recognition

       All of our revenue to date has been derived from cost reimbursements for
       collaborative research and development activities and technology license
       fees (including milestone payments). Technology license fees are for the
       transfer of technology rights for which we receive nonrefundable cash
       payments. Milestone payments are for the achievement of specified levels
       of progress related to research and development under collaborative
       agreements. Collaborative research and development revenue is recognized,
       based on costs incurred, as services are provided.

       Pursuant to Securities and Exchange Commission Staff Accounting Bulletin
       No. 101, as amended ("SAB 101"), "Revenue Recognition in Financial
       Statements," effective January 1, 2000, nonrefundable upfront technology
       license fees, for product candidates where we are providing continuing
       services related to product development, are deferred. We recognize these
       fees as revenue over the product development periods, based on estimated
       total development costs. Milestone payments are recognized as revenue at
       the time such payments are due, based on the ratio of cumulative costs
       incurred to date, to total estimated development costs. Any remaining
       balance is deferred and recognized as revenue over the remaining product
       development period. No revenue is refundable if the related research
       effort is unsuccessful.

       Prior to 2000, milestone payments were recognized as revenue upon
       attainment of a specified event and other nonrefundable payments for
       technology or licensing fees were recognized as revenue when payment was
       received. Revenue was recognized when the work had been performed, we had
       no continuing performance obligations with respect to the work performed,
       and the contracting party was obligated to pay us.

  (j)  Research and Development Costs

       Research and development costs are expensed as incurred.

  (k)  Income Taxes

       Income taxes are accounted for using the asset and liability method
       whereby deferred tax assets and liabilities are recognized for the future
       tax consequences attributed to differences between the financial
       statement carrying amounts of existing assets and liabilities and their
       respective tax bases and loss carryforwards and tax credits. 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. A valuation allowance is
       established when necessary to reduce deferred tax assets to the amounts
       expected to be realized.

  (l)  Net Income (Loss) Per Common Share

       Basic net income (loss) per common share and diluted net loss per common
       share are calculated using the weighted-average number of common shares
       outstanding during the period. Diluted net income per common share is
       based on the potential reduction in the per share amount that would occur
       upon exercise of dilutive options and warrants using the treasury stock
       method.

  (m)  Stock Based Compensation

       We apply the provisions of Accounting Principles Board ("APB") Opinion
       No. 25, "Accounting for Stock Issued to Employees," and related
       interpretations in accounting for our employee stock option grants.
       Accordingly, we do not recognize compensation expense for fixed options
       granted to employees with an exercise price equal to or in excess of the
       fair value of common shares at the date of grant.

  (n)  Operating Segments

       We operate in one segment, the discovery and development of proprietary
       pharmaceuticals for the treatment of serious medical conditions.

  (o)  New Accounting Standards

       In March 2000, the Financial Accounting Standards Board issued
       Interpretation No. 44, "Accounting for Certain Transactions Involving
       Stock Compensation: an Interpretation of APB Opinion No. 25," which
       became effective on July 1, 2000. Our adoption of Interpretation No. 44
       did not have a material impact on our consolidated financial statements.

                                      36
<PAGE>

    In June 1998, the Financial Accounting Standards Board issued Statement of
    Financial Accounting Standard No. 133 ("SFAS 133"), "Accounting for
    Derivative Instruments and Hedging Activities," which is effective for
    fiscal years beginning after June 15, 2000. The adoption of SFAS 133 will
    not have a material impact on our consolidated financial statements as we do
    not currently hold any derivative instruments.

(2) Change in Accounting for Certain Revenues

    In the fourth quarter of 2000, we adopted the provisions of SAB 101.
    Pursuant to SAB 101, nonrefundable upfront technology license fees, for
    product candidates where we are providing continuing services related to
    product development, are deferred. We recognize these fees as revenue over
    the product development periods, based on estimated total development costs.
    Milestone payments are recognized as revenue at the time such payments are
    due, based on the ratio of cumulative costs incurred to date, to total
    estimated development costs. Any remaining balance is deferred and
    recognized as revenue over the remaining product development period. For the
    year ended December 31, 2000, the effect of adopting SAB 101 was to increase
    technology license revenue and decrease the loss before the accounting
    change each by $42.9 million [93 cents per share].

    The table below presents the pro forma amounts of our revenue, net income
    (loss) and related per share amounts for prior years, had revenue been
    recognized pursuant to SAB 101.

<TABLE>
<CAPTION>
                                                          December 31,
                                                        ------------------

                                                          1999      1998
     <S>                                                <C>       <C>
                                                        ------------------
     Revenue
       As reported                                      $ 79,600  $110,768
       Deferral of fees previously reported as revenue   (15,000)  (75,000)
       Revenue recognized over the product development
        period                                            30,886     4,023
                                                        --------  --------
       Pro forma                                        $ 95,486  $ 39,791
     Net income (loss)
       As reported                                      $(33,195) $ 31,310
       Pro forma                                         (17,309)  (39,667)
     Net income (loss) per common share - basic
       As reported                                      $  (0.76) $   0.78
       Pro forma                                        $  (0.40) $  (0.99)
     Net income (loss) per common share - diluted
       As reported                                      $  (0.76) $   0.67
       Pro forma                                        $  (0.40) $  (0.99)
</TABLE>

(3) Investment Securities

    The following table summarizes our investment securities at December 31,
    2000 and 1999:

<TABLE>
<CAPTION>
                                             Gross      Gross
                                           unrealized unrealized
                              Market value   gains      losses   Amortized cost
                              ------------ ---------- ---------- --------------
   <S>                        <C>          <C>        <C>        <C>
   December 31, 2000:
   Corporate debt securities    $28,266       $68        $  9       $28,207
   U.S. government agency
    mortgage-backed
    securities                    6,018        29           6         5,995
                                -------       ---        ----       -------
     Total                      $34,284       $97        $ 15       $34,202
                                =======       ===        ====       =======
   December 31, 1999:
   Corporate debt securities    $47,929       $11        $145       $48,063
   U.S. government agency
    mortgage-backed
    securities                    7,420         -          82         7,502
                                -------       ---        ----       -------
     Total                      $55,349       $11        $227       $55,565
                                =======       ===        ====       =======
</TABLE>

    Market value and amortized cost of debt securities at December 31, 2000, by
    contractual maturity, are shown below:

<TABLE>
<CAPTION>
                         Market value Amortized cost
                         ------------ --------------
       <S>               <C>          <C>
       Maturing within:
       1 year              $25,158       $25,160
       2 years             $ 9,126       $ 9,042
</TABLE>

                                      37
<PAGE>

    Actual maturities may be different from the contractual maturities because
    borrowers may have the right to call or prepay obligations with or without
    call or prepayment penalties.

    Investment income includes interest of $4.4 million, $4.3 million and $2.3
    million earned on investments for 2000, 1999 and 1998, respectively, and
    realized gains (losses) of $(7), $(14) and $28 for 2000, 1999 and 1998,
    respectively.

(4) Receivables from Affiliates

<TABLE>
<CAPTION>
                                                           December 31,
                                                         ------------------

                                                           2000      1999
         <S>                                             <C>       <C>
                                                         ------------------
         Suncos                                          $  1,558  $  1,894
         ICOS Clinical Partners                             1,156     9,556
         Lilly ICOS                                        12,273     5,649
         ICOS-TBC                                           1,977         -
         Other                                                 87        22
                                                         --------  --------
                                                         $ 17,051  $ 17,121
                                                         ========  ========

    Except for a note receivable of $7,341 due from ICOS Clinical Partners at
    December 31, 1999, substantially all of the above balances represent
    amounts due under collaborative research and development arrangements.

(5) Net Property and Equipment, at Cost

<CAPTION>
                                                           December 31,
                                                         ------------------

                                                           2000      1999
         <S>                                             <C>       <C>
                                                         ------------------
         Land                                            $  2,310  $  2,310
         Buildings and improvements                        10,092    10,057
         Leasehold improvements                            10,398     9,923
         Furniture and equipment                           26,256    23,641
                                                         --------  --------
                                                           49,056    45,931
         Less accumulated depreciation and amortization   (29,929)  (24,889)
                                                         --------  --------
                                                         $ 19,127  $ 21,042
                                                         ========  ========

(6) Accrued Payroll and Benefits

<CAPTION>
                                                           December 31,
                                                         ------------------

                                                           2000      1999
         <S>                                             <C>       <C>
                                                         ------------------
         Vacation and other compensation                 $  1,319  $  1,214
         Accrued payroll taxes and other                      321     2,351
                                                         --------  --------
                                                         $  1,640  $  3,565
                                                         ========  ========

(7) Due to Affiliates

<CAPTION>
                                                           December 31,
                                                         ------------------

                                                           2000      1999
         <S>                                             <C>       <C>
                                                         ------------------
         Lilly ICOS                                      $ 23,612  $      -
         ICOS-TBC                                           1,441         -
                                                         --------  --------
                                                         $ 25,053  $      -
                                                         ========  ========
</TABLE>

    Due to affiliates represents our share of the losses of Lilly ICOS and
    ICOS-TBC in excess of our investment.

(8) Leases

    We lease certain property and equipment under noncancellable operating
    leases that expire through 2006. Many of our leases contain renewal options
    and provide for escalations of rent and payment of real estate taxes,
    maintenance, insurance and certain other operating expenses of the
    properties.

    Total rent expense was $3.5 million, $3.4 million and $1.6 million for
    2000, 1999 and 1998, respectively.

                                      38
<PAGE>

    Future minimum lease payments under noncancellable operating leases are as
    follows:

<TABLE>
             <S>                           <C>
             2001                          $3,306
             2002                           3,137
             2003                           2,456
             2004                             366
             2005                             170
             Thereafter                        43
                                           ------
             Total minimum lease payments  $9,478
                                           ======
</TABLE>

    During 1999, we began subleasing certain property to others under short-
    term operating leases expiring in 2001 and 2002, with options to extend the
    subleases through 2003 and 2004. Total rent expense presented above has not
    been reduced by sublease income totaling $1,265 and $682 in 2000 and 1999,
    respectively. Similarly, minimum lease payments indicated above do not
    reflect minimum rentals of $688 due in the future under noncancellable
    subleases.

(9) Federal Income Taxes

    Income tax expense (benefit) differs from the amount computed by applying
    the U.S. federal income tax rate to pre-tax income (loss) as a result of
    the following:

<TABLE>
<CAPTION>
                                                    2000      1999      1998
                                                  --------  --------  --------
     <S>                                          <C>       <C>       <C>
         Estimated federal income tax expense
          (benefit)                               $(34,253) $(11,286) $ 10,866
         Value of warrants issued to partners of
          ICOS Clinical Partners                       736     1,445     1,139
         Research and experimentation tax credit
          carryforwards                             (2,233)     (843)   (1,271)
         Change in valuation allowance              35,624    10,646   (10,182)
         Other                                         126        38        96
                                                  --------  --------  --------
                                                  $      -  $      -  $    648
                                                  ========  ========  ========
</TABLE>

    The change in valuation allowance shown above excludes, in each year,
    deductions generated by non-qualified stock option exercises that will be
    credited directly to stockholders' equity upon realization.

    Temporary differences and carryforwards which give rise to deferred tax
    assets are comprised of the following:

<TABLE>
<CAPTION>
                                                                   December 31,
                                                                ------------------
                                                                  2000      1999
         <S>                                                    <C>       <C>
                                                                ------------------
         Depreciation                                           $  4,310  $  4,272
         Deferred revenue                                          7,051         -
         Net operating loss carryforwards                         71,899    42,262
         Research and experimentation tax credit carryforwards     8,396     6,364
         Alternative minimum tax credit carryforward                 612       612
         Investments in affiliates                                 6,202         -
         Other                                                     1,484       185
                                                                --------  --------
         Gross deferred tax assets                                99,954    53,695
         Valuation allowance                                     (99,954)  (52,589)
                                                                --------  --------
         Net deferred tax assets                                       -     1,106
         Deferred tax liability - Investments in affiliates            -    (1,106)
                                                                --------  --------
                                                                $      -  $      -
                                                                ========  ========
</TABLE>

    The increases (decrease) in the valuation allowance for deferred tax assets
    of $47.4 million, $15.2 million and $(9.2) million, in 2000, 1999 and 1998,
    respectively, are attributable primarily to net operating loss
    carryforwards.

                                      39
<PAGE>

    At December 31, 2000, we have net operating loss carryforwards available to
    offset future taxable income as follows:

<TABLE>
<CAPTION>
                 Year of Expiration
                 ------------------

                 <S>                                                  <C>
                        2009                                          $  5,060
                        2010                                            21,507
                        2011                                            21,039
                        2012                                            26,774
                        2013                                             7,688
                        2018                                               359
                        2019                                            36,832
                        2020                                            86,166
                                                                      --------
                                                                      $205,425
                                                                      ========
</TABLE>

     Approximately $48.4 million of the net operating loss carryforwards as of
     December 31, 2000, results from stock option deductions, the realization of
     which would result in a credit to stockholders' equity. At December 31,
     2000, we also had available approximately $8.4 million of research and
     experimentation tax credit carryforwards to offset future tax liabilities.
     These credits expire from 2009 to 2020.

     Under provisions of the Internal Revenue Code of 1986, as amended,
     utilization of our net operating loss carryforwards may be subject to
     limitation if it should be determined that a greater than 50% ownership
     change were to occur in the future.

     During 1999, we paid $648 of federal income taxes.

(10) Preferred Stock

     We have the authority to issue up to 2.0 million shares of preferred stock
     in one or more series. Our Board of Directors has the authority to fix the
     powers, designations, preferences, and relative participating, optional, or
     other rights thereof, including dividend rights, conversion rights, voting
     rights, redemption terms, liquidation preferences, and the number of shares
     constituting any series, without any further vote or action by our
     stockholders. The issuance of preferred stock in certain circumstances may
     have the effect of delaying or preventing a change in control of ICOS. Such
     issuance with voting and conversion rights may adversely affect the voting
     power of the common stock holders. We have no shares of preferred stock
     outstanding. In the future, we may issue preferred stock as part of our
     overall financing strategy.

(11) Common Stock Options and Warrants

     Stock Option Plan

     Effective May 6, 1999, we adopted the 1999 Stock Option Plan (the "Plan"),
     under which a total of 10.2 million shares of common stock are reserved for
     grant to various executive, scientific, and administrative personnel as
     well as nonemployee directors. The Plan replaced our 1989 Stock Option Plan
     and our 1991 Stock Option Plan for Nonemployee Directors (the "Prior
     Plans").

     All incentive stock options are granted with an exercise price not less
     than 100% of the fair market value of the common stock on the grant date.
     Nonqualified stock options are generally granted with an exercise price
     equal to 100% of the fair market value of the common stock on the grant
     date. We have not granted nonqualified stock options below fair market
     value. The options generally vest over a four-year period commencing on the
     grant date and have a term of ten years from the grant date.

                                      40
<PAGE>

  A summary of stock options, including the Prior Plans, is presented below
  (shares stated in thousands):

<TABLE>
<CAPTION>
                                        Stock options
                                         outstanding
                                   ------------------------
                                               Weighted-
                                                average
                                   Number of exercise price
                                    shares     per share
                                   --------- --------------
     <S>                           <C>       <C>
     Balance at December 31, 1997    5,446       $ 7.25
     Options granted                 1,377        17.19
     Cancellations                     (81)       12.77
     Options exercised                (292)        6.58
                                    ------       ------
     Balance at December 31, 1998    6,450         9.33
     Options granted                 2,514        37.60
     Cancellations                     (90)       19.50
     Options exercised                (861)        8.07
                                    ------       ------
     Balance at December 31, 1999    8,013        18.22
     Options granted                 1,036        34.27
     Cancellations                    (121)       25.46
     Options exercised              (1,226)       11.12
                                    ------       ------
     Balance at December 31, 2000    7,702       $21.39
                                    ======       ======
</TABLE>

  At December 31, 2000, 2.5 million shares were reserved and available for
  grant under the Plan.

  The following table summarizes information about stock options outstanding
  and exercisable at December 31, 2000 (shares stated in thousands):

<TABLE>
<CAPTION>
                         Stock options outstanding          Stock options exercisable
                ------------------------------------------- --------------------------
                            Weighted-average   Weighted-                  Weighted-
     Range of                  remaining        average                    average
     exercise     Number    contractual life exercise price   Number    exercise price
      prices    outstanding    (in years)      per share    exercisable   per share
     --------   ----------- ---------------- -------------- ----------- --------------
     <S>        <C>         <C>              <C>            <C>         <C>
     $ 3.75 -
       $ 7.25      1,557          3.61           $ 5.50        1,556        $ 5.50
       7.31 -
         8.61      1,465          5.05             8.02        1,436          8.02
       8.63 -
        20.63      1,324          6.39            15.79        1,002         15.53
      20.94 -
        41.25      1,729          8.33            30.64          755         30.75
      42.88 -
        55.88      1,627          8.57            43.34          454         42.96
    ----------------------------------------------------------------------------------

     $ 3.75 -
       $55.88      7,702          6.47           $21.39        5,203        $15.06
</TABLE>

  We apply APB Opinion No. 25 in accounting for our stock option grants
  resulting in no compensation cost being recognized. Had we determined
  compensation cost based on the fair value of our stock options on the grant
  date under Statement of Financial Accounting Standards No. 123, "Accounting
  for Stock Based Compensation," our net income (loss) would have been
  adjusted to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                              2000       1999     1998
                                            ---------  --------  -------
     <S>                                    <C>        <C>       <C>
     Net income (loss)
       As reported                          $ (97,866) $(33,195) $31,310
       Pro forma                             (121,724)  (47,705)  24,735
     Net income (loss) per share - basic
       As reported                          $   (2.11) $  (0.76) $  0.78
       Pro forma                                (2.63)    (1.10)    0.62
     Net income (loss) per share - diluted
       As reported                          $   (2.11) $  (0.76) $  0.67
       Pro forma                                (2.63)    (1.10)    0.53
</TABLE>

                                      41
<PAGE>

     The per share weighted-average fair value of stock options granted during
     2000, 1999 and 1998, was $22.57, $22.29 and $10.23, respectively, on the
     grant date using the Black-Scholes option pricing model with the following
     assumptions:
<TABLE>
<CAPTION>
                              2000  1999  1998
                              ----  ----  ----
     <S>                      <C>   <C>   <C>
     Expected dividend yield   0.0%  0.0%  0.0%
     Risk-free interest rate   6.6%  5.8%  5.4%
     Expected volatility      74.1% 66.0% 70.5%
     Expected life in years    6.8   6.5   4.4
</TABLE>

     Warrants To Purchase Common Stock

     In connection with ICOS Clinical Partner's sale of limited partnership
     units, we issued, on June 5, 1997, and August 15, 1997, Series A warrants
     to purchase an aggregate of 5.6 million and 2.0 million shares,
     respectively, of our common stock at exercise prices of $9.13 and $10.35
     per share, respectively. The Series A warrants are exercisable from October
     1, 1998 through May 31, 2002. We also issued, on June 30, 1999, Series B
     warrants to purchase an aggregate of 7.6 million shares of our common stock
     at an exercise price of $52.49 per share. The Series B warrants are
     exercisable from July 31, 1999 through June 30, 2004.

     The warrants were issued in conjunction with a research and development
     agreement between ICOS and ICOS Clinical Partners. Amounts to be received
     from ICOS Clinical Partners are allocated between warrant issuance proceeds
     and the research and development funding to be received. The warrants were
     valued using the Black-Scholes option pricing model, with the following
     assumptions:

<TABLE>
     <S>               <C>
     .  Expected
        dividend
        yield:         0.0%
     .  Risk-free
        interest
        rate:          6.095% to 6.470%
     .  Expected
        volatility:    45%
     .  Expected life
        in years       4.8 to 7.1
</TABLE>

     The resulting valuation under Black-Scholes was discounted by 50% to 60% to
     take into account severe restrictions on the marketability of the warrants,
     including the lack of an existing market for the warrants,
     nontransferability of the warrants without our written consent, and certain
     limitations on the aggregate number of warrants that can be transferred in
     a single year.

     During 2000, Series A and B warrants to purchase 1.2 million shares were
     exercised at a weighted-average exercise price of $9.70 per share. During
     1999, Series A warrants to purchase 2.4 million shares were exercised at a
     weighted-average exercise price of $9.51 per share. At December 31, 2000,
     warrants to purchase 10.2 million shares were outstanding at a weighted-
     average exercise price of $41.41 per share.

(12) Net Income (Loss) per Common Share

<TABLE>
<CAPTION>
                                                       For the year ended
                                                          December 31,
                                                    ---------------------------
                                                      2000      1999     1998
     <S>                                            <C>       <C>       <C>
                                                    ---------------------------
     Basic net income (loss) per share
      computations:
     Numerator:
       Net income (loss)                            $(97,866) $(33,195) $31,310
     Denominator:
       Weighted-average common shares                 46,343    43,449   40,139
                                                    --------  --------  -------
     Basic net income (loss) per share              $  (2.11) $  (0.76) $  0.78
                                                    ========  ========  =======
     Diluted net income (loss) per share
      computations:
     Numerator:
       Net income (loss)                            $(97,866) $(33,195) $31,310
     Denominator:
       Weighted-average common shares                 46,343    43,449   40,139
       Effect of dilutive securities:
         Stock options                                     -         -    3,285
         Stock warrants                                    -         -    3,425
                                                    --------  --------  -------
         Denominator for diluted net income (loss)
          per share                                   46,343    43,449   46,849
                                                    --------  --------  -------
     Diluted net income (loss) per share            $  (2.11) $  (0.76) $  0.67
                                                    ========  ========  =======
</TABLE>


                                      42
<PAGE>

     Antidilutive securities excluded from the computation of diluted net income
     (loss) per share were as follows:

<TABLE>
<CAPTION>
                        For the year ended
                           December 31,
                        -------------------
                         2000   1999  1998
        <S>             <C>    <C>    <C>
                        -------------------
        Stock options    7,702  8,013    40
        Stock warrants  10,157 11,381 7,551
</TABLE>

(13) Related Party Transactions

     We provide certain administrative, research and support services to Ceptyr,
     Inc. ("Ceptyr"). Ceptyr also subleases space from us. We recognized income
     of approximately $818 and $278 from Ceptyr in 2000 and 1999, respectively.
     Dr. Wilcox, our Executive Vice President, Operations, is a director of
     Ceptyr.

     During 1999, we chartered an airplane from AMI Jet Charter, Inc. d.b.a. TAG
     Aviation ("TAG") and recognized approximately $282 in expenses for services
     rendered. The aircraft subject to the charter arrangement was under the
     control of Peregrine Aviation, LLC ("Peregrine"), a company wholly owned by
     George B. Rathmann, Ph.D., who concurrently served as the Chairman of our
     Board of Directors. Peregrine subleased the plane to TAG, which used it as
     part of its charter fleet. We believe that the rates charged by TAG were
     below the standard rates for commercial charter services.

(14) Scientific Collaboration Agreements

     Lilly ICOS LLC

     In October 1998, ICOS and Eli Lilly formed Lilly ICOS, a 50/50-owned
     limited liability company, to develop and commercialize PDE5 inhibitors.
     Lilly ICOS is developing Cialis(TM) as an oral therapeutic agent for the
     treatment of both erectile dysfunction and female sexual dysfunction. Under
     the terms of this arrangement, we received a $75.0 million payment upon
     formation of the joint venture and an additional $15.0 million payment in
     1999 upon initiation of a Phase 3 clinical trial program for Cialis. We
     could receive additional payments based on the progression of Cialis
     through development. The joint venture was initially capitalized by Eli
     Lilly through cash contributions and the contribution by us of an exclusive
     worldwide license to intellectual property relating to PDE5 inhibitors,
     including intellectual property associated with Cialis and its research
     platform. Both ICOS and Eli Lilly provide Lilly ICOS with research and
     development services. The joint venture will market any products resulting
     from this collaborative effort in North America and the countries in the
     European Union or European Free Trade Area through the services of ICOS and
     Eli Lilly. For countries outside North America and these European
     countries, in exchange for royalty payments, Lilly ICOS has granted Eli
     Lilly an exclusive license to develop, manufacture and commercialize the
     PDE5 inhibitors developed in the collaboration.

     We recognized collaborative research and development revenue of $19.9
     million, $19.9 million and $3.8 million from Lilly ICOS in 2000, 1999 and
     1998, respectively.

     The technology we contributed to Lilly ICOS had a zero basis for financial
     reporting purposes and, accordingly, our initial investment in Lilly ICOS
     was recorded at zero. We did not recognize any portion of Lilly ICOS'
     operating losses during the time joint venture activities were funded
     exclusively by Eli Lilly. Since the third quarter of 2000, we have
     recognized our share of Lilly ICOS' losses because we will be funding our
     proportionate share of Lilly ICOS' operations. For the year ended December
     31, 2000, we recognized our $23.6 million share of the net losses of Lilly
     ICOS.

                                      43
<PAGE>

  Summarized unaudited financial information for Lilly ICOS is as follows:

<TABLE>
<CAPTION>
   Financial position - December 31:                2000       1999
   ---------------------------------                ----       ----
   <S>                                         <C>        <C>
   Total assets - all current                  $   8,186  $  18,226
                                               =========  =========
   Total liabilities - all current, payable
    to related parties                         $  55,411  $  17,992
   Members' equity (deficit)                     (47,225)       234
                                               ---------  ---------
                                               $   8,186  $  18,226
                                               =========  =========

<CAPTION>
   Operating results - For the year ended
   December 31:                                     2000       1999       1998
   --------------------------------------           ----       ----       ----
   <S>                                         <C>        <C>        <C>
   Research and development expenses, related
    parties                                    $ (87,950) $ (59,073) $  (6,538)
   Contribution of technology, related party     (40,000)   (70,000)  (175,000)
   Administrative expenses                          (183)      (104)      (284)
   Interest income                                   663        926        318
                                               ---------  ---------  ---------
   Net loss                                    $(127,470) $(128,251) $(181,504)
                                               =========  =========  =========
</TABLE>

  Suncos Corporation

  In February 1997, ICOS and Suntory formed Suncos, a 50/50-owned
  corporation, to develop and commercialize Pafase(R) worldwide. Under the
  terms of this arrangement, the joint venture was established with a $30
  million cash investment by Suntory to Suncos and subsequent capital
  contributions have been made by both Suntory and ICOS in equal amounts.
  Both Suntory and ICOS provide Suncos with research and development
  services. We granted Suncos an exclusive license to all rights to Pafase on
  a worldwide basis. Suncos has granted Suntory exclusive rights to develop
  and commercialize Pafase in Japan, and Suncos has granted ICOS exclusive
  rights to develop and commercialize Pafase in the United States. Suncos
  retains the rights to develop and commercialize Pafase in the rest of the
  world. Suncos is managed jointly by Suntory and ICOS. Suntory and ICOS will
  each pay royalties to Suncos on sales of Pafase in their respective
  territories.

  We recognized collaborative research and development revenue of $15.2
  million, $25.1 million and $14.9 million from Suncos in 2000, 1999 and
  1998, respectively.

  The technology we contributed to Suncos had a zero basis for financial
  reporting purposes and, accordingly, we recorded our initial investment in
  Suncos as zero. We did not begin to report our share of Suncos' losses
  until such time that Suncos' accumulated losses were equal to Suntory's
  investment and we made capital contributions to Suncos. During 1999, we and
  Suntory each made capital contributions to Suncos of $15.0 million, and we
  recognized $11.8 million in equity losses, equal to our share of Suncos'
  net loss subsequent to our initial equity investment. During 2000, we and
  Suntory each made capital contributions to Suncos of $5.0 million, and we
  recorded approximately $7.8 million as our share of Suncos' 2000 net loss.

  Summarized unaudited financial information for Suncos is as follows:

<TABLE>
<CAPTION>
   Financial position - December 31:                2000      1999
   ---------------------------------                ----      ----
   <S>                                          <C>       <C>
   Total assets - all current                   $  2,511  $  8,364
                                                ========  ========
   Total liabilities - all current, payable to
    related parties                             $  1,583  $  1,930
   Stockholders' equity                              928     6,434
                                                --------  --------
                                                $  2,511  $  8,364
                                                ========  ========

<CAPTION>
   Operating results -- For the year ended
   December 31:                                     2000      1999      1998
   ---------------------------------------          ----      ----      ----
   <S>                                          <C>       <C>       <C>
   Operating expenses, related parties          $(15,672) $(26,044) $(16,594)
   Interest income                                   166       430       699
                                                --------  --------  --------
   Net loss                                     $(15,506) $(25,614) $(15,895)
                                                ========  ========  ========
</TABLE>

                                      44
<PAGE>

  ICOS-Texas Biotechnology L.P.

  In June 2000, ICOS and Texas Biotechnology formed ICOS-TBC, a 50/50-owned
  limited partnership, to develop and commercialize endothelin receptor
  antagonists, such as sitaxsentan and TBC3711. Under the terms of this
  arrangement, ICOS and Texas Biotechnology will equally fund the development
  of endothelin receptor antagonists and equally share in the profits of the
  partnership. We made an initial $2.0 million payment to Texas Biotechnology
  and may make further milestone payments of up to $53.5 million. Texas
  Biotechnology made an initial contribution to ICOS-TBC of an exclusive
  worldwide license to the intellectual property associated with endothelin
  receptor antagonists, including patent rights and technical information.
  Both parties will provide the partnership with research and development
  services. ICOS-TBC will manufacture, market and sell any products resulting
  from the collaboration worldwide.

  For the period June 6, 2000 (inception) through December 31, 2000, we
  recognized collaborative research and development revenue of $2.8 million
  from ICOS-TBC. During the same period, we also recognized our $5.5 million
  share of the net losses of ICOS-TBC.

  Summarized unaudited financial information for ICOS-TBC is as follows:

<TABLE>
<CAPTION>
   Financial position - December 31:                                2000
   ---------------------------------                                ----
   <S>                                                          <C>
   Total assets - all current                                   $    491
                                                                --------
   Total liabilities - all current, payable to related parties  $  3,397
   Members' deficit                                               (2,906)
                                                                --------
                                                                $    491
                                                                ========

<CAPTION>
   Operating results - For the period June 6, 2000 (inception)
   through December 31:                                             2000
   -----------------------------------------------------------      ----
   <S>                                                          <C>
   Revenue                                                      $    547
   Research and development expenses, related parties             (7,515)
   Contribution of technology, related party                      (4,000)
   Administrative expenses                                            (7)
                                                                --------
   Net loss                                                     $(10,975)
                                                                ========
</TABLE>

  ICOS Clinical Partners, L.P.

  On August 15, 1997, ICOS Clinical Partners completed the sale to private
  investors of its limited partnership interests for aggregate net proceeds
  of approximately $79.8 million. Approximately $25.9 million, before payment
  of offering costs, was paid to ICOS Clinical Partners at closing of the
  sale of partnership units. ICOS Clinical Partners received $21.9 million in
  both 1998 and 1999 with the final balance of $10.1 million received in
  2000.

  Net proceeds from the sale are being used by ICOS Clinical Partners to fund
  continued development of product candidates by ICOS pursuant to the terms
  of the Product Development Agreement based on three compounds:
  LeukArrest(TM), Pafase(R) and ICM3.

  We recognized collaborative research and development revenue of $9.5
  million, $19.1 million and $15.1 million from ICOS Clinical Partners in
  2000, 1999 and 1998, respectively. We loaned ICOS Clinical Partners an
  aggregate of $7.3 million to fund certain of its initial expenditures,
  primarily organizational expenses, selling commissions, financial advisory
  fees and other fees. The loan bore interest at the prime rate plus 0.25%
  and was paid in full during 2000. For the years ended December 31, 2000,
  1999 and 1998, interest income on the loan was $0.3 million, $0.6 million
  and $0.6 million, respectively.

  We have a 1% interest in ICOS Clinical Partners and are the sole general
  partner. We account for our interest in ICOS Clinical Partners using the
  equity method. Under the terms of the partnership agreement, the limited
  partners have the ability to replace us as the general partner, to approve
  the sale or refinancing of all of the partnership assets and to terminate
  the partnership.

  Our share of losses of ICOS Clinical Partners was $0.2 million for each of
  the years ended December 31, 2000, 1999 and 1998. The investment in this
  affiliate, at equity, was $22 and $43 at December 31, 2000 and 1999,
  respectively.

                                      45
<PAGE>

  Summarized unaudited financial information for ICOS Clinical Partners is as
  follows:

<TABLE>
<CAPTION>
   Financial position - December 31:               2000      1999
   ---------------------------------               ----      ----
   <S>                                         <C>       <C>
   Total assets - all current                  $  3,368  $  6,574
                                               ========  ========
   Payable to ICOS Corporation                 $  1,156  $  9,915
   Partners' capital (deficit)                    2,212    (3,341)
                                               --------  --------
                                               $  3,368  $  6,574
                                               ========  ========

<CAPTION>
   Operating results - For the year ended
   December 31:                                    2000      1999      1998
   --------------------------------------          ----      ----      ----
   <S>                                         <C>       <C>       <C>
   Investment income                           $    167  $    324  $    328
   Research and development expenses, related
    party                                       (11,571)  (23,292)  (18,520)
   Interest expense, related party                 (277)     (604)     (624)
   Administrative expenses                         (246)     (283)     (309)
                                               --------  --------  --------
   Net loss                                    $(11,927) $(23,855) $(19,125)
                                               ========  ========  ========
</TABLE>

  Abbott Laboratories

  In April 1995, we formed a collaboration with Abbott Laboratories to
  discover certain small molecule drugs. In September 1997, we expanded and
  extended this relationship. The research program under the collaboration
  provided us with research funding from Abbott Laboratories and was
  completed at the end of its term on April 1, 1999. In June 2000, we
  acquired Abbott Laboratories' worldwide rights to all compounds developed
  in connection with the collaboration, including LFA-1 antagonists such as
  IC747. Abbott Laboratories will receive royalties and milestone payments on
  any products that we market that incorporate these compounds.

  Other Collaborative Arrangements

  We have also entered into other collaborative arrangements under which we
  may be obligated to pay royalties or milestone payments if product
  development is successful. It is not anticipated that the aggregate of any
  royalty or milestone obligations under these arrangements will be material
  to our operations.

                                      46
<PAGE>

15. Quarterly Financial Data (Unaudited)

    Summary data relating to the results of operations for each quarter of the
    years ended December 31, 2000 and 1999 follows. Amounts for the first three
    quarters of 2000 have been restated to reflect the adoption of SAB 101
    effective January 1, 2000. The restatement had the effect of increasing
    revenue and reducing the loss before cumulative effect of change in
    accounting principle by $7.4 million (16 cents per share), $9.2 million (20
    cents per share) and $10.2 million (22 cents per share) in the first, second
    and third quarters, respectively.

<TABLE>
<CAPTION>
                                                 Quarters
                               ------------------------------------------------
                                First     Second    Third     Fourth    Total
                               --------  --------  --------  --------  --------
    <S>                        <C>       <C>       <C>       <C>       <C>
    2000
    ----
    Revenue                    $ 17,200  $ 19,642  $ 21,678  $ 32,213  $ 90,733
    Loss before cumulative
     effect of change in
     accounting principle        (4,449)   (8,261)  (11,467)  (10,614)  (34,791)
    Net loss                    (67,524)   (8,261)  (11,467)  (10,614)  (97,866)
    Loss per common share
     before cumulative effect
     of change in accounting
     principle -
      Basic                    $  (0.10) $  (0.18) $  (0.25) $  (0.22) $  (0.75)
      Diluted                     (0.10)    (0.18)    (0.25)    (0.22)    (0.75)
    Net loss per common share
     -
      Basic                    $  (1.49) $  (0.18) $  (0.25) $  (0.22) $  (2.11)
      Diluted                     (1.49)    (0.18)    (0.25)    (0.22)    (2.11)

    1999
    ----
    Revenue                    $ 16,145  $ 16,020  $ 17,622  $ 29,813  $ 79,600
    Net income (loss)            (7,185)  (13,960)  (16,399)    4,349   (33,195)
    Net income (loss) per
     common share -
      Basic                    $  (0.17) $  (0.32) $  (0.37) $   0.10  $  (0.76)
      Diluted                     (0.17)    (0.32)    (0.37)     0.09     (0.76)
    Pro forma amounts
     assuming the change in
     accounting principle was
     applied retroactively to
     prior years -
    Net income (loss)          $ (1,547) $ (8,256) $ (9,689) $  2,183  $(17,309)
    Net income (loss) per
     common share -
      Basic                    $  (0.04) $  (0.19) $  (0.22) $   0.05  $  (0.40)
      Diluted                     (0.04)    (0.19)    (0.22)     0.04     (0.40)
</TABLE>

                                      47
<PAGE>

                                   PART III

Item 10. Directors and Executive Officers of the Registrant

The information requested by this item is incorporated by reference from the
sections labeled "Election of Directors," "Continuing Class 3 Directors (until
2002)," "Continuing Class 1 Directors (until 2003)," "Other Executive
Officers," "Section 16(a) Beneficial Ownership Reporting Compliance,"
"Compensation of Directors," "Executive Compensation," "2000 Option Grants,"
"2000 Option Exercises and Year-end Option Values," "Compensation Committee
Interlocks and Insider Participation," "Employment Contracts, Termination of
Employment and Change of Control Arrangements," "Security Ownership of Certain
Beneficial Owners and Management," and "Certain Relationships and Related
Transactions" in the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 4, 2001.

Item 11. Executive Compensation

The information requested by this item is incorporated by reference from the
sections labeled "Compensation of Directors," "Executive Compensation," "2000
Option Grants," "2000 Option Exercises and Year-end Option Values,"
"Compensation Committee Interlocks and Insider Participation," and "Employment
Contracts, Termination of Employment and Change of Control Arrangements" in
the Company's Proxy Statement for the Annual Meeting of Stockholders to be
held on May 4, 2001.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The information requested by this item is incorporated by reference from the
section labeled "Security Ownership of Certain Beneficial Owners and
Management" in the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 4, 2001.

Item 13. Certain Relationships and Related Transactions

The information requested by this item is incorporated by reference from the
section labeled "Certain Relationships and Related Transactions" in the
Company's Proxy Statement for the Annual Meeting of Stockholders to be held on
May 4, 2001.

                                      48
<PAGE>

                                    PART IV

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

      a) 1.  Consolidated Financial Statements

             See Index to Consolidated Financial Statements under Item 8 of this
             Form 10-K.

         2.  Consolidated Financial Statement Schedules

             Balance sheets of Lilly ICOS LLC as of December 31, 2000 and 1999,
             and the related statements of operations, comprehensive operations,
             members' equity (deficit), and cash flows for each of the years in
             the two-year period ended December 31, 2000, the period from
             October 2, 1998 (inception) through December 31, 1998 and the
             period from October 2, 1998 (inception) through December 31, 2000.

             Balance sheets of Suncos Corporation as of December 31, 2000 and
             1999, and the related statements of operations, stockholders'
             equity and comprehensive loss, and cash flows for each of the years
             in the three-year period ended December 31, 2000 and the period
             from February 6, 1997 (inception) through December 31, 2000.

             Independent Auditors' Reports

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

         3.  Exhibits

             See Index to Exhibits filed herewith.

      b)  Reports on Form 8-K

          No report on Form 8-K was filed during the fourth quarter of the
          fiscal year ended December 31, 2000.

      d)  Lilly ICOS LLC Financial Statements

          Suncos Corporation Financial Statements


                                      49
<PAGE>

                                 LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                          Page

<S>                                                                       <C>
Independent Auditors' Report                                                 51

Balance Sheets as of December 31, 2000 and 1999                              52

Statements of Operations for each of the years in the two-year period
 ended December 31, 2000, the period from October 2, 1998 (inception)
 through December 31, 1998 and the period from October 2, 1998
 (inception) through December 31, 2000                                       53

Statements of Comprehensive Operations for each of the years in the two-
 year period ended December 31, 2000, the period from October 2, 1998
 (inception) through December 31, 1998 and the period from October 2,
 1998 (inception) through December 31, 2000                                  54

Statements of Members' Equity (Deficit) for each of the years in the
 two-year period ended December 31, 2000, the period from October 2,
 1998 (inception) through December 31, 1998 and the period from October
 2, 1998 (inception) through December 31, 2000                               55

Statements of Cash Flows for each of the years in the two-year period
 ended December 31, 2000, the period from October 2, 1998 (inception)
 through December 31, 1998 and the period from October 2, 1998
 (inception) through December 31, 2000                                       56

Notes to Financial Statements                                             57-58
</TABLE>

                                       50
<PAGE>

                         INDEPENDENT AUDITORS' REPORT

The Board of Directors
Lilly ICOS LLC:

We have audited the accompanying balance sheets of Lilly ICOS LLC (a
development stage company) as of December 31, 2000 and 1999, and the related
statements of operations, comprehensive operations, members' equity (deficit)
and cash flows for each of the years in the two-year period ended December 31,
2000, the period from October 2, 1998 (inception) to December 31, 1998 and the
period from October 2, 1998 (inception) to December 31, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Lilly ICOS LLC as of December
31, 2000 and 1999, and the results of its operations and its cash flows for
each of the years in the two-year period ended December 31, 2000, the period
from October 2, 1998 (inception) to December 31, 1998 and the period from
October 2, 1998 (inception) to December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America.

/s/ KPMG LLP

Seattle, Washington
January 26, 2001

                                      51
<PAGE>

                                 LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                             (in thousands)
                                                            -----------------
                                                              December 31,
                                                            -----------------
                                                              2000     1999
                                                            --------  -------

                          ASSETS

<S>                                                         <C>       <C>
Current assets:

  Cash and cash equivalents                                 $  7,143  $ 4,689

  Investment securities available for sale, at market value        -   13,537

  Receivable                                                   1,043        -
                                                            --------  -------
                                                             $ 8,186  $18,226
                                                            ========  =======

<CAPTION>
         LIABILITIES AND MEMBERS' EQUITY (DEFICIT)

<S>                                                         <C>       <C>
Current liabilities - accrued expenses payable to members   $ 55,412  $17,993

Members' equity (deficit):

  Eli Lilly and Company                                      (23,613)     122

  ICOS Corporation                                           (23,613)     122

  Accumulated other comprehensive loss                             -      (11)
                                                            --------  -------
    Total members' equity (deficit)                          (47,226)     233
                                                            --------  -------
                                                             $ 8,186  $18,226
                                                            ========  =======
</TABLE>




                See accompanying notes to financial statements.

                                       52
<PAGE>

                                 LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                (in thousands)
                                  -------------------------------------------
                                                    Period from  Period from
                                                     October 2,   October 2,
                                                        1998         1998
                                     Year ended     (inception)  (inception)
                                    December 31,      through      through
                                  ----------------- December 31, December 31,
                                    2000     1999       1998         2000
                                  -------- -------- ------------ ------------
<S>                               <C>      <C>      <C>          <C>
Operating expenses:
  Development expense -
   contributed technology
   license from ICOS Corporation  $ 40,000 $ 70,000   $175,000     $285,000
  Development expense - Eli Lilly
   and Company                      67,864   39,698      3,051      110,613
  Development expense - ICOS
   Corporation                      20,086   19,375      3,487       42,948
  General and administrative           183      104        284          571
                                  -------- --------   --------     --------
    Total operating expenses       128,133  129,177    181,822      439,132
Investment income                      663      925        318        1,906
                                  -------- --------   --------     --------
    Net loss                      $127,470 $128,252   $181,504     $437,226
                                  ======== ========   ========     ========
</TABLE>






                See accompanying notes to financial statements.

                                       53
<PAGE>

                                 LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)

                     STATEMENTS OF COMPREHENSIVE OPERATIONS

<TABLE>
<CAPTION>
                                          (in thousands)
                            --------------------------------------------
                                               Period from  Period from
                                                October 2,   October 2,
                                                   1998         1998
                               Year ended      (inception)  (inception)
                              December 31,       through      through
                            -----------------  December 31, December 31,
                              2000     1999        1998         2000
                            -------- --------  ------------ ------------
<S>                         <C>      <C>       <C>          <C>
Net loss                    $127,470 $128,252    $181,504     $437,226
Other comprehensive loss:
  Unrealized gain (loss) on
   investment securities          11      (10)         (1)           -
                            -------- --------    --------     --------
    Comprehensive loss      $127,459 $128,262    $181,505     $437,226
                            ======== ========    ========     ========
</TABLE>






                See accompanying notes to financial statements.

                                       54
<PAGE>

                                 LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)

                    STATEMENTS OF MEMBERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                                      (in thousands)
                            ---------------------------------------------------------------------
                                 Eli Lilly and Company                     Accumulated    Total
                            --------------------------------                  other     members'
                                      Contributions              ICOS     comprehensive  equity
                             Equity    receivable    Total    Corporation     loss      (deficit)
                            --------  ------------- --------  ----------- ------------- ---------
  <S>                       <C>       <C>           <C>       <C>         <C>           <C>
  Balances at October 2,
   1998 (inception)         $      -    $      -    $      -   $      -       $  -      $       -
  Member contributions:
   Cash                      100,000           -     100,000          -          -        100,000
   Technology license              -           -           -    175,000          -        175,000
   Receivable                 80,000     (80,000)          -          -          -              -
  Capital distribution             -           -           -    (75,000)         -        (75,000)
  Unrealized loss on
   investment securities           -           -           -          -         (1)            (1)
  Net loss                   (90,752)          -     (90,752)   (90,752)         -       (181,504)
--------------------------------------------------------------------------------------------------
  Balances at December 31,
   1998                       89,248     (80,000)      9,248      9,248         (1)        18,495
   Member contributions:
   Cash                       15,000      40,000      55,000          -          -         55,000
   Technology license              -           -           -     70,000          -         70,000
  Capital distribution             -           -           -    (15,000)         -        (15,000)
  Unrealized loss on
   investment securities           -           -           -          -        (10)           (10)
  Net loss                   (64,126)          -     (64,126)   (64,126)         -       (128,252)
--------------------------------------------------------------------------------------------------
  Balances at December 31,
   1999                       40,122     (40,000)        122        122        (11)           233
  Member contributions:
   Cash                            -      40,000      40,000          -          -         40,000
   Technology license              -           -           -     40,000          -         40,000
  Unrealized gain on
   investment securities           -           -           -          -         11             11
  Net loss                   (63,735)          -     (63,735)   (63,735)         -       (127,470)
--------------------------------------------------------------------------------------------------
  Balances at December 31,
   2000                     $(23,613)   $      -    $(23,613)  $(23,613)      $  -      $ (47,226)
--------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------
</TABLE>




                 See accompanying notes to financial statements

                                       55
<PAGE>

                                 LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                              (in thousands)
                               -----------------------------------------------
                                                     Period from  Period from
                                                      October 2,   October 2,
                                                         1998         1998
                                   Year ended        (inception)  (inception)
                                  December 31,         through      through
                               --------------------  December 31, December 31,
                                 2000       1999         1998         2000
                               ---------  ---------  ------------ ------------
<S>                            <C>        <C>        <C>          <C>
Cash flows from operating
 activities:
 Net loss                      $(127,470) $(128,252)  $(181,504)   $(437,226)
 Adjustments to reconcile net
  loss to net cash provided by
  (used in) operating
  activities:
  Contributed technology
   license                        40,000     70,000     175,000      285,000
  Amortization of investment
   discounts                        (153)      (398)       (306)        (857)
  Change in operating assets
   and liabilities:
   Receivable                     (1,043)         -           -       (1,043)
   Accrued expenses payable to
    members                       37,419     11,170       6,823       55,412
                               ---------  ---------   ---------    ---------
    Net cash provided by (used
     in) operating activities    (51,247)   (47,480)         13      (98,714)
Cash flows from investing
 activities:
 Purchases of investment
  securities                           -    (37,710)    (24,997)     (62,707)
 Maturities of investment
  securities                      13,701     49,863           -       63,564
                               ---------  ---------   ---------    ---------
    Net cash provided by (used
     in) investing activities     13,701     12,153     (24,997)         857
Cash flows from financing
 activities:
 Member contributions             40,000     55,000     100,000      195,000
 Capital distributions                 -    (15,000)    (75,000)     (90,000)
                               ---------  ---------   ---------    ---------
    Net cash provided by
     financing activities         40,000     40,000      25,000      105,000
    Net increase in cash and
     cash equivalents              2,454      4,673          16        7,143
Cash and cash equivalents at
 beginning of period               4,689         16           -            -
                               ---------  ---------   ---------    ---------
Cash and cash equivalents at
 end of period                 $   7,143  $   4,689   $      16    $   7,143
                               =========  =========   =========    =========
</TABLE>




                 See accompanying notes to financial statements

                                       56
<PAGE>

                                LILLY ICOS LLC
                         (A DEVELOPMENT STAGE COMPANY)
                         Notes to Financial Statements

                          December 31, 2000 and 1999
                    (in thousands, unless otherwise noted)

(1) Organization and Business Operations

    Lilly ICOS LLC (the "Company"), a 50/50-owned limited liability company, is
    a development stage company that was formed in October, 1998 by Eli Lilly
    and Company ("Eli Lilly") and ICOS Corporation ("ICOS") to develop and
    commercialize PDE5 inhibitors. Profits, losses and distributions, except for
    distributions for payment of ICOS' exclusive license (see Note 3), are
    allocated based on respective ownership interests. The Company is developing
    Cialis(TM) as an oral therapeutic agent for the treatment of both male
    erectile dysfunction and female sexual dysfunction. Both ICOS and Eli Lilly
    provide the Company with research and development services. The Company will
    market any products resulting from this collaborative effort in North
    America and the countries in the European Union or European Free Trade Area
    through the services of Eli Lilly and ICOS. For countries outside North
    America and these European countries, in exchange for royalty payments, the
    Company has granted Eli Lilly an exclusive license to develop, manufacture
    and commercialize the PDE5 inhibitors developed in the collaboration.

(2) Summary of Significant Accounting Policies

     (a)  Use of Estimates in the Preparation of Financial Statements

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

     (b)  Financial Instruments

          The Company's financial instruments consist of cash and cash
          equivalents, a receivable, and accrued expenses payable to related
          parties. The Company's financial instruments are short-term and
          therefore are considered to have fair value equal to book value.

     (c)  Cash and Cash Equivalents

          All highly liquid short-term investments with a maturity at purchase
          of three months or less are considered to be cash equivalents.

     (d)  Investment Securities

          The Company's investment securities are classified as available-for-
          sale and carried at market value, based on quoted market prices, with
          unrealized gains and losses excluded from results of operations and
          included as a component of total comprehensive operations. Realized
          gains and losses on sales of investment securities are determined on
          the specific identification method and included in investment income.

     (e)  Research and Development Costs

          Research and development costs are expensed as incurred.

     (f)  Income Taxes

          No provision for Federal income taxes is included in the financial
          statements since such taxes, if any, are payable or recoverable by
          each member.

     (g)  Operating Segments

          The Company operates in one segment, the development and
          commercialization of PDE5-related products for human therapeutic use.

     (h)  New Accounting Standard

          In June 1998, the Financial Accounting Standards Board issued
          Statement of Financial Accounting Standard No. 133 ("SFAS 133"),
          "Accounting for Derivative Instruments and Hedging Activities," which
          is effective for fiscal years beginning after June 15, 2000. The
          adoption of SFAS 133 will not have a material impact on the Company's
          financial statements as the Company does not currently hold any
          derivative instruments.

                                      57
<PAGE>

(3) Equity Transactions

    ICOS contributed to the Company an exclusive license for the PDE5 technology
    in October 1998, and Eli Lilly contributed to the Company $180 million ($100
    million of which was received in October 1998 and $40 million received in
    both October 1999 and October 2000). ICOS and Eli Lilly each acquired a 50%
    ownership interest in the Company.

    The technology license contributed to the Company by ICOS is valued based on
    the cash contributions from Eli Lilly and the concurrent capital
    distributions to ICOS discussed below. The contributed technology license
    was initially valued at $255 million ($175 million was recognized in 1998
    and $40 million was recognized in both 1999 and 2000). The contributed
    valuation of the technology license may increase by up to $150 million if
    certain milestones are achieved as provided for in the Limited Liability
    Company Agreement ("LLC Agreement"). The contributed valuation of the
    technology license increased $30 million in 1999 upon the initiation of a
    global phase three clinical trial program.

    Under the terms of the LLC Agreement, ICOS received a capital distribution
    of $75 million in October 1998. In September 1999, ICOS received an
    additional $15 million capital distribution upon the initiation of the
    global phase three clinical trial program and may receive up to an
    additional $60 million based on the achievement of certain additional
    milestones as specified in the LLC Agreement. The $15 million capital
    distribution was funded by an additional capital contribution from Eli
    Lilly, and any additional capital distributions related to potential future
    increases in the valuation of the contributed technology license are also
    required to be funded by additional capital contributions from Eli Lilly.

    ICOS and Eli Lilly have agreed to each fund 50% of the Company's financing
    needs.

(4) License Agreements

    In October 1998, in connection with ICOS' initial capital contribution of an
    exclusive license, the Company entered into a license agreement with ICOS
    under which the Company received an exclusive right and license to certain
    proprietary patent rights, technical information, technology and know-how
    relating to and useful in the manufacture, production and worldwide
    commercial sale of PDE5 for human therapeutic use. The value of the license
    was charged to development expense as the underlying technology represented
    incomplete product research and development.

    In October 1998, in connection with Eli Lilly's initial capital
    contribution, the Company also entered into a license agreement with Eli
    Lilly ("the License Agreement"), under which the Company granted to Eli
    Lilly an exclusive right and license to the PDE5 technology in order to
    develop, manufacture, market and sell PDE5 products in Eli Lilly's
    territory, as defined in the License Agreement. Under the License Agreement,
    Eli Lilly will pay to the Company a royalty on net sales of PDE5 products
    that are sold by Eli Lilly or any of its affiliates or sublicensees in the
    Eli Lilly territory.

(5) Research and Development Service Agreement

    In October 1998, the Company entered into a Research and Development Service
    Agreement ("the R&D Agreement") with Eli Lilly and ICOS. Under the terms of
    the R&D Agreement, to the extent requested by the Company, Eli Lilly and
    ICOS will research and develop PDE5 products for treatment of human sexual
    dysfunction. The Company pays Eli Lilly and ICOS a per-hour amount
    calculated on the basis of actual hours incurred by Eli Lilly and ICOS, plus
    certain nonclinical and clinical expenses. There is no minimum commitment
    for research and development and the Company can contract with other parties
    to provide research and development.

(6) Marketing and Sales Service Agreement

    In October 1998, the Company entered into a Marketing and Sales Service
    Agreement with Eli Lilly and ICOS to jointly promote the Company's future
    products.

(7) Investment Securities

    Investment securities at December 31, 1999 consist of investments in
    commercial paper with an amortized cost of $13,547.

(8) Receivable

    The receivable of $1,043 at December 31, 2000 represents an interim award
    related to legal expenses incurred in connection with a revocation hearing
    in the United Kingdom between the Company and Pfizer Corporation. Pursuant
    to a judgement by the court on November 8, 2000, Pfizer was ordered to
    reimburse the Company for legal costs related to the revocation hearing.
    Payment was received from Pfizer in January, 2001.

                                      58
<PAGE>

                               SUNCOS CORPORATION
                       (A DEVELOPMENT STAGE CORPORATION)

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                         Page

<S>                                                                      <C>
Independent Auditors' Report                                                60

Balance Sheets as of December 31, 2000 and 1999                             61

Statements of Operations for each of the years in the three-year period
 ended December 31, 2000 and the period from February 6, 1997
 (inception) through December 31, 2000                                      62

Statements of Stockholders' Equity and Comprehensive Loss for each of
 the years in the three-year period ended December 31, 2000 and the
 period from February 6, 1997 (inception) through December 31, 2000         63

Statements of Cash Flows for each of the years in the three-year period
 ended December 31, 2000 and the period from February 6, 1997
 (inception) through December 31, 2000                                      64

Notes to Financial Statements                                            65-66
</TABLE>

                                       59
<PAGE>

                         INDEPENDENT AUDITORS' REPORT

The Board of Directors
Suncos Corporation:

We have audited the accompanying balance sheets of Suncos Corporation (a
development stage corporation) as of December 31, 2000 and 1999, and the
related statements of operations, stockholders' equity and comprehensive loss,
and cash flows for each of the years in the three-year period ended December
31, 2000 and the period from February 6, 1997 (inception) through December 31,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Suncos Corporation as of
December 31, 2000 and 1999, and the results of its operations and its cash
flows for each of the years in the three-year period ended December 31, 2000
and the period from February 6, 1997 (inception) through December 31, 2000, in
conformity with accounting principles generally accepted in the United States
of America.

The accompanying financial statements have been prepared assuming that Suncos
Corporation will continue as a going concern. As discussed in note 3 to the
financial statements, Suncos Corporation has experienced recurring losses from
operations and has a deficit accumulated during the development stage, which
raises substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in note 3.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.

/s/ KPMG LLP

Seattle, Washington
January 26, 2001

                                      60
<PAGE>

                               SUNCOS CORPORATION
                       (A DEVELOPMENT STAGE CORPORATION)

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                             (in thousands,
                                                              except share
                                                                  data)
                                                            ------------------
                                                              December 31,
                                                            ------------------
                                                              2000      1999
                                                            --------  --------

                          ASSETS

<S>                                                         <C>       <C>
Current assets - cash and cash equivalents                  $  2,511  $  8,364
                                                            ========  ========

<CAPTION>
           LIABILITIES AND STOCKHOLDERS' EQUITY

<S>                                                         <C>       <C>
Current liabilities - accrued expenses payable to related
 parties                                                    $  1,583  $  1,930
                                                            --------  --------

Stockholders' equity:

  Common stock, $.0001 par value. Authorized, issued and
   outstanding 10,000 shares at December 31, 2000 and 9,000
   shares at December 31, 1999                                     -         -

  Additional paid-in capital                                  70,000    60,000

  Deficit accumulated during the development stage           (69,072)  (53,566)
                                                            --------  --------
    Total stockholders' equity                                   928     6,434
                                                            --------  --------
                                                             $ 2,511  $  8,364
                                                            ========  ========
</TABLE>




                See accompanying notes to financial statements.

                                       61
<PAGE>

                               SUNCOS CORPORATION
                       (A DEVELOPMENT STAGE CORPORATION)

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                            (in thousands)
                                 ------------------------------------
                                                         Period from
                                                         February 6,
                                                             1997
                                                         (inception)
                                 Year ended December 31,   through
                                 ----------------------- December 31,
                                  2000    1999    1998       2000
                                 ------- ------- ------- ------------
<S>                              <C>     <C>     <C>     <C>
Operating expenses:
  Development - Suntory Limited  $   459 $   942 $ 1,615   $ 5,109
  Development - ICOS Corporation  14,612  24,288  14,412    64,486
  General and administrative         601     814     567     2,006
                                 ------- ------- -------   -------
    Total operating expenses      15,672  26,044  16,594    71,601
Investment income                    166     430     699     2,529
                                 ------- ------- -------   -------
    Net loss                     $15,506 $25,614 $15,895   $69,072
                                 ======= ======= =======   =======
</TABLE>






                See accompanying notes to financial statements.

                                       62
<PAGE>

                               SUNCOS CORPORATION
                       (A DEVELOPMENT STAGE CORPORATION)

           STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS

<TABLE>
<CAPTION>
                                          (in thousands, except share data)
                           ----------------------------------------------------------------
                                                                    Deficit
                                                     Accumulated  accumulated
                           Common Stock  Additional     other     during the      Total
                           -------------  paid-in   comprehensive development stockholders'
                           Shares Amount  capital       loss         stage       equity
                           ------ ------ ---------- ------------- ----------- -------------
  <S>                      <C>    <C>    <C>        <C>           <C>         <C>
  Balances at February 6,
   1997 (inception)             -  $ -    $     -        $ -       $      -     $      -
  Issuance of common
   stock - 3,000 shares
   for $30,000 cash and
   3,000 shares in
   exchange for
   technology               6,000    -     30,000          -              -       30,000
  Comprehensive loss:
   Net loss                     -    -          -          -        (12,057)     (12,057)
   Unrealized loss on
    investment securities       -    -          -         (2)             -           (2)
                                                                                --------
   Total comprehensive
    loss                        -    -          -          -              -      (12,059)
-------------------------------------------------------------------------------------------
  Balances at December
   31, 1997                 6,000    -     30,000         (2)       (12,057)      17,941
  Comprehensive loss:
   Net loss                     -    -          -          -        (15,895)     (15,895)
   Unrealized gain on
    investment securities       -    -          -          2              -            2
                                                                                --------
   Total comprehensive
    loss                        -    -          -          -              -      (15,893)
-------------------------------------------------------------------------------------------
  Balances at December
   31, 1998                 6,000    -     30,000          -        (27,952)       2,048
  Issuance of 3,000
   shares of common stock
   for cash                 3,000    -     30,000          -              -       30,000
  Net loss                      -    -          -          -        (25,614)     (25,614)
-------------------------------------------------------------------------------------------
  Balances at December
   31, 1999                 9,000    -     60,000          -        (53,566)       6,434
  Issuance of 1,000
   shares of common stock
   for cash                 1,000    -     10,000          -              -       10,000
  Net loss                      -    -          -          -        (15,506)     (15,506)
-------------------------------------------------------------------------------------------
  Balances at December
   31, 2000                10,000  $ -    $70,000        $ -       $(69,072)    $    928
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
</TABLE>




                See accompanying notes to financial statements.

                                       63
<PAGE>

                               SUNCOS CORPORATION
                       (A DEVELOPMENT STAGE CORPORATION)

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                               (in thousands)
                                   ------------------------------------------
                                                                 Period from
                                                                 February 6,
                                                                     1997
                                                                 (inception)
                                    Year ended December 31,        through
                                   ----------------------------  December 31,
                                     2000      1999      1998        2000
                                   --------  --------  --------  ------------

<S>                                <C>       <C>       <C>       <C>
Cash flows from operating
 activities:

  Net loss                         $(15,506) $(25,614) $(15,895)   $(69,072)

  Adjustments to reconcile net
   loss to net cash used in
   operating activities:

    Amortization of investment
     discounts                            -         -      (229)     (1,113)

    Change in operating assets and
     liabilities:

      Interest receivable                 -        43       (33)          -

      Accrued expenses payable to
       related parties                 (347)   (1,850)    2,252       1,583
                                   --------  --------  --------    --------
        Net cash used in operating
         activities                 (15,853)  (27,421)  (13,905)    (68,602)
                                   --------  --------  --------    --------

Cash flows from investing
 activities:

  Purchases of investment
   securities                             -   (12,700)  (28,948)    (68,527)

  Maturities of investment
   securities                             -    17,761    39,557      69,640
                                   --------  --------  --------    --------

        Net cash provided by
         investing activities             -     5,061    10,609       1,113
                                   --------  --------  --------    --------
Cash provided by financing
 activities - proceeds from
 issuance of common stock            10,000    30,000         -      70,000
                                   --------  --------  --------    --------

        Net increase (decrease) in
         cash and cash equivalents   (5,853)    7,640    (3,296)      2,511

Cash and cash equivalents at
 beginning of period                  8,364       724     4,020           -
                                   --------  --------  --------    --------
Cash and cash equivalents at end
 of period                         $  2,511  $  8,364  $    724    $  2,511
                                   ========  ========  ========    ========
</TABLE>


                See accompanying notes to financial statements.

                                       64
<PAGE>

                              SUNCOS CORPORATION
                       (A DEVELOPMENT STAGE CORPORATION)
                         Notes to Financial Statements

                          December 31, 2000 and 1999
            (in thousands, except share data or as otherwise noted)

(1) Organization and Business Operations

    Suncos Corporation (the "Company"), a 50/50-owned corporation, is a
    development stage corporation that was formed in February 1997 by ICOS
    Corporation ("ICOS") and Suntory Limited of Japan ("Suntory") to develop and
    commercialize Pafase(R) products for human therapeutic use. Suncos is
    managed jointly by ICOS and Suntory and each company provides Suncos with
    research and development services. The Company has an exclusive license to
    all rights to Pafase(R) on a worldwide basis. The Company has granted
    Suntory exclusive rights to develop and commercialize Pafase(R) in Japan,
    and has granted ICOS exclusive rights to develop and commercialize Pafase(R)
    in the United States. The Company retains the rights to develop and
    commercialize Pafase(R) in the rest of the world.

    Upon formation of the Company, ICOS contributed an exclusive license for
    Pafase(R) technology to the Company and Suntory contributed $30 million to
    the Company, each in exchange for 3,000 shares of common stock. The
    technology contributed to the Company by ICOS had a zero basis for financial
    reporting purposes and, accordingly, the Company recorded no value for ICOS'
    initial contribution. The initial $30 million cash investment was depleted
    in 1999. During 1999, ICOS and Suntory each invested an additional $15
    million in the Company in exchange for 1,500 shares of common stock each.
    During 2000, ICOS and Suntory each invested an additional $5 million in the
    Company in exchange for 500 shares of common stock each. Any future amounts
    to be invested in the Company are at the discretion of ICOS and Suntory.

(2) Summary of Significant Accounting Policies

     (a)  Use of Estimates in the Preparation of Financial Statements

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

     (b)  Financial Instruments

          The Company's financial instruments consist of cash and cash
          equivalents and accrued expenses payable to related parties. The
          Company's financial instruments are short-term and therefore are
          considered to have fair value equal to book value.

     (c)  Cash and Cash Equivalents

          All highly liquid short-term investments with a maturity at purchase
          of three months or less are considered to be cash equivalents.

     (d)  Research and Development Costs

          Research and development costs are expensed as incurred.

     (e)  Income Taxes

          Income taxes are accounted for using the asset and liability method
          whereby deferred tax assets and liabilities are recognized for the
          future tax consequences attributed to differences between the
          financial statement carrying amounts of existing assets and
          liabilities and their respective tax bases and loss 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. A valuation allowance is established when necessary to reduce
          deferred tax assets to the amount estimated by management to be
          realizable.

                                      65
<PAGE>

     (f)  Operating Segments

          The Company operates in one segment, the development and
          commercialization of Pafase(R) products for human therapeutic use.

     (g)  New Accounting Standard

          In June 1998, the Financial Accounting Standards Board issued
          Statement of Financial Accounting Standard No. 133 ("SFAS 133"),
          "Accounting for Derivative Instruments and Hedging Activities," which
          is effective for fiscal years beginning after June 15, 2000. The
          adoption of SFAS 133 will not have a material impact on the Company's
          financial statements as the Company does not currently hold any
          derivative instruments.

     (h)  Reclassifications

          Certain amounts reported in prior periods have been reclassified to
          conform to the 2000 presentation.

(3) Financing

    The Company has experienced recurring losses from operations and has a
    deficit accumulated during the development stage of $69,072 at December 31,
    2000.

    The Company's existing cash and cash equivalents were sufficient to fund
    operations into January 2001. As of the date of this report, ICOS and
    Suntory are involved in discussions regarding additional funding to the
    joint venture. To continue operations, the Company will need to obtain
    additional financing from the joint venture partners or other sources. There
    is no assurance that such financing will be available. If additional funds
    are not available, the Company will be required to delay, reduce, or
    eliminate its research and development programs.

(4) Development and Supply Agreement

    The Company has a Development and Supply Agreement (the "Agreement") with
    ICOS and Suntory. Under the terms of the Agreement, ICOS and Suntory conduct
    development work with respect to the improvement and commercial development
    of the Pafase(R) technology. The Company pays ICOS and Suntory certain
    actual expenses incurred by ICOS and Suntory plus a mark-up of 5%. ICOS has
    agreed to supply to the Company, for ultimate use by Suntory and the
    Company, sufficient amounts of Pafase(R) to carry out the goals and purposes
    of the development program.

    The Agreement terminates at the earlier of December 2011, the liquidation
    of the Company or completion of the development program.

(5) Services Agreements

    The Company has services agreements with ICOS and Suntory whereby both
    companies have agreed to make general management support available in
    connection with the daily operation of the Company and provide commercial
    development, marketing research and administrative services to the Company.
    ICOS and Suntory are reimbursed for a percentage of their total general and
    administrative expenses calculated based on the ratio of full-time
    equivalent employees assigned to Pafase(R) to total full-time equivalent
    employees, plus a mark-up of 5%.

(6) Federal Income Taxes

    The Company has realized no income tax benefit since its inception due to
    the inability to utilize net operating loss carryforwards.

    Carryforwards which give rise to deferred tax assets at December 31, 2000
    and 1999 consist of the following:

<TABLE>
<CAPTION>
                                             2000      1999
                                           --------  --------
         <S>                               <C>       <C>
         Net operating loss carryforwards  $ 24,175  $ 18,213
         Less valuation allowance           (24,175)  (18,213)
                                           --------  --------
          Net deferred tax assets          $      -  $      -
                                           ========  ========
</TABLE>

    The increase in the valuation allowance was $5,962, $8,709 and $5,404 in
    2000, 1999 and 1998, respectively.

    The Company has net operating loss carryforwards of $69,072 at December 31,
    2000, available to offset future taxable income, which expire from 2013 to
    2020.

                                      66
<PAGE>

                               Index to Exhibits

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
 <C>   <S>                                                                 <C>
 3.1   Restated Certificate of Incorporation of ICOS Corporation            A
 3.2   Restated Bylaws of ICOS Corporation                                  A
 4.1   Restated Certificate of Incorporation of ICOS Corporation
       (included in Exhibit 3.1)
 10.1  ICOS Corporation 1989 Stock Option Plan (Amended and Restated as
       of January 8, 1997)                                                  E
 10.2  ICOS Corporation 1991 Stock Option Plan for Non-employee
       Directors (Amended and Restated as of January 8, 1997)               E
 10.3  ICOS Corporation 1999 Stock Option Plan                              K
 10.4  Employment Agreement dated as of September 16, 1993 between Gary
       Wilcox and ICOS Corporation                                          C
 10.5  Employment agreement between ICOS Corporation and Paul N. Clark
       dated June 11, 1999                                                  L
 10.6  Industrial Real Estate Lease dated August 1, 1992 between Trinity
       at Canyon Park and ICOS Corporation                                  B
 10.7  Real Estate Purchase and Sale Agreement dated October 30, 1992
       between Canyon Park Business Center Limited Partnership and ICOS
       Corporation                                                          B
 10.8  Industrial Real Estate Lease dated December 20, 1996 between WRC
       Properties, Inc. and ICOS Corporation                                H
 10.9  Industrial Real Estate Lease dated August 6, 1993 between John H.
       Harland Company and ICOS Corporation                                 C
 10.10 Industrial Real Estate Lease Renewal and Amendment Agreement
       dated May 20, 1997 between Benaroya Capital Company, L.L.C. and
       ICOS Corporation                                                     H
 10.11 Industrial Real Estate Lease Renewal and Amendment Agreement
       dated August 5, 1997 between WRC Properties, Inc. and ICOS
       Corporation                                                          H
 10.12 Second Amendment dated October 30, 1998 to Industrial Real Estate
       Lease Agreement between Teachers Insurance & Annuity Association
       of America, Inc., as successors to WRC Properties, Inc., and ICOS
       Corporation                                                          J
 10.13 Industrial Real Estate Lease Agreement dated January 7, 1999
       between CarrAmerica Realty Corporation and ICOS Corporation          J
 10.14 Industrial Real Estate Lease Agreement dated September 6, 2000
       between Benaroya Capital Company, LLC and ICOS Corporation           N
 10.15 R&D Collaboration/License Agreement dated April 1, 1995 between
       Abbott Laboratories and ICOS Corporation                             D*
 10.16 First Amendment to R & D Collaboration/License Agreement dated
       April 1, 1995 between Abbott Laboratories and ICOS Corporation       F*
 10.17 Shareholders Agreement, entered into December 18, 1996, among
       ICOS Corporation, Suntory Limited and Suncos Corporation.            E*
 10.18 rPAF-AH License Agreement, dated February 6, 1997, between ICOS
       Corporation and Suncos Corporation                                   E*
 10.19 Development and Supply Agreement, dated February 6, 1997, among
       ICOS Corporation, Suntory Limited and Suncos Corporation             E*
 10.20 ICOS Services Agreement, dated February 6, 1997, between ICOS
       Corporation and Suncos Corporation                                   E*
 10.21 ICOS License Agreement, dated February 6, 1997, between Suncos
       Corporation and ICOS Corporation                                     E*
 10.22 Agreement of Limited Partnership dated as of June 5, 1997, by and
       among ICOS Development Corporation, as general partner, and each
       of the limited partners of ICOS Clinical Partners, L.P.              G*
 10.23 Purchase Agreement dated as of June 5, 1997 between the
       Registrant and each of the Limited Partners from time to time of
       ICOS Clinical Partners, L.P.                                         G*
 10.24 Product Development Agreement, dated as of June 5, 1997, by and
       between the Registrant and ICOS Clinical Partners, L.P.              G*
 10.25 Limited Liability Company Agreement of Lilly ICOS LLC (the "LLC
       Agreement") dated September 30, 1998 between ICOS Corporation and
       Eli Lilly and Company, including Exhibit E thereto.                  I*
 10.26 Lilly License Agreement, dated September 30, 1998, between Lilly
       ICOS LLC and Eli Lilly and Company (Exhibit A to the LLC
       Agreement).                                                          I*
 10.27 The PDE5 License Agreement, dated September 30, 1998, between
       ICOS Corporation and Lilly ICOS LLC (Exhibit B to the LLC
       Agreement).                                                          I*
 10.28 Research and Development Agreement, dated September 30, 1998,
       among ICOS Corporation, Lilly ICOS LLC and Eli Lilly and Company
       (Exhibit C to the LLC Agreement).                                    I*
 10.29 Marketing and Sales Service Agreement, dated September 30, 1998,
       between ICOS Corporation, Lilly ICOS LLC, and Eli Lilly and
       Company (Exhibit F to the LLC Agreement).                            I*
</TABLE>

                                       67
<PAGE>

<TABLE>
 <C>   <S>                                                                 <C>
 10.30 Agreement of Limited Partnership of ICOS-Texas Biotechnology L.P.
       (the "ICOS-TBC Agreement") dated June 6, 2000, among ICOS-ET-LP
       LLC, Texas Biotechnology Corporation, ICOS-ET-GP LLC and TBC-ET,
       Inc., including Exhibit D thereto.                                   M*
 10.31 Endothelin License Agreement dated June 6, 2000, between Texas
       Biotechnology Corporation and ICOS-Texas Biotechnology L.P.
       (Exhibit A to the ICOS-TBC Agreement).                               M*
 10.32 Research and Development Service Agreement dated June 6, 2000,
       among ICOS Corporation, Texas Biotechnology Corporation and ICOS-
       Texas Biotechnology L.P. (Exhibit B to the ICOS-TBC Agreement).      M*
 10.33 Formation and Performance Agreement, dated June 6, 2000, by and
       between ICOS Corporation and Texas Biotechnology Corporation.        M*
 10.34 Restated R&D Collaboration/License Agreement dated May 31, 2000,
       between ICOS Corporation and Abbott Laboratories.                    M*
 23.1  Consent of KPMG LLP (ICOS Corporation)                               N
 23.2  Consent of KPMG LLP (Lilly ICOS LLC)                                 N
 23.3  Consent of KPMG LLP (Suncos Corporation)                             N

       see below for explanatory notes
</TABLE>

---------------
 A  Filed as an exhibit to the Company's Registration Statement (Registration
    No. 333-3312) effective May 7, 1996 and incorporated herein by reference.
 B  Filed as an exhibit to the Company's Form 10-K Annual Report on March 29,
    1993 and incorporated herein by reference.
 C  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on
    November 2, 1993 and incorporated herein by reference.
 D  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on May 12,
    1995 and incorporated herein by reference.
 E  Filed as an exhibit to the Company's Form 10-K Annual Report on March 31,
    1997 and incorporated herein by reference.
 F  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on August
    14, 1997 and incorporated herein by reference.
 G  Filed as an exhibit to the Company's Form 8-K Current Report on August 26,
    1997 and incorporated herein by reference.
 H  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on
    November 17, 1997 and incorporated herein by reference.
 I  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on
    November 13, 1998 and incorporated herein by reference.
 J  Filed as an exhibit to the Company's Form 10-K Annual Report on March 31,
    1999 and incorporated herein by reference.
 K  Filed as an exhibit to the Company's definitive Proxy Statement dated
    March 30, 1999 and incorporated herein by reference.
 L  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on August
    13, 1999 and incorporated herein by reference.
 M  Filed as an exhibit to the Company's Form 10-Q Quarterly Report on August
    14, 2000 and incorporated herein by reference.
 N  Filed with this document.
 *  Confidential treatment has been requested with respect to portions of this
    exhibit.

                                      68
<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Bothell,
State of Washington, on the 29th day of March, 2001.

                                      ICOS CORPORATION
                                      (Registrant)

                                         /s/ Paul N. Clark
                                      By: _____________________________________
                                         Paul N. Clark
                                         Chairman of the Board of Directors,
                                         Chief Executive Officer and President
                                         (Principal Executive Officer)

                                         /s/ Michael A. Stein
                                      By: _____________________________________
                                         Michael A. Stein
                                         Vice President and Chief Financial
                                         Officer
                                         (Principal Financial and Accounting
                                         Officer)

                                       69
<PAGE>

                               POWER OF ATTORNEY

Each person whose individual signature appears below hereby authorizes and
appoints Paul N. Clark and Michael A. Stein, and each of them, with full power
of substitution and resubstitution and full power to act without the other, as
his true and lawful attorney-in-fact and agent to act in his name, place and
stead and to execute in the name and on behalf of each person, individually
and in each capacity stated below, and to file any and all amendments to this
report, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing, ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his substitute or
substitutes may lawfully do or cause to be done by virtue thereof.

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

<TABLE>
<CAPTION>
                  Signature                          Title                 Date
                  ---------                          -----                 ----

    <S>                                    <C>                        <C>
            /s/ Paul N. Clark              Chairman of the Board of   March 29, 2001
    ______________________________________ Directors, Chief Executive
                Paul N. Clark              Officer and President
                                           (Principal Executive
                                           Officer)

            /s/ Gary L. Wilcox             Director and Executive     March 29, 2001
    ______________________________________ Vice President, Operations
                Gary L. Wilcox

            /s/ Frank T. Cary              Director                   March 29, 2001
    ______________________________________
                Frank T. Cary

          /s/ James L. Ferguson            Director                   March 29, 2001
    ______________________________________
              James L. Ferguson

        /s/ William H. Gates, III          Director                   March 29, 2001
    ______________________________________
            William H. Gates, III

          /s/ David V. Milligan            Director                   March 29, 2001
    ______________________________________
              David V. Milligan

           /s/ Robert W. Pangia            Director                   March 29, 2001
    ______________________________________
               Robert W. Pangia

       /s/ Alexander B. Trowbridge         Director                   March 29, 2001
    ______________________________________
           Alexander B. Trowbridge

          /s/ Walter B. Wriston            Director                   March 29, 2001
    ______________________________________
              Walter B. Wriston
</TABLE>

                                      70