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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



Form 10-K



|           |  |                                                                                          |  | 
|---------- |  | ---------------------------------------------------------------------------------------- |  | 
|(Mark One) |  |                                                                                          |  | 
|þ          |  | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934     |  | 
|           |  |                                                                                         
|           |  | For the Fiscal Year Ended December 31, 2003                                              |  | 
|           |  |                                                                                         
|           |  | 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 incorporation) |  | (I.R.S. 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 þ     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.   þ



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



State the aggregate market
value of voting and non-voting stock held by non-affiliates of the registrant as of June 30, 2003. $2,094,741,250



Indicate the number of shares outstanding of each of the registrants classes of Common Stock as of January 31, 2004.



|                             |  |                 
|---------------------------- |  | ----------------
|Title of Class               |  | Number of Shares
|Common Stock, $.01 par value |  | 63,218,406      



DOCUMENTS
INCORPORATED BY REFERENCE



Portions of the
Registrants Definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 14, 2004, are incorporated by reference in Part III of this Form 10-K.



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ICOS CORPORATION



TABLE OF CONTENTS



|           |  |                                                                                                |  |     
|---------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                |  | Page
|Part I     |  |                                                                                                |  |     
|Item 1.    |  | Business                                                                                       |  | 1   
|Item 2.    |  | Properties                                                                                     |  | 25  
|Item 3.    |  | Legal Proceedings                                                                              |  | 25  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                            |  | 26  
|Part II    |  |                                                                                                |  |     
|Item 5.    |  | Market for Registrants Common Equity and Related Stockholder Matters                          |  | 26  
|Item 6.    |  | Selected Consolidated Financial Data                                                           |  | 27  
|Item 7.    |  | Managements Discussion and Analysis of Results of Operations and Financial Condition          |  | 29  
|Item 7A.   |  | Quantitative and Qualitative Disclosures about Market Risk                                     |  | 42  
|Item 8.    |  | Consolidated Financial Statements and Supplementary Data                                       |  | 43  
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | *   
|Item 9A.   |  | Controls and Procedures                                                                        |  | 65  
|Part III   |  |                                                                                                |  |     
|Item 10.   |  | Directors and Executive Officers of the Registrant                                             |  | 65  
|Item 11.   |  | Executive Compensation                                                                         |  | 65  
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 65  
|Item 13.   |  | Certain Relationships and Related Transactions                                                 |  | 66  
|Item 14.   |  | Principal Accounting Fees and Services                                                         |  | 66  
|Part IV    |  |                                                                                                |  |     
|Item 15.   |  | Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K                  |  | 66  
|Signatures |  | 82                                                                                            

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* Not Applicable



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PART I



|Item 1. |  | Business
|------- |  | --------



Overview



ICOS
Corporation, a biotechnology company, is dedicated to bringing innovative therapeutic products to patients. Headquartered in Bothell, Washington, we are marketing our first product, Cialis® (tadalafil), for the treatment of erectile dysfunction, through Lilly ICOS LLC (Lilly
ICOS), our joint venture with Eli Lilly and Company (Lilly). Our goal is to develop and commercialize treatments for serious unmet medical conditions such as chronic obstructive pulmonary disease, cancer and inflammatory diseases.



Over the years, we have established collaborations with pharmaceutical and
biotechnology companies to enhance our internal development capabilities, to acquire rights to additional product candidates and to offset a substantial portion of the financial risk of developing individual product candidates. In each case, we
acquired or retained substantial rights to the product candidates covered by the collaborations. These rights are intended to provide us with the opportunity to participate in a significant portion of the potential economic benefit from successful
development and commercialization. Our most significant ongoing collaboration is Lilly ICOS. We expect to establish additional collaborations with pharmaceutical and other biotechnology companies in the future.



Business Strategy



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



Successfully commercializing Cialis in the United States, Europe, and other countries.    With the United States Food and Drug Administrations (FDA) 2003 approval of Cialis for erectile dysfunction, and
subsequent Cialis product launch in the United States, we have succeeded in bringing our first product to the commercial market on a worldwide basis. Through sales and marketing efforts with Lilly, we intend to aggressively increase awareness of the
unique benefits of Cialis, as we expand our position in the large and growing erectile dysfunction market.



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



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



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



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



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



Cialis



Our first commercial product, Cialis, is being prescribed
around the world for patients with erectile dysfunction. Cialis is being manufactured and marketed by Lilly ICOS, which has rights to commercialize Cialis in North America and Europe. In the context of Lilly ICOS territories, North America includes
the United States, Canada and Mexico. Europe includes the current fifteen member countries of the European Union  Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, Switzerland
and the United Kingdom  plus Finland, Iceland, and Norway. Lilly has exclusive rights to market Cialis in territories in the remainder of the world, and pays royalties to Lilly ICOS, equal to 20% of net sales in those territories.



During the first quarter of 2003, Lilly ICOS launched Cialis in Europe,
followed by additional launches later in the year in North America. Cialis became available for the treatment of erectile dysfunction in Mexico, in August 2003, and Canada, in November 2003. Lilly ICOS received FDA approval, to market Cialis in the
United States, on November 21, 2003. The product was available in pharmacies throughout the United States by early December 2003.



Cialis is an oral inhibitor of the phosphodiesterase type 5 enzyme (PDE5). Lilly ICOS has conducted approximately 100 clinical studies, involving more
than 10,000 human subjects, in evaluating Cialis for the treatment of erectile dysfunction. Efficacy studies demonstrated that Cialis both improved a patients ability to attain and maintain an erection sufficient for sexual intercourse and
significantly increased the percentage of successful sexual attempts. Clinical studies further demonstrated that Cialis is effective up to thirty-six hours after taking the drug and may work as early as thirty minutes after dosing. We believe that
the drugs duration and the ability to take the drug without regard to food allows men and their partners more freedom and spontaneity to choose the right moment for sexual activity.



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



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



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allowing the penile blood vessels to return to their undilated state. Inhibition of PDE5 can enhance blood flow to the penis, contributing to an erection.



Current Treatment.    Until 1998,
treatments for erectile dysfunction were primarily limited to the use of injectables, vacuum pumps and prostheses, which are inconvenient and unpleasant options that have limited the size of the treated population. With the introduction in 1998 of
Viagra® (sildenafil citrate), which also inhibits
PDE5, millions of men were motivated for the first time to acknowledge their affliction and seek treatment. In 2003, Bayer AG, together with its marketing partner GlaxoSmithKline, introduced Levitra® (vardenafil HC1) as an alternative treatment for erectile dysfunction. We believe,
however, that many men have ceased therapies for erectile dysfunction due to ineffectiveness, unpleasant side effects or inconvenient administration. We believe that as few as 10% of the worlds male population who could benefit from orally
administered treatment for erectile dysfunction are currently undergoing treatment. We believe the entry of Cialis into the marketplace is encouraging use among the untreated population of erectile dysfunction patients, in addition to encouraging
those currently using other therapies to switch to Cialis.



Research and
Development Pipeline



We are studying and developing
product candidates targeting a variety of serious diseases and medical conditions, as summarized in the following paragraphs.



Clinical Program



IC485 is an orally administered, small molecule inhibitor of the type 4 cyclic adenosine monophosphate (cAMP) phosphodiesterase enzyme, or PDE4.
Inhibition of PDE4 leads to an increase in the second messenger, cAMP, within cells. This inhibition may in turn reduce the cells production of tumor necrosis factor alpha (TNF-alpha) and a variety of other inflammatory mediators.



Chronic Obstructive Pulmonary Disease (COPD) Clinical Application



Background.    COPD is under
consideration as the primary clinical application for IC485. According to the U.S. Centers for Disease Control and Prevention, a national health survey suggests that as many as 24 million people in the United States are affected by COPD.



Current Treatment.    COPD is currently treated
with bronchodilators (beta 2 antagonists and anti-cholinergics), corticosteroids and anti-inflammatory drugs. However, these drugs have been of limited benefit in treating the disease and only recently have some of these therapies been approved for
the treatment of COPD patients.



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



Development
Status.    We began a Phase 2 study evaluating IC485 for patients with COPD in 2003. We expect to complete this study in 2005.



Discovery and Preclinical Research



We continuously evaluate new product candidates as part of our discovery research program. We use an integrated approach in this process that incorporates
our capabilities in molecular, cellular and structural biology,



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high throughput drug screening, medicinal chemistry and gene expression profiling. The following table summarizes our research and preclinical programs.



|                                                    |  |                                                               |  |            
|--------------------------------------------------- |  | ------------------------------------------------------------- |  | -----------
|Program                                             |  | Target Indication                                             |  | Status     
|                                                   
|                                                    |  |                                                              
|Cell cycle checkpoint/DNA repair inhibitors         |  | Cancer                                                        |  | Preclinical
|                                                    |  |                                                              
|Lipid and protein kinase inhibitors                 |  | Inflammatory diseases                                         |  | Preclinical
|                                                    |  |                                                              
|Other phosphodiesterase inhibitors                  |  | Multiple diseases                                             |  | Preclinical
|                                                    |  |                                                              
|Cell adhesion molecule antagonists(including LFA-1) |  | Cardiovascular, autoimmune, inflammatoryand fibrotic diseases |  | Preclinical
|                                                    |  |                                                              
|Chemokine receptor antagonists                      |  | Allergic inflammatory diseases                                |  | Research   
|                                                    |  |                                                              
|Novel antibiotics                                   |  | Infectious diseases                                           |  | Research   



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



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



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



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 blood cells are activated and a robust immune response ensues against normal tissue. In preclinical studies, we are testing our kinase inhibitors for their ability to quell an autoimmune response.



Other Phosphodiesterase Inhibitors



In addition to PDE4 and PDE5, the targets for IC485 and Cialis (tadalafil),
respectively, we continue our discovery efforts and are conducting preclinical evaluations of inhibitors that selectively target other distinct members of the phosphodiesterase family of enzymes. These enzymes collectively regulate many bodily
functions. Drugs targeted to individual enzymes impact specific bodily functions associated with the



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cardiovascular, urinary and nervous systems. We are currently evaluating inhibitor compounds in preclinical models of Parkinsons disease and urinary
incontinence.



Cell Adhesion Molecule Antagonists



Efforts are underway to develop small molecule antagonists
that target several different cell adhesion molecules. These adhesion proteins are expressed on the surface of white blood cells and function as both regulators of cell movement and of cell signaling. Depending on which cell adhesion pathway is
affected, these drugs can target diseases such as inflammatory diseases, including psoriasis, fibrotic diseases, including degenerative diseases of the lung, liver and kidney, or autoimmune diseases, including rheumatoid arthritis. Our current
preclinical studies include the testing of inhibitors in models of inflammatory and fibrotic diseases.



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
thirteen years, we have assembled a highly integrated multidisciplinary research staff which includes:



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



| |  | medicinal and process chemists, robotics experts, and pharmacologists, toxicologists and pathologists who create, evaluate and optimize new product candidates.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



To use our expertise most effectively, we have
concentrated our product discovery efforts on specific gene families, including phosphodiesterases, cell adhesion molecules and cell cycle checkpoint enzymes. In each case, we seek first to identify all the members of the family, understand the
distribution of each member within the body and, through multiple functional tests, determine which members are most likely to affect human disease in a manner that can lead to therapeutic treatment. Once a given target is linked to an important
biological function, such as activation of white blood cells, it is screened by our robotics group against a complex library of small organic molecules, from which lead compounds are identified. These lead 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 be 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 a small
molecule interacts with its target, such as the cell adhesion molecule LFA-1 (leukocyte function-associated antigen one), has been used to identify lead compounds that selectively block the function of other protein targets containing a related
structural motif termed IDAS. This approach not only provides additional opportunities in other therapeutic areas, but also may markedly reduce 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, fibrotic 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;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | compounds that block the function of other cell adhesion molecules that are potentially important in diseases such as rheumatoid arthritis, asthma and other degenerative diseases of
the kidney, liver and lung;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | lead inhibitors of other members of the PDE family of enzymes, including those that may be involved in regulating diseases of the central nervous system and urological disorders,
such as incontinence; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | molecules that represent lead compounds for new classes of antibiotics.
| | - | -----------------------------------------------------------------------



Total research and development expenses were $85.8 million in 2003, $129.4 million in 2002, and $99.0 million in 2001.



Patents and Proprietary Rights



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



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



In
connection with the treatment of erectile dysfunction, our principal competitor, Pfizer Inc., or Pfizer, has been granted a number of U.S. and foreign patents. On October 22, 2002, the U.S. Patent and Trademark Office, or PTO, issued to Pfizer a
method of use U.S. Patent No. 6,469,012. Later that day, Pfizer filed a lawsuit in the United States District Court for the District of Delaware against ICOS, Lilly, and Lilly ICOS alleging that the proposed marketing of product
candidate Cialis would infringe this patent. In September 2003, the PTO ordered the reexamination of U.S. Patent No. 6,469,012. The reexamination process is provided for by law and requires the PTO to consider the validity of the patent based on
substantial new questions of patentability raised by the PTO. In October 2003, ICOS, Lilly ICOS and Lilly filed a motion for a stay with the District Court, to suspend the patent infringement lawsuit, pending the outcome of the reexamination. In
November 2003, the judge granted the requested stay. We believe that Pfizers suit lacks merit and intend to vigorously pursue our defenses. If Pfizer were to prevail, however, we might be subject to substantial damages, prohibited from
marketing Cialis for the treatment of erectile dysfunction in the United States, or required to enter into a licensing agreement to market Cialis in the United States. We cannot assure you that any required agreement would be available on
commercially reasonable terms, if at all.



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



While we pursue patent protection and enforcement of our product candidates and aspects of our technologies when appropriate, we also rely on trade secrets, know-how and continuing technological advancement to develop
and maintain our competitive position. To protect this competitive position, we regularly enter into confidentiality and proprietary information agreements with third parties, including employees, suppliers and collaborators. Our 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 ICOS and providing that any invention conceived by an employee within the scope of
his employment duties is the exclusive property of ICOS. Furthermore, our know-how that is accessed by third parties through collaborations and research and development contracts and through our relationships with scientific consultants is generally
protected through confidentiality agreements with the appropriate parties. We cannot, however, assure you that these protective arrangements will be honored by third parties, including employees, suppliers and collaborators,



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or that these arrangements will effectively protect our rights relating to unpatented proprietary information, trade secrets and know-how. In addition, we
cannot assure you that other parties will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our proprietary information and technologies.



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



Government Regulation



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



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



| |  | preclinical laboratory tests, animal tests and formulation studies;
| | - | -------------------------------------------------------------------



| |  | the submission to the FDA of an Investigational New Drug Application, which must become effective before clinical testing may begin in humans;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | the conduct of adequate and well-controlled clinical studies to establish the safety and efficacy of the product candidate for each indication;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | the submission of a New Drug Application (NDA) or Biologics License Application, as the case may be, to the FDA; and
| | - | --------------------------------------------------------------------------------------------------------------------



| |  | FDA review and approval of an NDA or Biologics License Application, as the case may be, prior to any commercial sale or shipment of the product candidate.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------



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Preclinical studies generally are conducted in the laboratory to evaluate the potential safety and
efficacy of a therapeutic product candidate and are undertaken in compliance with Good Laboratory Practices regulations. The results of these studies are submitted to the FDA as part of an Investigational New Drug Application, which must be reviewed
by the FDA before clinical testing may begin in the United States. Once the FDA is satisfied with or does not comment on the submission of the Investigational New Drug Application, clinical studies on humans may begin, although the FDA may put a
hold on these studies at any time. Additional studies in animals are conducted after the Investigational New Drug Application is effective, and the results are submitted to the FDA to justify continued testing of the drug in humans. At the time of
submission of the NDA or Biologics License Application, these studies and all other animal studies conducted are submitted to the FDA in support of such application.



Clinical studies are conducted in accordance with Good Clinical Practices regulations at independent investigator sites
under protocols, designed by the sponsor, which detail the objectives of the study, the parameters to be used in monitoring safety and the efficacy criteria to be evaluated. Typically, clinical evaluation involves three sequential phases, which may
overlap. During Phase 1, clinical studies are conducted with a relatively small number of subjects to determine the early safety profile of a drug, as well as the pattern of drug distribution and drug metabolism by the subject. In Phase 2, clinical
studies are conducted with groups of patients afflicted by a specific target disease to determine preliminary efficacy, optimal dosages and dosage tolerance, and to gather additional safety data. In Phase 3, large-scale, multicenter comparative
clinical studies are conducted with patients afflicted with a specific target disease to provide data for the statistical proof of efficacy and safety as required by the FDA and others. The FDA and a clinical study sponsor may suspend clinical
studies 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 an NDA for small molecule products or a Biologics License Application for biological products, in order to seek FDA approval. FDA approval of the NDA or Biologics License
Application is required before marketing of a product may begin in the United States. The cost of this process may be substantial. In response to an NDA or Biologics License Application, the FDA may grant marketing approval, request additional
information or deny the application if the FDA determines that the application does not satisfy its regulatory approval criteria, including the pre-approval of relevant product manufacturing facilities. No action can be taken to market any new drug
or biologic product in the United States until an appropriate marketing application has been approved by the FDA. Following approval, the FDA may require additional testing and surveillance programs to monitor the side effects or adverse events
associated with use of a new product. The FDA may prevent or limit future marketing of a product based on the results of these post-marketing programs. Additional testing is also required to gain approval for the use of a product as a treatment for
indications other than those already approved.



In 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 (including a pre-approval inspection) by the FDA and must
comply with current Good Manufacturing Practices, or GMP, regulations. In addition, to supply products for use in the United States, foreign manufacturing establishments must comply with these regulations and are subject to periodic inspection by
the FDA or corresponding regulatory agencies in countries under reciprocal agreements with the FDA.



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



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



Our research and development
activities involve the controlled use of chemicals, viruses, radioactive compounds and other hazardous materials. If an accident involving these materials were to occur, we could be held liable for any resulting damages, which 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.



We are also subject to various federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and
manufacturing practices and the experimental use of animals. The extent and character of government regulation that might result from future legislation or administrative action, including additions or changes to environmental laws, cannot be
accurately predicted and may materially affect our business operations and revenues. Additionally, our present and future business is and will continue to be subject to various other forms of governmental regulation.



Competition



Competition in the pharmaceutical and biotechnology industries is intense and is expected to increase over time. Cialis is
expected to encounter intense competition, and we expect that our product candidates will encounter significant competition as well, should they reach the market. A number of pharmaceutical and biotechnology companies are currently developing
products targeting many of the same diseases and medical conditions that we target, and some of our competitors products have entered clinical studies or are already commercially available.



Many of our competitors have substantially more experience, capital, research
and development, regulatory, manufacturing, sales, marketing, human and other resources than we do. Our competitors include pharmaceutical, biotechnology and other companies. Furthermore, significant levels of biotechnology research now occur in
universities, government agencies and other nonprofit research institutions. All of these entities have become increasingly active in seeking patent protection and licensing revenues for their research results, thereby providing us with additional
future 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.



We believe the
principal competitive factors affecting our markets are the timing and scope of regulatory approvals, safety and efficacy of therapeutic products, cost and availability of these products, availability of



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alternative treatments, third party reimbursement programs and patent and proprietary rights protection. Although we believe that we are positioned to
compete adequately with respect to these factors in the future, our future success is currently difficult to predict. Cialis was only recently approved. Our product candidates are in various stages of development and, accordingly, subject to
substantial research, development, regulatory approval and commercialization risks. The timing of market entry can be an important factor in determining a new products eventual success and profitability. Early entry may have important
advantages in gaining product acceptance and market share. Therefore, the relative speed with which we can develop products and receive regulatory approval will likely be important to our competitive success.



The erectile dysfunction market is well established and intensely
competitive. Throughout most of the world, Cialis competes against Viagra, which Pfizer has already successfully commercialized, and Levitra, which is being commercialized by Bayer AG together with its marketing partner GlaxoSmithKline. Like Cialis,
both Viagra and Levitra are PDE5 inhibitors for the treatment of erectile dysfunction. Our principal competitor, Pfizer, is the largest pharmaceutical company in the world and GlaxoSmithKline is the second largest. Other erectile dysfunction
treatments are in development, and any other products or technologies that are directly or indirectly successful in treating erectile dysfunction could negatively impact the market for Cialis.



IC485, if approved for the treatment of COPD, could compete with other PDE4
inhibitors such as cilomilast, roflumilast and other compounds which are currently under regulatory review or are in late-stage development. In addition, Spiriva HandiHaler, a bronchodilator, and Advair Diskus® 250/50, a combination of a bronchodilator and a corticosteroid, have recently been
approved for the treatment of COPD.



Our other potential
products, if approved and commercialized, could compete against well-established existing therapeutic products that may currently be reimbursed by government health administration authorities, private health insurers and health maintenance
organizations.



Manufacturing



We currently do not have facilities to produce small molecule drugs. We have
established relationships with third party manufacturers to produce the required materials for our small molecule programs. 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. We participate in quality control and quality assurance processes related to the manufacture of potential products for us and
our affiliates. However, there is no assurance that regulatory bodies will not raise issues regarding manufacturing and quality processes.



Cialis is currently manufactured by Lilly under contract with Lilly ICOS. Lilly depends on others for the timely supply of raw materials used to
manufacture Cialis and the performance of certain manufacturing processes. There can be no assurance that Lilly ICOS will be able to accurately anticipate future demand for Cialis or maintain adequate manufacturing capacity.



We manufacture recombinant protein-based clinical materials in our production
facilities in Bothell, Washington, a suburb of Seattle, to support our clinical studies. 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. In the absence of a need to manufacture our own product candidates at our production facilities, we are manufacturing purified recombinant protein bulk product for third parties pursuant to
contractual arrangements and may enter into additional arrangements in the future.



We depend on the timely supply of raw materials used to manufacture product candidates for use in preclinical testing and clinical studies and for our contract manufacturing business. We attempt to remain apprised of
the financial condition of our suppliers, their ability to supply our needs and the market conditions for these raw materials. Raw materials may be subject to contamination and recall. A material shortage, contamination, or recall could adversely
impact or disrupt the manufacturing of our products.



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Marketing and Sales



Cialis



We recently hired and deployed an ICOS sales force of approximately 165 experienced pharmaceutical sales representatives that, together with sales
representatives from Lilly, are co-promoting Cialis across the United States on behalf of Lilly ICOS. Our sales representatives are focused primarily on physicians in private practice, specializing in the field of urology. We utilize typical
pharmaceutical company selling and marketing techniques, including sales representatives calling on individual physicians, medical education programs, professional symposia, promotional materials and public relations. Costs of marketing and selling
Cialis are charged to Lilly ICOS and reported as collaboration revenue from related parties in our consolidated statements of operations. Beginning in September 2003, and continuing through December 2004, our costs of marketing and selling Cialis in
the United States are fully reimbursable by Lilly ICOS. Thereafter, selling activities using ICOS sales representatives are generally reimbursable by Lilly ICOS at 60% of actual cost. The cost of marketing activities will continue to be fully
reimbursed by Lilly ICOS.



We have limited marketing support
service experience and, therefore, rely heavily on Lilly to supply marketing support services for Cialis in the United States, including customer service, order entry, shipping and billing services. Lilly is currently responsible for all sales and
marketing activities for Cialis outside the United States. However, beginning as early as 2006, we are required to assume a portion of the sales and marketing responsibilities for Cialis in Canada, Mexico and five European countries. Starting in
2007, we are required to assume a portion of the sales and marketing responsibilities in all territories where Cialis is sold by Lilly ICOS. As an alternative to deploying a sales force ourselves, we may fulfill our sales and marketing
responsibilities in those territories by engaging Lilly or unrelated third parties.



Product Candidates



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



The manner in which we commercialize our product candidates, if successfully developed, will depend in large part on their
market potential and our financial resources. In addition to our own marketing and sales force, we may establish co-promotion, corporate partnering, licensing or other arrangements for the marketing and sale of future products in some or all
geographic markets.



We currently employ approximately 200
individuals dedicated to sales and marketing.



Human Resources



As of December 31, 2003, we employed approximately 675
individuals, all of whom are in the United States. We consider our employee relations to be good. We have never had a work stoppage, and none of our employees are represented under a collective bargaining agreement. We believe that our future
success is dependent in part on our ability to attract, integrate and retain skilled scientific, sales and marketing, and other professional and senior management personnel. Competition in our industry for these skilled workers is intense, and we
cannot assure you that we will be able to attract, integrate and retain these personnel.



Important Factors Regarding Forward-Looking Statements



This report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as
anticipate, believe, continue, could, estimate, expect, intend, may, might, plan, possible,



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potential, predict, should or will or the negative of such terms or other comparable terminology.
Forward-looking statements are only predictions that provide our current expectations or forecasts of future events. In particular, forward-looking statements include:



| |  | information concerning possible or assumed future results of operations, trends in financial results and business plans;
| | - | ------------------------------------------------------------------------------------------------------------------------



| |  | statements about 2004 financial guidance;
| | - | -----------------------------------------



| |  | statements about our product development schedule and the potential success of our research and development efforts;
| | - | --------------------------------------------------------------------------------------------------------------------



| |  | statements about our expectations for regulatory approvals for any of our product candidates;
| | - | ---------------------------------------------------------------------------------------------



| |  | statements about our potential or prospects for future product sales;
| | - | ---------------------------------------------------------------------



| |  | statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------



| |  | statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments and other financing proceeds to meet these requirements;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | statements about the outcome of contingencies, such as legal proceedings;
| | - | -------------------------------------------------------------------------



| |  | other statements about our plans, objectives, expectations and intentions; and
| | - | ------------------------------------------------------------------------------



| |  | other statements that are not historical fact.
| | - | ----------------------------------------------



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



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



Risk Factors



ICOS operates in an environment that involves a number of risks and
uncertainties. The risks and uncertainties described below are not the only risks and uncertainties we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may impair our business operations. If any
of the following risks actually occur, our business, operating results and financial position could be harmed.



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Risks Related to Our Business



We have a history of losses and may never achieve profitability.



We have incurred significant operating losses since we began operations in
1990. As of December 31, 2003, we had an accumulated deficit of $589.5 million. We currently do not expect to achieve profitability, on a quarterly basis, for at least two to three years. Even if we do become profitable, we cannot assure you that we
would be able to sustain or increase profitability on a quarterly or annual basis. We anticipate that operating expenses will increase in the future as we continue development of our potential products, seek to obtain necessary regulatory approvals
and manufacture and market these product candidates. Directly, and through Lilly ICOS, we expect to incur substantial marketing and other costs related to commercializing Cialis in the United States, Europe, Mexico and Canada. In order to pursue new
growth opportunities, we may need to make incremental expenditures for additional laboratory, production and office facilities to accommodate the activities and personnel associated with these increased development and commercialization efforts.
Even if we successfully develop other products, we may be unable to generate significant revenues from Cialis and other products to achieve and maintain profitability.



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 many factors, some of which we cannot control. For example, factors affecting our revenues presently or in the future could include:



| |  | timing of non-recurring license fees and the achievement of milestones under new and existing license and collaborative agreements;
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | timing and success of product launches;
| | - | ---------------------------------------



| |  | level of demand for our products, including changes in physician prescribing habits;
| | - | ------------------------------------------------------------------------------------



| |  | changes in wholesaler buying patterns;
| | - | --------------------------------------



| |  | changes in reimbursement rates or policies;
| | - | -------------------------------------------



| |  | government regulation;
| | - | ----------------------



| |  | increased competition for new or existing products;
| | - | ---------------------------------------------------



| |  | level of our contract manufacturing for third parties;
| | - | ------------------------------------------------------



| |  | fluctuations in foreign currency exchange rates;
| | - | ------------------------------------------------



| |  | changes in our product pricing strategies; and
| | - | ----------------------------------------------



| |  | inability to provide adequate supply of our products.
| | - | -----------------------------------------------------



Revenue historically recognized under our prior collaborative agreements may not be an indicator of revenue from any future collaborations. In addition,
our expenses, including payments owed by us under licensing or collaborative arrangements, are unpredictable and may fluctuate from quarter to quarter. 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 our future performance.



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



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past, some companies that have experienced decreases in the market price of their stock have been subject to securities class action litigation. A securities
class action lawsuit against us could result in substantial damages, costs and a diversion of our managements attention and resources.



Even though Cialis has been approved for commercial sale, we may be required to perform additional clinical studies or change the labeling of Cialis if
we or others identify previously unknown side effects, which could harm sales of Cialis.



Even though Cialis has been approved for commercial sale, if we or others identify previously unknown side effects, or if manufacturing problems occur:



| |  | regulatory approval may be withdrawn;
| | - | -------------------------------------



| |  | reformulation of the product, additional clinical studies, changes in labeling of the product or changes to or re-approvals of our or our partners manufacturing facilities may
be required;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | sales of Cialis may drop significantly;
| | - | ---------------------------------------



| |  | our reputation in the marketplace may suffer; and
| | - | -------------------------------------------------



| |  | lawsuits, including class action suits, may be brought against us.
| | - | ------------------------------------------------------------------



Any of the above occurrences could harm or prevent sales of Cialis or could increase the costs and expenses of commercializing and marketing Cialis.



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



As a company, we have little experience in selling or marketing pharmaceutical products and have only recently hired experienced sales and marketing managers and pharmaceutical sales representatives. Lilly is expected
to provide the majority of the sales and marketing resources to Lilly ICOS. Because we expect to market or co-market Cialis and our potential products through a direct sales force, we will need to either successfully deploy our sales force 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 Cialis or for our potential products. In
addition, co-promotion or other marketing arrangements with others to commercialize potential products could significantly limit the revenues we derive from these potential products, and these parties may fail to commercialize our potential products
successfully.



The success of Cialis depends on the
marketing, promotion, sales and distribution activities of our partner, Lilly.



Through Lilly ICOS, we and Lilly have joint responsibility for the promotion, sale and distribution of Cialis in North America and Europe. In addition, Lilly has promotion, sales and distribution rights to Cialis for
the other parts of the world, with royalties to be paid to Lilly ICOS. We believe that, for Cialis to be widely adopted, the efforts of a sizeable, experienced pharmaceutical sales force are needed. We may rely heavily on Lilly for promotion, sales
and marketing of Cialis, even with respect to our joint responsibilities, because we have limited staff, capabilities and experience in these areas. If Lilly fails to devote appropriate resources to promote, sell and distribute Cialis, sales of
Cialis could be reduced. In addition, if Lilly breaches or terminates its agreement with us, or otherwise fails to conduct its activities related to Cialis in a timely manner, sales of Cialis could be delayed, reduced or become substantially more
costly for us to achieve.



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Cialis and our potential products, even if approved by the FDA or regulatory agencies outside of the
United States, may not achieve market acceptance among hospitals, insurers or patients.



Cialis and our potential products, even if approved by the FDA or regulatory agencies outside of the United States, may fail to achieve market acceptance, which would impair our ability to become profitable. We
believe that the degree of market acceptance of Cialis and our potential products will depend on:



| |  | our ability to provide acceptable evidence of efficacy and safety, including side effects;
| | - | ------------------------------------------------------------------------------------------



| |  | our ability to provide Cialis and these potential products at competitive prices; and
| | - | -------------------------------------------------------------------------------------



| |  | the availability and extent of third-party reimbursement for Cialis and these potential products.
| | - | -------------------------------------------------------------------------------------------------



In addition, market acceptance depends on the effectiveness of our marketing strategies. To date, we have relied
significantly on the marketing experience of Lilly, as we have limited sales and marketing experience or capabilities.



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



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



In addition, success in preclinical and
early clinical studies does not ensure that late-stage or large-scale studies will succeed. Many companies in the pharmaceutical and biotechnology industries, including us, have suffered significant setbacks in clinical studies, even after promising
results had been obtained in earlier studies. We have stopped two late-stage, Phase 3 clinical studies of product candidates following interim analyses: a Phase 3 study of Pafase® (rPAF-AH) for the treatment of severe sepsis was stopped in late 2002; and a study of LeukArrest (rovelizumab) for the treatment of ischemic stroke was
stopped in early 2000. Recently, the results of a Phase 2 clinical study conducted with IC14, for the treatment of sepsis resulting from community acquired pneumonia, did not meet our criteria to continue further investment. Similarly, we recently
completed patient follow-up in a Phase 2 clinical study evaluating RTX (resiniferatoxin) for the treatment of interstitial cystitis. In late January 2004, we determined that RTX was not effective in relieving patients symptoms. We will not pursue additional studies of interstitial
cystitis.



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



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Government regulatory authorities may not approve our product candidates or may delay their approval.



Any failure to receive the regulatory approvals necessary
to commercialize our product candidates could cause our business to fail. Our product candidates are subject to extensive and rigorous government regulation. For example, the FDA regulates, among other things, the development, testing, manufacture,
safety, efficacy, record keeping, labeling, storage, approval, advertising, promotion, sale and distribution of pharmaceutical products. Our products marketed abroad are also subject to extensive regulation by foreign governments. Except for Cialis,
none of our product candidates has been approved for sale in any country. 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 and clinical studies of each product candidate, is lengthy, expensive and uncertain. To secure FDA approval, we must submit extensive preclinical and clinical data and supporting information to the FDA, for each indication for which we
are seeking approval, to establish the product candidates safety and efficacy. The approval process may take 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 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 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.



Our corporate compliance program can
never guarantee that we are in compliance with all laws and regulations.



Our operations are subject to extensive government regulation. Although we have developed and implemented a corporate compliance program, we cannot assure you that we or our employees, directors or agents are or will
be in compliance with all laws and regulations. If we fail to comply with any of these laws or regulations, various negative consequences could result, including the termination of clinical studies, the failure to gain regulatory approval of a
product candidate, restrictions on our products or manufacturing processes, withdrawal of Cialis from the market, significant fines or other penalties and costly litigation.



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



We do not have facilities to
manufacture small molecule products, 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 studies contemplated by us over time. We intend to rely significantly on contract manufacturers, including our collaboration partners, to produce large quantities of drug material needed for clinical studies and
commercialization of Cialis and our potential products. We will have to depend on these manufacturers to deliver materials on a timely basis and to comply with regulatory requirements, including GMP regulations enforced by the FDA through its
facilities inspection program. Contract manufacturers may be unable to meet our needs with



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respect to timing, quantity or quality of materials, and may fail to satisfy applicable regulatory requirements with respect to the manufacture of these
materials. If we are unable to contract for a sufficient supply of needed materials on acceptable terms, or if we should encounter delays or difficulties in our relationships with manufacturers, our revenues and potential profitability may be lower.
For example, our ability to satisfy demand for our products could be reduced, which could adversely affect our operating results. Further, our clinical studies may be delayed, which would delay the submission of product candidates for regulatory
approval and the market introduction and subsequent commercialization of our potential products.



Manufacturing product candidates in compliance with regulatory requirements is complex, time-consuming and expensive. If we make changes in our
manufacturing processes, the FDA and corresponding foreign authorities may require us to demonstrate that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. Also, we may want
to rely on results of prior preclinical and clinical studies 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 and clinical studies 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 development. Manufacturing changes could result in delays in development or regulatory approval or in reduction or interruption of commercial sales of our potential products, any of which 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 be unable to develop manufacturing facilities that are sufficient to produce drug material for clinical studies or commercial use. Moreover, we and any contract manufacturers that we may use must continually adhere to current GMP
regulations. The FDA pre-market approval of our product candidates will not be granted if our facilities or the facilities of contract manufacturers cannot pass a preapproval plant inspection. In complying with these regulations and foreign
regulatory requirements, we and any of our contract manufacturers will be obligated to expend time, money and effort in production, record keeping and quality control in an effort to ensure that our potential products meet applicable specifications
and other requirements. If we or any of our contract manufacturers fail to comply with these requirements, we may be subject to regulatory sanctions.



Cialis is currently manufactured for Lilly ICOS by Lilly and it is expected that Cialis will continue to be manufactured by Lilly for sale in all markets
where regulatory approval is granted.



Our business may be
harmed if we cannot obtain sufficient quantities of raw materials and process them reliably and timely.



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



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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, failure to achieve market
acceptance for our products and an inability to achieve profitability.



Cialis and our potential products, if approved and commercialized, compete or will compete against well-established existing therapeutic products or treatments. In addition, a number of pharmaceutical and biotechnology companies are
currently developing products targeting the same diseases and medical conditions that we target. For example, Pfizer has already successfully commercialized Viagra, a PDE5 inhibitor that competes with our product, Cialis. Also, Bayer AG, together
with its marketing partner GlaxoSmithKline, began marketing Levitra in the United States in August 2003. The FDA approved Cialis for sale in the United States in November 2003, and product launch began shortly thereafter. Initial commercial
introduction in the United States could be negatively impacted as a result of Cialis reaching the U.S. market after Levitra.



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



| |  | develop products that are safer, more effective or less costly than any of our current or future products or that render our products obsolete;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | obtain FDA and other regulatory approvals or reach the market with their products more rapidly than we can or with labeling claims more favorable than ours, which would reduce the
potential sales of our product candidates;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | obtain intellectual property rights that could increase our costs or prevent development or commercialization of our product candidates;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------



| |  | devote greater resources to market or sell their products;
| | - | ----------------------------------------------------------



| |  | adapt more quickly to new technologies and scientific advances;
| | - | ---------------------------------------------------------------



| |  | initiate or withstand substantial price competition more successfully than we can;
| | - | ----------------------------------------------------------------------------------



| |  | have greater success in recruiting skilled workers from the limited pool of available talent;
| | - | ---------------------------------------------------------------------------------------------



| |  | more effectively negotiate third-party licensing and collaborative arrangements; and
| | - | ------------------------------------------------------------------------------------



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



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



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



Our success depends to a significant extent on our ability and the ability of our collaboration partners to obtain, maintain
and enforce patents and other proprietary rights. Patent law relating to the scope of claims in the



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biotechnology field in which we operate is still evolving and is surrounded by a great deal of uncertainty. Accordingly, we cannot assure you that our
pending patent applications will result in issued patents. In addition, we cannot assure you that others have not filed patent applications for technology covered by our pending applications or that we were the first to invent the technology. There
may be third-party patents or patent applications relevant to Cialis or 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 is unenforceable, or may refuse to stop the other party from using the
technology at issue on the ground that its technology is not covered by our patents. Policing unauthorized use of our intellectual property is difficult, and we cannot assure you that we will be able to prevent misappropriation of our proprietary
rights, particularly in countries where the laws may not protect such rights as fully as in the United States.



In addition to our patented technology, we also rely on unpatented technology, trade secrets and confidential information. We may be unable 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 and intellectual property agreement at the commencement of an employment, consulting or collaborative relationship with us. These agreements may not, however, provide effective protection of our
technology or information or, in the event of unauthorized use or disclosure, may not provide adequate remedies.



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



Patent litigation is very common in the pharmaceutical industry. We cannot assure you that third parties will not assert patent or other intellectual property infringement claims against us or our collaboration
partners with respect to technologies used in Cialis or in potential products. For example, on October 22, 2002, the PTO issued to Pfizer a method of use U.S. Patent No. 6,469,012. Later that day, Pfizer filed a lawsuit in United States
District Court for the District of Delaware against ICOS, Lilly and Lilly ICOS alleging that the proposed marketing of Cialis would infringe this patent.



In September 2003, the PTO ordered the reexamination of U.S. Patent No. 6,469,012. The reexamination process is provided for by law and requires the PTO
to consider the validity of the patent based on substantial new questions of patentability raised by the PTO. In October 2003, ICOS, Lilly ICOS and Lilly filed a motion for a stay with the District Court to suspend the patent infringement lawsuit,
pending the outcome of the reexamination. In November 2003, the judge granted the requested stay. We believe that Pfizers suit lacks merit and intend to vigorously pursue our defenses.



The Pfizer suit and any additional 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. Furthermore, as a result of a patent infringement suit brought against us or our
collaboration partners, we or our collaboration partners may be forced to stop or delay developing, manufacturing or selling



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Cialis or potential products that are claimed to infringe a third partys intellectual property unless that party grants us or our collaboration
partners rights to use its intellectual property. We or our collaboration partners may be unable to obtain these rights on commercially reasonable terms, if at all. Even if we or our collaboration partners were able to obtain rights to the third
partys intellectual property, these rights may be nonexclusive, thereby giving our competitors access to the same intellectual property. For example, if Pfizer were to prevail in its suit against us, we might be subject to substantial damages,
prohibited from marketing Cialis for the treatment of erectile dysfunction in the United States, or required to enter into a license agreement to market Cialis in the United States. We cannot assure you that any required agreement would be available
on commercially reasonable terms, if at all. In the event that we are unable to profitably market Cialis in the United States, our future financial condition, and our ability to obtain additional funding, would be adversely affected, including our
ability to pursue our product development programs.



Ultimately
we may be unable to commercialize Cialis or some of our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business. 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.



Additionally, we may have to resort to costly and time-consuming proceedings and litigation to determine the validity or scope of the proprietary rights
of others. For example, we, Lilly and eleven other companies were involved in an opposition proceeding in the European Patent Office in which we opposed a patent previously granted by the European Patent Office to Pfizer. This patent (EP702555) is a
method of use patent related to U.S. Patent No. 6,469,012 subsequently granted to Pfizer in the United States. Although the opposition proceeding was successful before the Opposition Division of the European Patent Office, which, on July
18, 2001, revoked all of the claims, Pfizer has appealed. Pfizers European patent had been nationalized by Pfizer in most European countries. Lilly ICOS brought suits challenging the patent in several of these countries. Generally, these cases
have been stayed pending the appellate decision in the opposition proceeding before the European Patent Office. The resolution of the European Patent Office appeal and pending or subsequent litigation in the various European countries could take
years. If Pfizers patent were not ultimately revoked by the European Patent Office or by the courts in European countries, we might be subject to litigation by Pfizer in Europe, prohibited from marketing Cialis for the treatment of erectile
dysfunction in some European countries, or required to enter into license agreements to market Cialis in Europe. We cannot assure you that such agreements would be available on commercially reasonable terms, if at all.



We, Lilly and Lilly ICOS, as appropriate, have also initiated or are
defending lawsuits against Pfizer in other jurisdictions around the world with respect to patents corresponding to Pfizers U.S. and the European Patent Office method of use patents. Presently, litigation is pending in Australia,
Brazil, Canada, Mexico, New Zealand and South Africa. Litigation in other countries may ensue as the world-wide commercialization of Cialis proceeds. The resolution of the litigation in these various countries could take years. If Pfizers
patent in any one or more of the countries were not ultimately revoked by the courts, we might be prohibited from marketing Cialis for the treatment of erectile dysfunction in those countries, or be required to enter into license agreements to
market Cialis in those countries. We cannot assure you that such agreements would be available on commercially reasonable terms, if at all.



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



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



We face inherent exposure to product liability claims in the event that the use of our product is alleged to have resulted in harm to others. This risk exists in clinical studies as well as for products that we sell.
In addition,



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the pharmaceutical and biotechnology industries in general have been subject to significant medical malpractice litigation. We may incur significant
liability if product liability or malpractice lawsuits against us are successful. Furthermore, product liability claims, regardless of their merits, could be costly and divert managements attention from other business concerns, or adversely
affect our reputation and the demand for our products. Although we maintain product liability insurance, we cannot be certain that this coverage is adequate or that it will continue to be available to us on acceptable terms.



If we are unable to obtain additional funding needed to develop, market
and sell our potential products, we could 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 studies, manufacturing, regulatory, and sales and marketing activities necessary to commercialize our
potential products. We may need to seek additional financing through public or private sources, including equity or debt financings, and through other alternatives, including collaborative arrangements. Poor financial results, unanticipated expenses
or unanticipated opportunities that require financial commitments could give rise to additional financing requirements. Financing may, however, be unavailable when we need it or may not be available on acceptable terms, if at all. If we raise
additional funds by issuing common stock or convertible debt securities, the percentage ownership of our existing stockholders could be reduced. Any debt or equity securities that we issue may have rights superior to those of our common stock. We
may also issue debt that has rights superior to those of the holders of our convertible subordinated debt. If we are unable to raise additional funds when we need them, we could be required to delay, scale back or eliminate expenditures for some of
our development programs or grant rights to third parties to develop and market product candidates that we would prefer to develop and market internally. If we are required to grant such rights, the ultimate value of these product candidates to us
may be reduced.



We have a significant amount of debt that
may adversely affect our financial condition.



We have
outstanding $278.7 million aggregate principal amount of convertible subordinated notes, bearing interest at 2%. The notes mature on July 1, 2023. However, on July 1, 2010, July 1, 2013 and July 1, 2018, holders of the notes may require us to
repurchase all or part of their notes, for cash, at a price equal to 100% of the principal amount of the notes plus accrued interest. This is a significant amount of debt that carries a substantial debt service obligation. If we are unable to
generate sufficient cash flow or otherwise obtain funds necessary to make required principal and interest payments on the notes, we will be in default under the terms of an indenture, which could, in turn, cause defaults under our future debt
obligations.



Even if we are able to meet our debt service
obligations, the amount of debt we have could materially and adversely affect us in a number of ways, including by:



| |  | limiting our ability to obtain financing for working capital, acquisitions or other purposes;
| | - | ---------------------------------------------------------------------------------------------



| |  | limiting our flexibility in planning for, or reacting to, changes in our business;
| | - | ----------------------------------------------------------------------------------



| |  | placing us at a competitive disadvantage relative to our competitors who have lower levels of debt; and
| | - | -------------------------------------------------------------------------------------------------------



| |  | making us more vulnerable to industry downturns and competitive pressures.
| | - | --------------------------------------------------------------------------



Our ability to meet our debt service obligations will depend on our future performance, which will be subject to financial, business and other factors
affecting our operations, many of which are beyond our control.



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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 continue to enter into, collaborative arrangements with third parties who provide us with funding and/or who perform research, development, regulatory compliance, manufacturing, or marketing activities
relating to Cialis and some or all of our product candidates. If we fail to secure or maintain successful collaborative arrangements, our development and marketing activities may be delayed or reduced. Currently, we have collaborative arrangements
with Lilly, 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 by our partners under certain
conditions. In addition, our partners may separately pursue competing products, therapeutic approaches or technologies to develop treatments for the diseases targeted by us or our collaborative efforts. Even if our partners continue their
contributions to the collaborative arrangements, they may nevertheless determine not to actively pursue the development or commercialization of any resulting products. Disputes may arise between us and our partners as to a variety of matters,
including financing obligations under our agreements and ownership of intellectual property rights. Also, our partners may fail to perform their obligations under the collaborative arrangements or may be slow in performing their obligations. In
addition, our partners may experience financial difficulties at any time that could prevent them from having available funds to contribute to these collaborations. In these circumstances, our ability to develop and market potential products could be
severely limited.



Acquisitions, mergers or investments in
businesses, products or technologies could harm our business, operating results and stock price.



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



| |  | difficulty of assimilating the new operations and personnel, products or technologies;
| | - | --------------------------------------------------------------------------------------



| |  | commercial failure of the new products;
| | - | ---------------------------------------



| |  | disruption of our ongoing business;
| | - | -----------------------------------



| |  | diversion of resources;
| | - | -----------------------



| |  | inability of management to maintain uniform standards, controls, procedures and policies;
| | - | -----------------------------------------------------------------------------------------



| |  | difficulty of managing our growth and information systems;
| | - | ----------------------------------------------------------



| |  | reduction in the overall growth rate of the combined organization;
| | - | ------------------------------------------------------------------



| |  | risks of entering markets in which we have little or no prior experience; and
| | - | -----------------------------------------------------------------------------



| |  | impairment of relationships with employees or customers.
| | - | --------------------------------------------------------



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



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The failure to attract or retain key management and technical employees and consultants 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:



| |  | delay our ongoing discovery research efforts;
| | - | ---------------------------------------------



| |  | delay preclinical or clinical testing of our product candidates;
| | - | ----------------------------------------------------------------



| |  | delay the regulatory approval process;
| | - | --------------------------------------



| |  | compromise our ability to negotiate additional collaborative arrangements; or
| | - | -----------------------------------------------------------------------------



| |  | prevent us from successfully commercializing our product candidates.
| | - | --------------------------------------------------------------------



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



Risks Related to Our Industry



Rapid changes in technology and industry standards could render Cialis or
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, Cialis or our potential products obsolete or noncompetitive. In addition, Cialis or 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 violation of fraud and
abuse laws.



We are subject to various federal and state
laws pertaining to healthcare fraud and abuse, including anti-kickback laws and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to offer or pay any remuneration in exchange for, or to induce, the referral
of business, including the purchase or prescription of a particular drug. The federal government has published regulations that identify safe harbors or exemptions for types of payment arrangements that do not violate the anti-kickback statutes. We
seek to comply with the safe harbors where possible. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented for payment to third-party payors (including Medicare and Medicaid), claims for reimbursed
drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services. Our activities relating to the sale and marketing of our products may be subject to scrutiny
under these laws. Violations of fraud and abuse laws may be punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal healthcare programs (including Medicare and
Medicaid). If the government were to allege against or convict us of violating these laws, there could be a material adverse effect on our business, including our stock price. Our activities could be subject to challenge, for the reasons discussed
above,



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and due to the broad scope of these laws and the increasing prosecutorial resources and attention being devoted to the sales practices of pharmaceutical
companies by law enforcement authorities. During the last few years, several companies have paid multi-million dollar fines for alleged violation of fraud and abuse laws, and several other companies are under active investigation.



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 were to occur, we could be held liable for any resulting damages,
which liability could exceed our resources. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and certain waste products. Although we believe that
our operations comply with the standards prescribed by these laws and regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials.



Available Information



We were incorporated in the state of Delaware in September 1989. The internet address of our corporate website is www.icos.com. We make our Annual Reports
on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports available free of charge through our internet website. In addition, we will voluntarily provide paper copies of such filings, free of charge,
upon request. The ICOS Corporation Code of Conduct, which is our written Code of Ethics under Section 406 of the Sarbanes-Oxley Act of 2002, is also available on our corporate website.



|Item 2. |  | Properties
|------- |  | ----------



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



|Item 3. |  | Legal Proceedings
|------- |  | -----------------



In October 2002, Pfizer Inc., Pfizer Limited, and Pfizer Ireland Pharmaceuticals filed a patent infringement lawsuit against ICOS, Lilly ICOS and Lilly in
the United States District Court for the District of Delaware. The complaint alleges that the intended and imminent use, offering for sale, selling, manufacture, or importing into the United States upon FDA approval of Cialis for the treatment of
erectile dysfunction by ICOS, Lilly ICOS and Lilly will constitute infringement of plaintiffs U.S. Patent No. 6,469,012. The plaintiffs seek a judgment declaring that the defendants using, selling, offering for sale, making or importing
of Cialis for the treatment of erectile dysfunction will infringe this patent. The plaintiffs also seek a permanent injunction, attorneys fees, costs and expenses. In January 2003, we filed an answer denying the central allegations of
plaintiffs complaint and setting forth various affirmative defenses. In September 2003, the PTO ordered the reexamination of U.S. Patent No. 6,469,012. The reexamination process is provided for by law and requires the PTO to consider the
validity of the patent based on substantial new questions of patentability raised by the PTO. In October 2003, ICOS, Lilly ICOS and Lilly filed a motion for a stay with the District Court, to suspend the patent infringement lawsuit, pending the
outcome of the reexamination. In November 2003, the judge granted the requested stay. In December 2003, Lilly ICOS filed its own reexamination request, related to U.S. Patent No. 6,469,012, with the PTO.



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Pfizers corresponding European method-of-use patent was previously held invalid in the first stage
of an opposition proceeding in the European Patent Office. Pfizer is now appealing that decision to the Technical Board of Appeal of the European Patent Office. A hearing is expected in the second half of 2004. The United Kingdom Court of Appeal has
previously held the United Kingdom counterpart to this patent invalid. Litigation relating to the corresponding patent is pending in Canada and Mexico.



Litigation is inherently unpredictable and the eventual outcome in a particular case is impossible to determine in advance. We believe that Pfizers
suit lacks merit and intend to vigorously pursue our various defenses. If Pfizer were to prevail in one or more countries, however, we might be subject to substantial damages, prohibited from marketing Cialis for the treatment of erectile
dysfunction in those countries, or required to enter into a licensing agreement to market Cialis in those countries. Any such adverse result could have a material adverse effect on our business, financial condition, results of operations and cash
flows.



|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 2003.



PART II



|Item 5. |  | Market for Registrants Common Equity and Related Stockholder Matters
|------- |  | ---------------------------------------------------------------------



Market Information



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.



|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|               |  | High |       | Low
|2003           |  |      |       |     |   |      
|First Quarter  |  | $    | 28.74 |     | $ | 15.45
|Second Quarter |  |      | 46.00 |     |   | 18.14
|Third Quarter  |  |      | 44.26 |     |   | 29.00
|Fourth Quarter |  |      | 47.85 |     |   | 37.95
|               |  |     
|2002           |  |      |       |     |   |      
|First Quarter  |  | $    | 57.66 |     | $ | 40.24
|Second Quarter |  |      | 47.72 |     |   | 16.40
|Third Quarter  |  |      | 29.47 |     |   | 13.35
|Fourth Quarter |  |      | 32.72 |     |   | 19.74



Holders



As of January 31, 2004, there were 2,058 holders of record of our common
stock. Because many of the outstanding shares of our common stock are held by brokers and other institutions on behalf of the beneficial stockholders, we are unable to estimate the total number of beneficial stockholders represented by the record
holders.



Dividends



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



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##### Table of Contents

|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 Results of
Operations and Financial Condition, and the consolidated financial statements and related notes included in this Form 10-K for the year ended December 31, 2003.



|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|-------------------------------------------------------------------------------- |  | ------------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | -------- | - |  | - | -------- | -
|                                                                                 |  | Year Ended December 31,               |         
|                                                                                 |  | 2003                                  |          |   | 2002 |   |          | 2001 |  |   | 2000     |   |  | 1999 |         
|                                                                                 |  | (In thousands, except per share data) |         
|Statement of Operations Data:                                                    |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Revenue:                                                                         |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Collaboration revenue from related parties                                       |  | $                                     | 25,943   |   |      | $ | 77,728   |      |  | $ | 54,754   |   |  | $    | 47,404   |   |  | $ | 64,100   |  
|Licenses of technology                                                           |  |                                       | 36,976   |   |      |   | 6,617    |      |  |   | 30,846   |   |  |      | 42,929   |   |  |   | 15,000   |  
|Contract manufacturing                                                           |  |                                       | 12,185   |   |      |   | 8,532    |      |  |   | 7,402    |   |  |      | 400      |   |  |   |         |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Total revenue                                                                    |  |                                       | 75,104   |   |      |   | 92,877   |      |  |   | 93,002   |   |  |      | 90,733   |   |  |   | 79,100   |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Operating expenses:                                                              |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Research and development                                                         |  |                                       | 85,758   |   |      |   | 129,350  |      |  |   | 99,009   |   |  |      | 82,998   |   |  |   | 96,733   |  
|Marketing and selling                                                            |  |                                       | 19,770   |   |      |   | 9,268    |      |  |   | 2,741    |   |  |      | 411      |   |  |   |         |  
|Cost of contract manufacturing                                                   |  |                                       | 9,703    |   |      |   | 7,599    |      |  |   | 5,198    |   |  |      | 81       |   |  |   |         |  
|General and administrative                                                       |  |                                       | 15,272   |   |      |   | 16,409   |      |  |   | 13,795   |   |  |      | 10,527   |   |  |   | 9,067    |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Total operating expenses                                                         |  |                                       | 130,503  |   |      |   | 162,626  |      |  |   | 120,743  |   |  |      | 94,017   |   |  |   | 105,800  |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Operating loss                                                                   |  |                                       | (55,399  | ) |      |   | (69,749  | )    |  |   | (27,741  | ) |  |      | (3,284   | ) |  |   | (26,700  | )
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Other income (expense):                                                          |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Equity in losses of affiliates                                                   |  |                                       | (87,180  | ) |      |   | (104,160 | )    |  |   | (64,902  | ) |  |      | (37,038  | ) |  |   | (12,042  | )
|Gain on sale of partnership interests                                            |  |                                       | 10,000   |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest expense                                                                 |  |                                       | (3,578   | ) |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest and other income                                                        |  |                                       | 10,038   |   |      |   | 12,292   |      |  |   | 12,470   |   |  |      | 5,531    |   |  |   | 5,547    |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Total other income (expense)                                                     |  |                                       | (70,720  | ) |      |   | (91,868  | )    |  |   | (52,432  | ) |  |      | (31,507  | ) |  |   | (6,495   | )
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Loss before income taxes and cumulative effect of change in accounting principle |  |                                       | (126,119 | ) |      |   | (161,617 | )    |  |   | (80,173  | ) |  |      | (34,791  | ) |  |   | (33,195  | )
|Income tax recovery                                                              |  |                                       | 612      |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Loss before cumulative effect of change in accounting principle                  |  |                                       | (125,507 | ) |      |   | (161,617 | )    |  |   | (80,173  | ) |  |      | (34,791  | ) |  |   | (33,195  | )
|Cumulative effect of change in accounting principle                              |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      | (63,075  | ) |  |   |         |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Net loss                                                                         |  | $                                     | (125,507 | ) |      | $ | (161,617 | )    |  | $ | (80,173  | ) |  | $    | (97,866  | ) |  | $ | (33,195  | )
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                                                 |  |                                       |          |   |     
|Per common share (basic and diluted):                                            |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Loss before cumulative effect of change in accounting principle                  |  | $                                     | (2.01    | ) |      | $ | (2.64    | )    |  | $ | (1.48    | ) |  | $    | (0.75    | ) |  | $ | (0.76    | )
|Cumulative effect of change in accounting principle                              |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      | (1.36    | ) |  |   |         |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Net loss                                                                         |  | $                                     | (2.01    | ) |      | $ | (2.64    | )    |  | $ | (1.48    | ) |  | $    | (2.11    | ) |  | $ | (0.76    | )
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Weighted-average common shares outstanding  basic and diluted                   |  |                                       | 62,561   |   |      |   | 61,304   |      |  |   | 54,073   |   |  |      | 46,343   |   |  |   | 43,449   |  
|                                                                                 |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                                                 | 
|                                                                                 |  | December 31,                          |         
|                                                                                 |  | 2003                                  |          |   | 2002 |   |          | 2001 |  |   | 2000     |   |  | 1999 |         
|                                                                                 |  | (In thousands)                        |         
|Balance Sheet Data:                                                              |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Cash, cash equivalents, investment securities and interest receivable            |  | $                                     | 469,525  |   |      | $ | 354,025  |      |  | $ | 470,707  |   |  | $    | 229,400  |   |  | $ | 69,254   |  
|Working capital                                                                  |  |                                       | 397,981  |   |      |   | 162,538  |      |  |   | 381,365  |   |  |      | 194,276  |   |  |   | 75,035   |  
|Total assets                                                                     |  |                                       | 524,854  |   |      |   | 385,660  |      |  |   | 507,587  |   |  |      | 268,174  |   |  |   | 112,788  |  
|Convertible subordinated debt                                                    |  |                                       | 278,650  |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Accumulated deficit                                                              |  |                                       | (589,473 | ) |      |   | (463,966 | )    |  |   | (302,349 | ) |  |      | (222,176 | ) |  |   | (124,310 | )
|Stockholders equity                                                             |  |                                       | 198,929  |   |      |   | 317,632  |      |  |   | 453,750  |   |  |      | 211,095  |   |  |   | 99,399   |  



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Notes to Selected Consolidated Financial Data:



|(1) | In the fourth quarter of 2000, we changed our accounting for nonrefundable upfront technology license fees and milestones received, for product candidates where we are providing
continuing services related to product development. Prior to 2000, milestones were recognized as revenue upon attainment of a specified event, and other nonrefundable technology or licensing fees were recognized as revenue when payment was received.
Pro forma amounts for 1999, giving effect to this accounting change as if it occurred prior to 1999, are a net loss of $17.3 million, or $0.40 per basic and diluted common share. Our current revenue recognition policy is discussed later herein under
Results of Operations  Critical Accounting Policies and Estimates  Revenue Recognition. Also, see Note 1 to our consolidated financial statements for further discussion regarding revenue recognition.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | The following tables summarize our revenue from collaborations with related parties and licenses of technology, and equity in losses of affiliates.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------



|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|----------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | -------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                      |  | Year Ended December 31, |        
|                                                      |  | 2003                    |         |   | 2002 |   |          | 2001 |  |   | 2000    |   |  | 1999 |        
|                                                      |  | (In thousands)          |        
|Collaboration revenue from related parties:           |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Lilly ICOS                                            |  | $                       | 22,093  |   |      | $ | 6,615    |      |  | $ | 9,965   |   |  | $    | 19,944  |   |  | $ | 19,902  |  
|Suncos Corporation (Suncos)                           |  |                         | 2,450   |   |      |   | 56,478   |      |  |   | 30,373  |   |  |      | 15,175  |   |  |   | 25,053  |  
|ICOS-Texas Biotechnology L.P. (ICOS-TBC)              |  |                         | 1,400   |   |      |   | 14,635   |      |  |   | 12,676  |   |  |      | 2,816   |   |  |   |        |  
|ICOS Clinical Partners, L.P. (ICOS Clinical Partners) |  |                         |        |   |      |   |         |      |  |   | 1,740   |   |  |      | 9,469   |   |  |   | 19,145  |  
|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                      |  | $                       | 25,943  |   |      | $ | 77,728   |      |  | $ | 54,754  |   |  | $    | 47,404  |   |  | $ | 64,100  |  
|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                      |  |                         |         |   |     
|Licenses of technology:                               |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Lilly ICOS                                            |  | $                       | 15,031  |   |      | $ | 1,557    |      |  | $ | 29,416  |   |  | $    | 42,331  |   |  | $ | 15,000  |  
|ICOS Clinical Partners                                |  |                         |        |   |      |   | 3,160    |      |  |   | 981     |   |  |      | 598     |   |  |   |        |  
|Biogen                                                |  |                         | 21,945  |   |      |   | 1,900    |      |  |   | 449     |   |  |      |        |   |  |   |        |  
|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                      |  | $                       | 36,976  |   |      | $ | 6,617    |      |  | $ | 30,846  |   |  | $    | 42,929  |   |  | $ | 15,000  |  
|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Equity in losses of affiliates:                       |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|Lilly ICOS                                            |  | $                       | (87,320 | ) |      | $ | (65,669  | )    |  | $ | (38,219 | ) |  | $    | (23,612 | ) |  | $ |        |  
|Suncos                                                |  |                         | 140     |   |      |   | (29,933  | )    |  |   | (15,200 | ) |  |      | (7,754  | ) |  |   | (11,802 | )
|ICOS-TBC                                              |  |                         |        |   |      |   | (8,558   | )    |  |   | (11,461 | ) |  |      | (5,476  | ) |  |   |        |  
|ICOS Clinical Partners                                |  |                         |        |   |      |   |         |      |  |   | (22     | ) |  |      | (196    | ) |  |   | (240    | )
|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                      |  | $                       | (87,180 | ) |      | $ | (104,160 | )    |  | $ | (64,902 | ) |  | $    | (37,038 | ) |  | $ | (12,042 | )
|                                                      |  |                         |         |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  



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|Item 7. |  | Managements Discussion and Analysis of Results of Operations and Financial Condition
|------- |  | -------------------------------------------------------------------------------------



Our Managements Discussion and Analysis of Results of Operations and Financial Condition should be read in conjunction
with our consolidated financial statements and related notes included elsewhere in this report.



Overview



The following
management discussion and analysis is intended to provide information which will enhance a readers understanding of our business, results of operations, financial condition and related matters. It is organized as follows:



| |  | In the section entitled ICOS Corporation Background, we briefly describe the importance of collaborations to our business, the business environment in which we operate,
our approved product (Cialis) and our clinical and discovery research and development projects and programs.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In Results of Operations, we discuss each of our most critical accounting policies as well as the primary factors that are likely to contribute to significant
variability of our results of operations from period to period. We then provide detailed narrative regarding significant changes in our and Lilly ICOS results of operations for 2003 compared to 2002, and 2002 compared to 2001.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | At 2004 Financial Guidance, we provide our expectations regarding ICOS and Lilly ICOS results of operations for the year ending December 31, 2004.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Under the section entitled Liquidity and Capital Resources, we discuss our 2003 year-end liquidity, our cash flows for the year ended December 31, 2003, compared to
those for the year ended December 31, 2002, factors that may influence our future cash requirements and the status of certain contractual obligations as of December 31, 2003.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

| |  | Finally, under Legal Proceedings, we discuss the status of certain litigation relating to Cialis.
| | - | ---------------------------------------------------------------------------------------------------



ICOS Corporation Background



ICOS Corporation is a biotechnology company that is dedicated to bringing
innovative therapeutic products to patients. We are marketing our first product, Cialis (tadalafil), for the treatment of erectile dysfunction, through Lilly ICOS. Our goal is to develop and commercialize treatments for serious unmet medical
conditions such as chronic obstructive pulmonary disease, cancer and inflammatory diseases.



Over the years, we have established collaborations with pharmaceutical and biotechnology companies to enhance our internal development capabilities, to acquire rights to additional product candidates, and to offset a
substantial portion of the financial risk of developing individual product candidates. In each case, we acquired or retained substantial rights to the product candidates covered by the collaborations. These rights are intended to provide us with the
opportunity to participate in a significant portion of the economic benefit from successful development and commercialization. Our most significant ongoing collaboration is Lilly ICOS. We expect to establish additional collaborations with
pharmaceutical and other biotechnology companies in the future.



We operate in a highly regulated business environment. Cialis and our product candidates require extensive regulatory review, approval and oversight prior to commercialization. For example, the FDA regulates, among other things, the
development, manufacture, approval, advertising, promotion, sale and distribution of pharmaceutical products. Our products marketed abroad are also subject to extensive regulation by foreign governments. The regulatory processes are lengthy,
expensive and uncertain. They may take years to complete, may involve ongoing requirements for post-marketing studies and can affect the nature, content, timing and cost of our marketing efforts.



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The markets in which we compete are well established and intensely competitive. Cialis and our product
candidates, if approved and commercialized, compete or are likely to compete against well-established existing therapeutic products or treatments. In addition, a number of pharmaceutical and biotechnology companies are currently developing products
targeting the same diseases and medical conditions that we target. Key factors affecting our markets include: the timing and scope of regulatory approvals; safety and efficacy of therapeutic products; cost and availability of these products;
availability of alternative treatments; and protection of patent and proprietary rights. Although, we believe that we are positioned to compete adequately with respect to these factors in the future, our future success is currently difficult to
predict. Cialis was only recently approved. Our product candidates are in various stages of research and development and, accordingly, subject to substantial research, development, regulatory approval and commercialization risks. Since timing of
market entry can be an important factor in determining a new products eventual success and profitability, the speed with which we can develop products and receive regulatory approval will likely be important to our commercial success.



Cialis (tadalafil)



Our first commercial product, Cialis, is being prescribed around the world
for patients with erectile dysfunction. Cialis is being manufactured and marketed by Lilly ICOS, which has rights to commercialize Cialis in North America and Europe. Lilly has exclusive rights to market Cialis in the remainder of the world, and
pays royalties to Lilly ICOS, equal to 20% of net sales, in those territories.



During the first quarter of 2003, Lilly ICOS launched Cialis in Europe, followed by additional launches later in the year in North America. Cialis became available for the treatment of erectile dysfunction in Mexico,
in August 2003, and Canada, in November 2003. Lilly ICOS received FDA approval, to market Cialis in the United States, on November 21, 2003. The product was available in pharmacies throughout the United States by early December 2003.



Lilly ICOS also has ongoing programs to evaluate tadalafil as a potential
treatment for other medical conditions.



IC485



IC485 is an orally administered, small molecule PDE4
inhibitor that is currently in clinical development. In the fourth quarter of 2003, we initiated a Phase 2 clinical study with IC485 for the potential treatment of COPD. We expect to complete this study in 2005.



Discovery and Preclinical Research



We are continuously evaluating possible new product candidates in our
discovery and preclinical research programs. The following table summarizes those programs.



|                                                    |  |                                                                |  |            
|--------------------------------------------------- |  | -------------------------------------------------------------- |  | -----------
|                                                    |  |                                                               
|Program                                             |  | Target Indication                                              |  | Status     
|                                                   
|                                                    |  |                                                               
|Cell cycle checkpoint/DNA repair inhibitors         |  | Cancer                                                         |  | Preclinical
|                                                    |  |                                                               
|Lipid and protein kinase inhibitors                 |  | Inflammatory diseases                                          |  | Preclinical
|                                                    |  |                                                               
|Other phosphodiesterase inhibitors                  |  | Multiple diseases                                              |  | Preclinical
|                                                    |  |                                                               
|Cell adhesion molecule antagonists(including LFA-1) |  | Cardiovascular, autoimmune, inflammatory and fibrotic diseases |  | Preclinical
|                                                    |  |                                                               
|Chemokine receptor antagonists                      |  | Allergic inflammatory diseases                                 |  | Research   
|                                                    |  |                                                               
|Novel antibiotics                                   |  | Infectious diseases                                            |  | Research   



In the status column
of the foregoing table: Preclinical indicates evaluation of lead or preferred compounds for safety, pharmacology and proof of efficacy in non-human animal models; and Research



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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.



Discontinued Product Candidates



By 2003 year-end, we completed patient follow-up in a Phase 2 clinical study evaluating RTX for the treatment of interstitial cystitis. In late January
2004, it was determined that RTX was not effective in relieving patients symptoms. We will not pursue additional studies of interstitial cystitis.



IC14, a monoclonal antibody, was evaluated as a treatment for sepsis resulting from community acquired pneumonia. In the fourth quarter of 2003, we
concluded that the results of a Phase 2 clinical study did not meet our criteria to continue further investment.



In 2003, we concluded our LFA-1 antagonist collaboration with Biogen, and reacquired sole development rights to the program. IC747, an LFA-1 antagonist
within the collaboration, concluded a small, exploratory Phase 2a clinical study in patients with psoriasis earlier in 2003. Based on the results of the study, the efficacy observed was insufficient to warrant further development of IC747.



In January 2003, we announced that joint development of
endothelin receptor antagonists, through ICOS-TBC, would not continue. Encysive agreed to be responsible for all costs and expenses of ICOS-TBC incurred subsequent to December 31, 2002. On April 22, 2003, Encysive acquired all of our interests in
ICOS-TBC for $10.0 million.



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



Results of Operations



Critical Accounting Policies and Estimates



Our critical accounting policies include revenue recognition, accounting for our share of the operating results of our unconsolidated affiliates, and
estimating expenses from contracted research and clinical study activities conducted by various third parties.



Revenue Recognition



We recognize revenue from our contracts for research, development, marketing and sales services, including those under collaborative agreements, as the
related costs are incurred. We refer to this revenue as cost reimbursement revenue. Payments received, that are related to future performance, are deferred and recognized as revenue when the future performance occurs.



Nonrefundable upfront technology license fees, for product candidates where
we are providing continuing services related to product development, are deferred, and recognized as revenue as we provide the services required under the agreement. We recognize revenue for nonrefundable upfront technology fees based on the ratio
of current development costs to total estimated current and future development costs through the date we file an NDA (or an equivalent) with the FDA. We believe this method appropriately matches revenue with the estimated costs of the development
effort. We also believe that development costs are the best available surrogate for benefits obtained as data is collected and other research and development activities progress in the collaboration.



We estimate the total projected development costs based on the specific terms
of each agreement, our judgment and experience and, when appropriate, the expertise of our collaboration partners. The ability to estimate total development effort and costs can vary significantly for each product candidate due to the inherent



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complexities and uncertainties of drug development. In the past, we have been able to estimate total expected development costs, for certain product
candidates, because they were in later stages of clinical development at the time such estimates were prepared or our partner had substantial previous experience in the relevant field of study. However, we may not be able to reasonably estimate
total expected development costs for product candidates in the future, particularly if such product candidates are in earlier stages of clinical development. To the extent we cannot estimate the costs to complete development, but can estimate an
expected NDA filing date, we will recognize license fee revenue ratably through the NDA filing date. If we are unable to reasonably estimate either total costs to complete development or an expected NDA filing date (performance period), we will
defer revenue recognition until one of those estimates can be made or the project is discontinued.



Milestones, in the form of additional license fees, typically represent nonrefundable payments to be received in conjunction with the achievement of a
specific event identified in the contract, such as initiation or completion of specified clinical development activities. We believe that a milestone represents the culmination of a distinct earnings process when it is not associated with ongoing
research, development or other performance on our part. We recognize such milestones as revenue when they become due and collectibility is reasonably assured. When a milestone does not represent the culmination of a distinct earnings process, we
recognize revenue at the time such payments are due, provided collectibility is reasonably assured, based on the ratio of effort to date (in terms of costs or time, as discussed above) to total estimated development effort. Any remaining balance is
deferred and recognized as revenue over the estimated remaining product development period, in the same manner as our upfront technology license fees.



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



Prior to 2000, milestones were recognized as revenue upon attainment of a specified event and nonrefundable technology license fees were recognized as
revenue when received, provided any required work had been performed, and we had no continuing performance obligations with respect to that work. In 2000, we adopted the provisions of Securities and Exchange Commission Staff Accounting Bulletin No.
101, as amended, Revenue Recognition in Financial Statements. In 2002 and 2001, we recognized $4.5 million and $15.6 million, respectively, of the $63.1 million deferred in 2000 as a result of this change in accounting. Substantially all
of this deferred revenue had been recognized by December 31, 2002.



Contract manufacturing revenue, including fees earned for process development and manufacturing services performed for third parties, is recognized when the manufacturing obligation is fulfilled or manufacturing services are performed, as
appropriate, based on the terms of the agreement, and collectibility is reasonably assured. Payments received in excess of amounts earned are recorded as deferred revenue.



Accounting for our Share of the Operating Results of our Unconsolidated Affiliates



We recognize our share of the operating results of our unconsolidated
affiliates, in proportion to our ownership interest in the affiliate, and report it as equity in losses of affiliates. Losses relating to our affiliates are recognized only to the extent we have made, or are committed to make, capital contributions
to the affiliate. Operating results of our affiliates include expenses related to research, development, marketing and sales services that we provide to them, and that we recognize as cost reimbursement revenue. The amount of our cost reimbursement
revenue, and the associated costs, both depend on the continued progression of clinical study research and development activities, the extent and timing of marketing and sales activities, and our level of



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participation in those activities. A shift of research, development and co-promotional activities among collaboration partners could have a significant
impact on our overall operating results to the extent that our negotiated reimbursement rates include indirect and overhead costs that may not vary based on our collaboration activities. Also, a shift of such activities could have a material impact
on our costs and expenses and the consequent amount of our cost reimbursement revenue. For example, the shift of development activities from ICOS to our affiliate partner would be expected to result in our reporting lower revenue and lower operating
expenses, though not necessarily of equal amounts.



Estimating Expenses from Third-Party Contract Research and Clinical Study Activities



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



Management Estimates and Assumptions



The preparation of our 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. Modifications to these assumptions could result in estimates that are substantially different from those reflected in our financial
statements.



General



Our results of operations may vary significantly from period to period.
Operating results will depend on, among other factors, the timing, cost and success of new product launches, the timing of expenses, continued funding by collaboration partners, and the timing and progression of research, development, marketing and
sales activities. We may experience significant fluctuations in cost reimbursement revenue, revenue from licenses of technology and contract manufacturing revenue. Cost reimbursement revenue will vary depending upon the extent and timing of research
and development collaboration activities, the timing and amount of marketing and sales activities, and our level of participation in those activities. Revenue from licenses of technology will vary as a result of (i) the nature and extent of product
collaboration and other licensing transactions, (ii) the timing of milestone payments, and (iii) changes in estimated development costs and/or expected completion dates, which depend on the success of clinical studies and other research and
development efforts. Contract manufacturing revenue may fluctuate depending upon our needs to manufacture our own internal product candidates, our ability to attract third parties to utilize any remaining manufacturing capacity and the particular
terms of the manufacturing agreements. Significant changes in joint venture collaboration activities, which are subject to the oversight of both parties, could cause the amount of affiliate losses to fluctuate from period to period.



Year Ended December 31, 2003 Compared With Year Ended December 31, 2002



Revenue



Total revenue was $75.1 million in 2003, compared to $92.9 million in 2002.



Cost reimbursement revenue was $25.9 million in 2003, compared
to $77.7 million in 2002. The decrease reflects the December 2002 termination of Pafase development activities and our decision, in early 2003, to conclude our participation in the endothelin receptor antagonist collaboration with Encysive. The
decrease was partially offset by higher cost reimbursement revenue from Lilly ICOS, primarily due to reimbursement of the



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cost of our sales force to promote Cialis in the United States. Beginning in September 2003, and continuing through December 2004, our costs of marketing and
selling Cialis in the United States are fully reimbursable by Lilly ICOS. Thereafter, any costs we incur selling Cialis are generally reimbursable by Lilly ICOS at 60% of actual cost. Any marketing costs we incur related to Cialis will continue to
be fully reimbursed by Lilly ICOS.



Revenue from licenses of
technology was $37.0 million in 2003, compared to $6.6 million in 2002. 2003 technology license fee revenue included $21.3 million of previously deferred upfront fees and forgiven loans, received from Biogen, which we recognized as revenue in
conjunction with our reacquisition of sole development rights to the LFA-1 antagonist program in June 2003. Revenue from licenses of technology for 2003 also included $15.0 million earned upon the first commercial sale of Cialis in the United
States.



Contract manufacturing revenue was $12.2 million in
2003, compared to $8.5 million in the prior year. The increase primarily reflects greater utilization of contract manufacturing capacity for third-party contracts in 2003, including additional development services provided under the associated
agreements. Revenue associated with our contract manufacturing services fluctuates significantly based on our internal manufacturing needs and our ability to sell excess capacity to third parties.



Operating Expenses



Total operating expenses were $130.5 million in 2003, compared to $162.6
million in 2002.



Research and
development.    Research and development expenses are principally comprised of costs for: personnel, including salaries and benefits; occupancy; clinical studies performed by third parties; materials and supplies to support
our programs; contract research; manufacturing; consulting arrangements; in-licensing fees; and other expenses incurred to sustain our overall research and development program.



Research and development expenses decreased $43.6 million, to $85.8 million in 2003. This decrease was primarily due to
discontinuation of activities associated with the Pafase and endothelin receptor antagonist programs, partially offset by increased costs related to development activities associated with Cialis and RTX.



Our research and development activities occur in two main areas: (i)
discovery and preclinical research; and, (ii) clinical research and development, including the formulation and manufacture of drug substance for use in clinical studies and, when appropriate, seeking approval for commercial manufacturing and
marketing.



Our discovery and preclinical research focuses on
the identification and initial testing of new product candidates. During this stage, we identify new drug targets and lead compounds, and then optimize their characteristics through repetitive cycles of chemical modification. Compounds that
demonstrate the most attractive characteristics and that appear to offer the potential for therapeutic benefit are subsequently evaluated in laboratory preclinical studies to evaluate their safety, pharmacology and efficacy in animal models. Based
on the results of preclinical studies, specific compounds may be selected to advance to clinical research and development.



Clinical research and development refers to internal and external activities associated with clinical studies in humans and advancing clinical product
candidates towards a goal of seeking regulatory marketing approval. Such activities include, among other things, services provided by clinical research organizations and principal investigators and concurrent activities associated with advancing a
clinical product candidate, such as the manufacture and formulation of drug compounds for clinical studies and in preparation for commercial scale production. The clinical development process involves several rigorous stages, many of which are
strictly prescribed and monitored by regulatory authorities, such as the FDA.



Our clinical research and development expenses include the costs of activities that are not attributable to individual projects, but are necessary to support our overall clinical program. These indirect
costs are primarily associated with general regulatory compliance, staff training, development and maintenance of clinical processes and information systems, executive management and administrative support. These indirect costs are not allocated to
development projects.



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The following table provides information regarding our research and development expenses, by project:



|                                        |  |                         |        |      |   |         |  |   |       
|--------------------------------------- |  | ----------------------- | ------ | ---- | - | ------- |  | - | ------
|                                        |  | Year Ended December 31,
|                                        |  | 2003                    |        | 2002 |   | 2001   
|                                        |  | (In thousands)         
|Approved product  Cialis               |  | $                       | 6,657  |      | $ | 2,671   |  | $ | 6,527 
|Ongoing clinical project:               |  |                         |        |      |   |         |  |   |       
|IC485                                   |  |                         | 9,441  |      |   | 9,846   |  |   | 7,214 
|Discontinued clinical projects:         |  |                         |        |      |   |         |  |   |       
|RTX                                     |  |                         | 9,862  |      |   | 2,663   |  |   | 1,977 
|IC14                                    |  |                         | 7,203  |      |   | 5,455   |  |   | 6,125 
|IC747                                   |  |                         | 4,043  |      |   | 5,416   |  |   | 4,256 
|Endothelin receptor antagonists         |  |                         | 1,245  |      |   | 12,241  |  |   | 11,923
|Pafase                                  |  |                         | 1,693  |      |   | 44,172  |  |   | 27,337
|Indirect clinical costs                 |  |                         | 8,232  |      |   | 8,326   |  |   | 7,157 
|Discovery and preclinical research      |  |                         | 37,382 |      |   | 38,560  |  |   | 26,493
|                                        |  |                         |        |      |   |         |  |   |       
|Total research and development expenses |  | $                       | 85,758 |      | $ | 129,350 |  | $ | 99,009
|                                        |  |                         |        |      |   |         |  |   |       



Through December 31,
2003, cumulative research and development expenditures for IC485 were $26.5 million.



Development of a new drug product is a lengthy and expensive process, involving a high degree of uncertainty. Very few research and development projects result in a commercial product. Before obtaining regulatory
approval for the sale of any of our potential products, we must subject them to extensive preclinical and clinical testing to demonstrate their safety and efficacy in humans. At any time during the multi-year clinical development period, 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 or other development activities could cause us
to interrupt, limit, delay or abort the development of a product candidate. Because of the uncertainties of clinical research and development, at this time we are unable to provide estimates of project completion dates, the timing of our research
and development efforts and the costs of completing research and development for IC485.



Various statutes and regulations govern or influence the manufacturing, safety, labeling, storage, record keeping, marketing and other factors that are critical in the development and commercialization of a product
candidate. The lengthy process of complying with the applicable statutes and regulations and seeking necessary regulatory approvals requires the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining regulatory
approvals could have a material adverse effect on our business.



A substantial delay in completing clinical studies or obtaining regulatory approvals could severely harm our business. Such delays could: require that we spend substantial additional funds to continue our development efforts; delay, for a
considerable period of time, our ability to seek or obtain regulatory approvals needed to market our potential products; and, provide existing or new competitive products with the opportunity to expand their share or enter the market before ours.
These, and similar events, could have a material adverse effect on our ability to bring a product to market, substantially increasing the cost of development and postponing, reducing or eliminating the potential to generate net cash inflows from the
successful commercialization of a product.



Marketing and
selling.    Marketing and selling expenses principally consist of costs associated with our pharmaceutical sales force, marketing activities for Cialis and market research activities for our product candidates in research and
development. Marketing and selling expenses increased $10.5 million, to $19.8 million in 2003. This increase reflects incremental costs associated with recruiting, hiring, training, and deploying our U.S. sales force to promote Cialis, primarily to
urologists.



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Cost of contract manufacturing.    Contract manufacturing expenses are
principally comprised of costs for: personnel, including salaries and benefits; occupancy; raw materials and consumables used in process development and manufacturing; testing services provided by third parties; facility overhead, including taxes,
depreciation, utilities and maintenance of manufacturing equipment; and other shared services, including information systems and staff support. Contract manufacturing expenses increased $2.1 million, to $9.7 million in 2003. The increase primarily
reflects incremental costs associated with greater utilization of manufacturing capacity for third-party contracts and additional development services provided under the associated agreements.



General and administrative.    General and
administrative expenses consist primarily of costs associated with corporate support functions, general management and other activities not related to research and development, marketing and sales or contract manufacturing. General and
administrative expenses decreased $1.1 million, to $15.3 million in 2003. This decrease primarily reflects timing of patent filings and patent prosecution expenses.



Equity in Losses of Affiliates



Our equity in losses of affiliates was $87.2 million in 2003, compared to $104.2 million in 2002.



Our 50% share of Lilly ICOS losses increased $21.7 million, to $87.3
million in 2003. This increase primarily reflects the substantial selling and marketing activities associated with the 2003 launches of Cialis in North America and Europe.



During 2002, we recognized $29.9 million in losses related to our equity interest in Suncos, our 50%-owned affiliate that
was developing Pafase. Upon discontinuation of the Pafase program, in December 2002, Suncos accrued estimated close-out costs, primarily associated with the programs clinical and manufacturing activities. During 2003, the accrual for estimated
close-out costs was adjusted, by an immaterial amount, to reflect actual close-out costs incurred.



During 2002, we recognized $8.6 million in losses related to our 50% interest in ICOS-TBC, the limited partnership developing endothelin receptor
antagonists. Encysive agreed to be responsible for all costs and expenses incurred by ICOS-TBC subsequent to December 31, 2002.



Gain on Sale of Partnership Interests



In April 2003, we recognized a $10.0 million gain upon the sale, to Encysive, of our partnership interests in ICOS-TBC.



Interest Expense



We incurred $3.6 million of interest expense on $278.7 million of 2%
convertible subordinated notes, which we placed in June and July of 2003.



Interest and Other Income



Interest and other income totaled $10.0 million in 2003, compared to $12.3 million in 2002. The decrease primarily reflects the impact of lower average interest rates in the current year, partially offset by an increase in our investment
portfolio due to investment of the proceeds from our convertible subordinated notes issued in 2003.



Lilly ICOS Results of Operations



Cialis is being manufactured and marketed, in North America and Europe, by Lilly ICOS. Lilly markets Cialis in the remainder of the world, and pays
royalties, to Lilly ICOS, equal to 20% of net sales in those territories.



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Lilly ICOS reported a net loss of $174.7 million in 2003, compared to a net loss of $131.3 million in
2002.



During 2003, Lilly ICOS first commercial product,
Cialis, was launched around the world. The commercial launches began in Europe in early February and continued throughout the year. U.S. approval occurred on November 21, 2003, and physician detailing and pharmacy stocking began immediately
thereafter. Cialis also became available in pharmacies in Mexico, in August 2003, and in Canada late in November 2003.



Cialis Product Sales Highlights for 2003 (in millions):



|                                 |  |   |      
|-------------------------------- |  | - | -----
|Sales in Lilly ICOS Territories: |  |   |      
|United States                    |  | $ | 27.9 
|Europe1                          |  |   | 95.1 
|Canada and Mexico                |  |   | 6.8  
|                                 |  |   |      
|Total Lilly ICOS                 |  |   | 129.8
|Sales in Lilly-Only Territories  |  |   | 73.5 
|                                 |  |   |      
|Worldwide Total                  |  | $ | 203.3
|                                 |  |   |      



Total Lilly ICOS
revenue, in 2003, was $144.5 million, including $14.7 million in royalties on Cialis sales reported by Lilly.



Cialis has successfully captured a significant share of unit (tablet) sales in Europe among the three PDE5 inhibitors  Cialis, Viagra and Levitra.
For December 2003, based on pharmacy purchases from wholesalers2, Cialis had a 33% share in France, 30% in Germany,
27% in Italy and 18% in both Spain and the United Kingdom. And, through December 2003, PDE5 inhibitor markets across the major European countries continued to grow at healthy rates.



Cost of sales totaled $12.5 million in 2003, including royalties payable by Lilly ICOS equal to 5% of its net product sales.



Selling, general and administrative expenses principally
consist of costs associated with conducting person to person sales calls with physicians; marketing activities, including advertising, physician education, congress and symposia, market research, public relations; and finance and legal costs.
Selling, general and administrative expenses increased $167.4 million over the prior year, to $243.1 million in 2003. The increase primarily reflects the substantial selling and marketing activities associated with the 2003 launches of Cialis in
Europe, beginning in early February, and North America later in the year.



Research and development expenses are principally comprised of costs for clinical studies; materials and supplies to support clinical programs; and other expenses incurred to support Lilly ICOS overall research
and development program. Research and development expenses increased $8.0 million from 2002, to $63.6 million in 2003. The increase primarily reflects costs related to post-marketing clinical studies in Europe, and clinical pharmacology studies in
the United States.



Year Ended December 31, 2002 Compared
With Year Ended December 31, 2001



Revenue



Revenue for the year ended December 31, 2002, was $92.9
million, compared to $93.0 million for the year ended December 31, 2001. Cost reimbursement revenue was $77.7 million for the year ended December 31, 2002, compared to $54.8 million for the year ended December 31, 2001. The increase in cost
reimbursement



---

|1 | Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, and the United Kingdom.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 | IMS Health. IMS MIDAS, Copyright 2004.
|- | --------------------------------------



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



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



Contract manufacturing revenue was $8.5
million in 2002, compared to $7.4 million in the prior year. The increase reflects the growth of our contract manufacturing program since its inception in the fourth quarter of 2000.



Operating Expenses



Research and development.    Research and development expenses were $129.4 million in 2002, compared to $99.0 million in 2001.
This increase was primarily due to higher patient enrollment in the Phase 3 clinical study with Pafase for severe sepsis and costs associated with Pafase manufacturing activities. The increase also reflects development activities related to other
clinical product candidates, IC485 and IC747, and increased spending on discovery and preclinical research activities. Research and development costs for Cialis decreased during 2002, primarily due to the completion of certain activities in 2001,
prior to the NDA filing.



Marketing and
selling.    Marketing and selling expenses increased $6.5 million, to $16.4 million in 2002. These increases were primarily due to incremental costs associated with establishing our U.S. sales force, in anticipation of the
expected U.S. launch of Cialis.



Cost of contract
manufacturing.    Contract manufacturing expenses increased $2.4 million, to $7.6 million in 2002. The increase primarily reflects costs associated with the growth of our contract manufacturing program since its inception in
the fourth quarter of 2000.



General and
administrative.    General and administrative expense increased $2.6 million, to $16.4 million in 2002. This increase primarily reflects costs associated with acquiring and/or retaining management and other personnel to
support ongoing business operations.



Equity in Losses of
Affiliates



In 2002, our equity in losses of affiliates
totalled $104.2 million, compared to $64.9 million in 2001. Our share of Lilly ICOS losses increased $27.5 million, to $65.7 million in 2002. This increase reflects higher Lilly ICOS sales and marketing costs, in anticipation of the commercial
launch of Cialis in the U.S. and Europe, and higher research and development costs associated with seeking regulatory approval in the U.S. and other countries. Our share of Suncos losses increased $14.7 million, to $29.9 million in 2002, reflecting
incremental clinical and manufacturing development activities for Pafase, prior to the December 2002 decision to discontinue the Pafase program. Upon discontinuation of the program, Suncos accrued $3.3 million of estimated close-out costs,
consisting primarily of expenses associated with the termination of clinical studies and manufacturing activities. Our share of ICOS-TBC losses decreased to $8.6 million in 2002, compared to $11.5 million in 2001. In 2001, we recognized $2.0 million
in losses associated with a milestone payment to Encysive upon the achievement of a clinical objective.



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Interest and Other Income



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



Lilly ICOS Results of Operations



Lilly ICOS reported total expenses and a net loss of $131.3 million in 2002, compared to total expenses of $106.6 million
and a net loss of $106.4 million in 2001.



Selling, general and
administrative expenses increased $35.6 million over the prior year, to $75.7 million in 2002. This increase primarily reflects sales and marketing costs in anticipation of the commercial launch of Cialis.



Research and development expenses decreased $10.9 million from 2001, to $55.6
million in 2002. The decrease primarily reflects a $30.0 million contributed technology charge, in 2001, associated with the filing of an NDA for Cialis, partially offset by incremental costs in 2002 associated with clinical studies in the United
States and Europe.



2004 Financial Guidance



For 2004, we expect that ICOS Corporations net loss will be in the
range of $192 million ($3.00 per share) to $215 million ($3.35 per share). The increase in expected loss, compared to 2003, is due to two primary reasons:



| |  | An expected increase in our share of the losses of Lilly ICOS. Lilly ICOS 2004 net loss is expected to be in the $235 million to $275 million range, as the U.S. Cialis launch
proceeds and associated direct-to-consumer and other marketing and sales programs become fully operational. The level of Cialis sales achieved in the U.S. is the primary variable that will affect Lilly ICOS results for 2004; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The impact of certain items in 2003 which, in the aggregate, reduced our 2003 net loss by approximately $40 million. Those items were: $21 million of technology license fee revenue
associated with the conclusion of our LFA-1 collaboration with Biogen; $15 million of license fee revenue earned upon the first commercial sale of Cialis in the U.S.; and, a $10 million gain upon the sale of our partnership interests in ICOS-TBC;
partially offset by approximately $6 million in start-up expenses to recruit, hire, train and deploy our sales force.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Liquidity and Capital Resources



At December 31, 2003, we had cash, cash equivalents, investment securities and associated interest receivable of $469.5 million, compared to $354.0
million at December 31, 2002. The increase primarily reflects net proceeds of $269.9 million received from the issuance of convertible subordinated notes partially offset by cash used in operations and cash used to fund investments in affiliates.



We used $71.0 million in cash for operating activities during
2003, compared to $41.0 million during 2002. The change in operating cash flow primarily reflects lower 2003 cost reimbursements and the timing of vendor payments, partially offset by a $15.0 million license fee collected in 2003 and lower research
and development costs in 2003.



We generated $79.7 million in
cash from investing activities during 2003, compared to using $210.0 million in cash for investing activities during 2002. Cash provided by investing activities in 2003 included a $167.1 million net decrease in our investment portfolio, compared to
a $106.8 million net increase in our investment



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portfolio in 2002. The decrease in our investment portfolio in 2003 primarily reflects our decision to reinvest the proceeds from maturing investments in
cash equivalents, anticipating that interest rates will increase in 2004. Investing outflows in 2003 included $86.4 million of affiliate capital contributions, compared to $97.0 million of affiliate capital contributions in 2002. This increase
primarily reflects our share of the funding of higher Lilly ICOS operating losses in 2003, partially offset by the discontinuation of activities associated with the Pafase and endothelin receptor antagonist programs. Current year cash inflows from
investing activities also include $4.0 million in proceeds from the sale of our partnership interests in ICOS-TBC.



We generated $282.9 million in cash from financing activities in 2003, compared to $30.5 million in 2002. Cash inflows from financing activities in 2003
included $269.9 million of net proceeds from the private placement of convertible subordinated notes. Proceeds from stock options and warrants totaled $8.7 million in 2003, for issuance of 0.9 million shares of our common stock, compared to $22.9
million in 2002, for issuance of 2.3 million shares of our common stock. The 2002 proceeds included $17.4 million from the exercise of Series A warrants to purchase 1.8 million shares of our common stock. The Series A warrants were issued in 1997,
and, if unexercised, expired on May 31, 2002. Financing cash inflows during 2003 and 2002 also included $4.3 million and $7.7 million, respectively, in borrowings under our line of credit with Biogen, all of which have been forgiven.



Our existing cash and cash equivalents, investment securities, interest
income from our investments, cash flow from other operating activities, including anticipated payments from Lilly ICOS and cash flow from potential future collaborations, may be sufficient to fund our future operations. However, in view of the very
early stage of the commercial launch of Cialis in North America, our ongoing research and development efforts, and potential expansion of our operations through in-licensing or other means, it is possible that we may need to seek additional
financing sometime over the next few years. 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 marketing and selling activities or our development programs, or grant rights to third parties to develop and market product candidates that we would prefer to develop and market on our own.



Our future cash requirements will depend on various factors which, to some
extent, are beyond our control, including:



| |  | the successful commercialization of Cialis throughout the world, including territories where Lilly has exclusive marketing rights;
| | - | ----------------------------------------------------------------------------------------------------------------------------------



| |  | funding levels for research and development programs, including continued funding from our collaboration partners;
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | the results, timing and extent of preclinical and clinical studies;
| | - | -------------------------------------------------------------------



| |  | the time and costs involved in filing and prosecuting patents and enforcing and defending patent claims;
| | - | --------------------------------------------------------------------------------------------------------



| |  | the regulatory process in the U.S. and other countries;
| | - | -------------------------------------------------------



| |  | acquisitions of products or technologies, if any;
| | - | -------------------------------------------------



| |  | relationships with research and development collaborators;
| | - | ----------------------------------------------------------



| |  | capital contributions to our affiliates;
| | - | ----------------------------------------



| |  | competing technological and market development activities; and
| | - | --------------------------------------------------------------



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



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We have engaged in collaborations and joint development agreements with other parties where the
capabilities and strategies of the other parties complement ours. Although corporate collaborations, partnerships and joint ventures have provided cost reimbursement revenue to us in the past, we cannot assure you that this type of revenue will be
available to us in the future. The vast majority of our cost reimbursement revenue, through August 2003, was for reimbursement of the cost of research and development services that we provided. Beginning in September 2003, collaboration revenue
includes reimbursement for the cost of sales services that we provide to Lilly ICOS related to commercialization of Cialis in the United States.



We intend to expand our operations and continue development of our current portfolio of product candidates in clinical studies, as well as to continue
discovery and preclinical research to identify additional product candidates. We also intend to continue to engage in pre-marketing activities necessary to bring our product candidates to market and to expand marketing and selling capabilities for
our approved products. Due to the uncertainties of drug development and commercialization, as discussed elsewhere herein, we are unable to determine if, or when, any of our current product candidates will begin to generate net cash inflows.



In the future, we may pursue new growth opportunities in a
variety of ways including, but not limited to, internal discovery and development of new products, in-licensing of products and technologies and/or merger or acquisition of companies with desirable products and/or technologies. Expansion of our
operations, including the U.S. launch of Cialis, will increase our future operating expenses. Furthermore, we may need to make incremental expenditures for additional laboratory, production and office facilities to accommodate the activities and
personnel associated with these increased development and commercialization efforts. Any of these activities may require substantial capital investment.



Our operating cash flows include the effect of certain noncancelable, contractual obligations. A summary of our contractual obligations, as of December
31, 2003, is as follows:



|                              |  |                        |         |                  |   |             |  |             |        |                  |   |       |  |   |        
|----------------------------- |  | ---------------------- | ------- | ---------------- | - | ----------- |  | ----------- | ------ | ---------------- | - | ----- |  | - | -------
|                              |  | Payments Due By Period
|                              |  | (in thousands)        
|                              |  | Total                  |         | Less than 1 year |   | 1 to 3years |  | 4 to 5years |        | More than5 years
|Convertible subordinated debt |  | $                      | 278,650 |                  | $ |            |  | $           |       |                  | $ |      |  | $ | 278,650
|Operating leases              |  |                        | 29,100  |                  |   | 7,171       |  |             | 12,737 |                  |   | 8,976 |  |   | 216    
|                              |  |                        |         |                  |   |             |  |             |        |                  |   |       |  |   |        
|                              |  | $                      | 307,750 |                  | $ | 7,171       |  | $           | 12,737 |                  | $ | 8,976 |  | $ | 278,866
|                              |  |                        |         |                  |   |             |  |             |        |                  |   |       |  |   |        



Convertible
subordinated debt:    In 2003, we issued $278.7 million of convertible subordinated notes, which accrue interest at 2% per annum, payable semiannually each January and July 1. The notes mature on July 1, 2023. The notes are
unsecured, subordinated to any senior indebtedness, and convertible, at the option of the holder, into our common stock at a conversion price of $61.50 per share, subject to adjustment in certain circumstances. Note holders may require us to
purchase, for cash, all or a portion of their notes on July 1, 2010, 2013 or 2018 at a price equal to the principal amount of the notes being repurchased. We may redeem all or a portion of the notes, at par, for cash at any time on or after July 5,
2010.



Operating leases:    We lease
certain property and equipment under operating leases which, in the aggregate, obligate us through 2009. 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.



In
addition to the contractual obligations noted above, we have entered into various licensing and research and development arrangements under which we may be obligated to make future payments to third parties upon the achievement of certain
success-based objectives. We also have entered into contracts with various third parties, under which we may be required to pay immaterial amounts in the event of contract termination.



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



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Off-Balance Sheet Arrangements



In the ordinary course of business, we enter into agreements that contingently require us to indemnify counterparties
against third-party claims. These may include: agreements with vendors and suppliers, under which we may indemnify them against claims arising from our use of their products or services; agreements with customers, under which we may indemnify them
against claims arising from their use of our products or services; real estate and equipment leases, under which we may indemnify lessors against third-party claims relating to use of their property; agreements with licensees or licensors, under
which we may indemnify the licensee or licensor against claims arising from their use of our intellectual property or our use of their intellectual property; and agreements with initial purchasers and underwriters of our securities, under which we
may indemnify them against claims relating to their participation in the transactions.



The nature and terms of these indemnifications vary from contract to contract, and generally a maximum obligation is not stated. Because we are unable to estimate our potential obligation, and because management does
not expect these indemnifications to have a material adverse effect on our consolidated financial position, results of operations or cash flows, no related liabilities are recorded at December 31, 2003. We hold insurance policies that mitigate
potential losses arising from certain indemnifications and, historically, we have not incurred significant costs related to performance under these obligations.



Legal Proceedings



In October 2002, Pfizer Inc., Pfizer Limited, and Pfizer Ireland Pharmaceuticals filed a patent infringement lawsuit against ICOS, Lilly ICOS, and Lilly
in the United States District Court for the District of Delaware. The complaint alleges that the intended and imminent use, offering for sale, selling, manufacture, or importing into the United States upon FDA approval of Cialis for the treatment of
erectile dysfunction by ICOS, Lilly ICOS and Lilly will constitute infringement of plaintiffs U.S. Patent No. 6,469,012. The plaintiffs seek a judgment declaring that the defendants using, selling, offering for sale, making or importing
of Cialis for the treatment of erectile dysfunction will infringe this patent. The plaintiffs also seek a permanent injunction, attorneys fees, costs and expenses. In January 2003, we filed an answer denying the central allegations of
plaintiffs complaint and setting forth various affirmative defenses. In September 2003, the PTO ordered the reexamination of U.S. Patent No. 6,469,012. The reexamination process is provided for by law and requires the PTO to consider the
validity of the patent based on substantial new questions of patentability raised by the PTO. In October 2003, ICOS, Lilly ICOS and Lilly filed a motion for a stay with the District Court, to suspend the patent infringement lawsuit, pending the
outcome of the reexamination. In November 2003, the judge granted the requested stay. In December 2003, Lilly ICOS filed its own reexamination request, related to U.S. Patent No. 6,469,012, with the PTO.



Pfizers corresponding European method-of-use patent was previously held
invalid in the first stage of an opposition proceeding in the European Patent Office. Pfizer is now appealing that decision to the Technical Board of Appeal of the European Patent Office. A hearing is expected in the second half of 2004. The United
Kingdom Court of Appeal has previously held the United Kingdom counterpart to this patent invalid. Litigation relating to the corresponding patent is pending in Canada and Mexico.



Litigation is inherently unpredictable and the eventual outcome in a particular case is impossible to determine in advance.
We believe that Pfizers suit lacks merit and intend to vigorously pursue our various defenses. If Pfizer were to prevail in one or more countries, however, we might be subject to substantial damages, prohibited from marketing Cialis for the
treatment of erectile dysfunction in those countries, or required to enter into a licensing agreement to market Cialis in those countries. Any such adverse result could have a material adverse effect on our business, financial position, results of
operations and cash flows.



|Item 7A. |  | Quantitative and Qualitative Disclosures about Market Risk
|-------- |  | ----------------------------------------------------------



At December 31, 2003 and 2002, our financial instruments include, among other items, cash, cash equivalents, marketable investment securities, a note
receivable and convertible subordinated debt, which bears interest at a fixed interest rate of 2% per annum. We do not use derivative financial instruments in our investment portfolio. Our



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exposure to market risk for changes in interest rates relates primarily to our marketable investment securities, note receivable and convertible subordinated
debt. Because of the relatively short maturities of our investments and note receivable, we do not expect interest rate fluctuations to materially affect the aggregate value of our financial assets. The fair value of our convertible subordinated
debt is expected to change, to a small extent, inversely to changes in interest rates. More importantly, however, the fair value of our convertible subordinated debt is expected to change as our stock price changes. The fair value of our convertible
subordinated debt was $275.5 million at December 31, 2003, with a carrying amount of $278.7 million at that date.



|Item 8. |  | Consolidated Financial Statements and Supplementary Data
|------- |  | --------------------------------------------------------



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                            |  |     
|--------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                            |  | Page
|Independent Auditors Report                                                                                                |  | 44  
|Consolidated Balance Sheets at December 31, 2003 and 2002                                                                   |  | 45  
|Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001                                  |  | 46  
|Consolidated Statements of Stockholders Equity and Comprehensive Loss for the Years Ended December 31, 2003, 2002 and 2001 |  | 47  
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001                                  |  | 48  
|Notes to Consolidated Financial Statements                                                                                  |  | 49  



SUPPLEMENTARY DATA



Balance sheets of Lilly ICOS LLC as of December 31, 2003
and 2002, and the related statements of operations, members deficit, and cash flows for each of the years in the three-year period ended December 31, 2003, are included elsewhere in this report.



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



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INDEPENDENT AUDITORS REPORT



The Board of
Directors and Stockholders

ICOS Corporation:



We have audited the accompanying consolidated balance sheets of ICOS Corporation and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



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



In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of ICOS Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.



/s/ KPMG LLP



Seattle, Washington

January 23, 2004



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ICOS CORPORATION



CONSOLIDATED
BALANCE SHEETS



(In thousands, except share data)



|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                       |  | December 31, |         
|                                                                                                                                                                       |  | 2003         |          |   | 2002 |  
|ASSETS                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Current assets:                                                                                                                                                        |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                              |  | $            | 332,039  |   |      | $ | 40,450   |  
|Investment securities, at market value                                                                                                                                 |  |              | 83,049   |   |      |   | 159,680  |  
|Interest receivable                                                                                                                                                    |  |              | 2,668    |   |      |   | 5,099    |  
|Receivables from affiliates                                                                                                                                            |  |              | 17,681   |   |      |   | 7,959    |  
|Note receivable                                                                                                                                                        |  |              | 6,000    |   |      |   |         |  
|Other                                                                                                                                                                  |  |              | 3,819    |   |      |   | 2,652    |  
|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                                   |  |              | 445,256  |   |      |   | 215,840  |  
|Investment securities, at market value                                                                                                                                 |  |              | 51,769   |   |      |   | 148,796  |  
|Property and equipment, net                                                                                                                                            |  |              | 18,970   |   |      |   | 20,209   |  
|Deferred financing costs and other                                                                                                                                     |  |              | 8,859    |   |      |   | 815      |  
|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|                                                                                                                                                                       |  | $            | 524,854  |   |      | $ | 385,660  |  
|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                   |  |              |          |   |      |   |          |  
|Current liabilities:                                                                                                                                                   |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                                                                       |  | $            | 3,872    |   |      | $ | 4,125    |  
|Accrued payroll and benefits                                                                                                                                           |  |              | 3,711    |   |      |   | 3,188    |  
|Accrued clinical expenses                                                                                                                                              |  |              | 1,733    |   |      |   | 7,841    |  
|Accrued interest                                                                                                                                                       |  |              | 2,957    |   |      |   |         |  
|Other accruals                                                                                                                                                         |  |              | 8,160    |   |      |   | 10,831   |  
|Due to affiliates                                                                                                                                                      |  |              | 25,842   |   |      |   | 25,012   |  
|Deferred revenue                                                                                                                                                       |  |              | 1,000    |   |      |   | 2,305    |  
|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                              |  |              | 47,275   |   |      |   | 53,302   |  
|Deferred revenue                                                                                                                                                       |  |              |         |   |      |   | 14,726   |  
|Convertible subordinated debt                                                                                                                                          |  |              | 278,650  |   |      |   |         |  
|Stockholders equity:                                                                                                                                                  |  |              |          |   |      |   |          |  
|Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued                                                                                              |  |              |         |   |      |   |         |  
|Common stock, $.01 par value; 100,000,000 shares authorized; 63,013,036 shares at December 31, 2003 and 62,104,891 shares at December 31,
2002, issued and outstanding |  |              | 630      |   |      |   | 621      |  
|Additional paid-in capital                                                                                                                                             |  |              | 787,019  |   |      |   | 777,697  |  
|Accumulated other comprehensive income                                                                                                                                 |  |              | 753      |   |      |   | 3,280    |  
|Accumulated deficit                                                                                                                                                    |  |              | (589,473 | ) |      |   | (463,966 | )
|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                                                                             |  |              | 198,929  |   |      |   | 317,632  |  
|                                                                                                                                                                       |  |              |          |   |      |   |          |  
|                                                                                                                                                                       |  | $            | 524,854  |   |      | $ | 385,660  |  
|                                                                                                                                                                       |  |              |          |   |      |   |          |  



See accompanying notes
to consolidated financial statements.



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ICOS CORPORATION



CONSOLIDATED
STATEMENTS OF OPERATIONS



(In thousands, except per
share data)



|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|-------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|                                                               |  | Year Ended December 31, |         
|                                                               |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Revenue:                                                       |  |                         |          |   |      |   |          |      |  |   |         |  
|Collaboration revenue from related parties                     |  | $                       | 25,943   |   |      | $ | 77,728   |      |  | $ | 54,754  |  
|Licenses of technology                                         |  |                         | 36,976   |   |      |   | 6,617    |      |  |   | 30,846  |  
|Contract manufacturing                                         |  |                         | 12,185   |   |      |   | 8,532    |      |  |   | 7,402   |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Total revenue                                                  |  |                         | 75,104   |   |      |   | 92,877   |      |  |   | 93,002  |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Operating expenses:                                            |  |                         |          |   |      |   |          |      |  |   |         |  
|Research and development                                       |  |                         | 85,758   |   |      |   | 129,350  |      |  |   | 99,009  |  
|Marketing and selling                                          |  |                         | 19,770   |   |      |   | 9,268    |      |  |   | 2,741   |  
|Cost of contract manufacturing                                 |  |                         | 9,703    |   |      |   | 7,599    |      |  |   | 5,198   |  
|General and administrative                                     |  |                         | 15,272   |   |      |   | 16,409   |      |  |   | 13,795  |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Total operating expenses                                       |  |                         | 130,503  |   |      |   | 162,626  |      |  |   | 120,743 |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Operating loss                                                 |  |                         | (55,399  | ) |      |   | (69,749  | )    |  |   | (27,741 | )
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Other income (expense):                                        |  |                         |          |   |      |   |          |      |  |   |         |  
|Equity in losses of affiliates                                 |  |                         | (87,180  | ) |      |   | (104,160 | )    |  |   | (64,902 | )
|Gain on sale of partnership interests                          |  |                         | 10,000   |   |      |   |         |      |  |   |        |  
|Interest expense                                               |  |                         | (3,578   | ) |      |   |         |      |  |   |        |  
|Interest and other income                                      |  |                         | 10,038   |   |      |   | 12,292   |      |  |   | 12,470  |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Total other income (expense)                                   |  |                         | (70,720  | ) |      |   | (91,868  | )    |  |   | (52,432 | )
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Loss before income taxes                                       |  |                         | (126,119 | ) |      |   | (161,617 | )    |  |   | (80,173 | )
|Income tax recovery                                            |  |                         | 612      |   |      |   |         |      |  |   |        |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Net loss                                                       |  | $                       | (125,507 | ) |      | $ | (161,617 | )    |  | $ | (80,173 | )
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Net loss per common share  basic and diluted                  |  | $                       | (2.01    | ) |      | $ | (2.64    | )    |  | $ | (1.48   | )
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  
|Weighted-average common shares outstanding  basic and diluted |  |                         | 62,561   |   |      |   | 61,304   |      |  |   | 54,073  |  
|                                                               |  |                         |          |   |      |   |          |      |  |   |         |  



See accompanying notes
to consolidated financial statements.



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ICOS CORPORATION



CONSOLIDATED
STATEMENTS OF STOCKHOLDERS EQUITY

AND COMPREHENSIVE LOSS



(In thousands, except number of shares and per share data)



|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|-------------------------------------------------------------------------------------------------- |  | ------------ | --- | ------------------------- | - | --------------------------------------------- |  | - | ------------------- | - |  | -------------------------- | -------- | - |  | - | -------- | -
|                                                                                                   |  | Common Stock |     | Additional Paid-inCapital |   | Accumulated Other Comprehensive Income (Loss) |  |   | Accumulated Deficit |   |  | Total Stockholders Equity |         
|Balances at December 31, 2000                                                                      |  | $            | 524 |                           | $ | 432,665                                       |  | $ | 82                  |   |  | $                          | (222,176 | ) |  | $ | 211,095  |  
|Comprehensive income (loss):                                                                       |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Net loss                                                                                           |  |              |    |                           |   |                                              |  |   |                    |   |  |                            | (80,173  | ) |  |   | (80,173  | )
|Net unrealized gains on investment securities                                                      |  |              |    |                           |   |                                              |  |   | 746                 |   |  |                            |         |   |  |   | 746      |  
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Total comprehensive income (loss)                                                                  |  |              |    |                           |   |                                              |  |   | 746                 |   |  |                            | (80,173  | ) |  |   | (79,427  | )
|Compensation expense related to certain stock options                                              |  |              |    |                           |   | 25                                            |  |   |                    |   |  |                            |         |   |  |   | 25       |  
|Issuance of 977,014 shares of common stock from exercise of options                                |  |              | 9   |                           |   | 11,637                                        |  |   |                    |   |  |                            |         |   |  |   | 11,646   |  
|Issuance of 884,350 shares of common stock from exercise of warrants                               |  |              | 9   |                           |   | 12,971                                        |  |   |                    |   |  |                            |         |   |  |   | 12,980   |  
|Issuance of 5,500,000 shares of common stock at $57.00 per share, net of offering costs of $16,455 |  |              | 55  |                           |   | 296,990                                       |  |   |                    |   |  |                            |         |   |  |   | 297,045  |  
|Value of warrants issued to partners of ICOS Clinical Partners, L.P                                |  |              |    |                           |   | 386                                           |  |   |                    |   |  |                            |         |   |  |   | 386      |  
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Balances at December 31, 2001                                                                      |  |              | 597 |                           |   | 754,674                                       |  |   | 828                 |   |  |                            | (302,349 | ) |  |   | 453,750  |  
|Comprehensive income (loss):                                                                       |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Net loss                                                                                           |  |              |    |                           |   |                                              |  |   |                    |   |  |                            | (161,617 | ) |  |   | (161,617 | )
|Net unrealized gains on investment securities                                                      |  |              |    |                           |   |                                              |  |   | 2,452               |   |  |                            |         |   |  |   | 2,452    |  
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Total comprehensive income (loss)                                                                  |  |              |    |                           |   |                                              |  |   | 2,452               |   |  |                            | (161,617 | ) |  |   | (159,165 | )
|Stock (including issuance of 20,000 shares of restricted stock) and option compensation expense    |  |              |    |                           |   | 194                                           |  |   |                    |   |  |                            |         |   |  |   | 194      |  
|Issuance of 500,247 shares of common stock from exercise of options                                |  |              | 5   |                           |   | 5,217                                         |  |   |                    |   |  |                            |         |   |  |   | 5,222    |  
|Issuance of 1,840,540 shares of common stock from exercise of warrants                             |  |              | 19  |                           |   | 17,612                                        |  |   |                    |   |  |                            |         |   |  |   | 17,631   |  
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Balances at December 31, 2002                                                                      |  |              | 621 |                           |   | 777,697                                       |  |   | 3,280               |   |  |                            | (463,966 | ) |  |   | 317,632  |  
|Comprehensive loss:                                                                                |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Net loss                                                                                           |  |              |    |                           |   |                                              |  |   |                    |   |  |                            | (125,507 | ) |  |   | (125,507 | )
|Net unrealized losses on investment securities                                                     |  |              |    |                           |   |                                              |  |   | (2,527              | ) |  |                            |         |   |  |   | (2,527   | )
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Total comprehensive loss                                                                           |  |              |    |                           |   |                                              |  |   | (2,527              | ) |  |                            | (125,507 | ) |  |   | (128,034 | )
|Stock and option compensation expense                                                              |  |              |    |                           |   | 627                                           |  |   |                    |   |  |                            |         |   |  |   | 627      |  
|Issuance of 908,145 shares of common stock from exercise of options                                |  |              | 9   |                           |   | 8,695                                         |  |   |                    |   |  |                            |         |   |  |   | 8,704    |  
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  
|Balances at December 31, 2003                                                                      |  | $            | 630 |                           | $ | 787,019                                       |  | $ | 753                 |   |  | $                          | (589,473 | ) |  | $ | 198,929  |  
|                                                                                                   |  |              |     |                           |   |                                               |  |   |                     |   |  |                            |          |   |  |   |          |  



See accompanying notes
to consolidated financial statements.



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ICOS CORPORATION



CONSOLIDATED
STATEMENTS OF CASH FLOWS



(In thousands)



|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|----------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                              |  | Year Ended December 31, |         
|                                                                              |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Cash flows from operating activities:                                         |  |                         |          |   |      |   |          |      |  |   |          |  
|Net loss                                                                      |  | $                       | (125,507 | ) |      | $ | (161,617 | )    |  | $ | (80,173  | )
|Adjustments to reconcile net loss to net cash used in operating activities:   |  |                         |          |   |      |   |          |      |  |   |          |  
|Depreciation and amortization                                                 |  |                         | 6,227    |   |      |   | 5,764    |      |  |   | 5,486    |  
|Amortization of deferred financing costs                                      |  |                         | 657      |   |      |   |         |      |  |   |         |  
|Gain on sale of investment securities, net                                    |  |                         | (1,290   | ) |      |   | (394     | )    |  |   | (79      | )
|Amortization of investment premiums, net                                      |  |                         | 5,367    |   |      |   | 6,472    |      |  |   | 1,681    |  
|Gain on sale of partnership interests                                         |  |                         | (10,000  | ) |      |   |         |      |  |   |         |  
|Equity in losses of affiliates                                                |  |                         | 87,180   |   |      |   | 104,160  |      |  |   | 64,902   |  
|Revenue from licenses of technology in excess of cash received                |  |                         | (21,976  | ) |      |   | (4,617   | )    |  |   | (7,846   | )
|Other                                                                         |  |                         | 627      |   |      |   | 194      |      |  |   | 25       |  
|Changes in operating assets and liabilities:                                  |  |                         |          |   |      |   |          |      |  |   |          |  
|Receivables                                                                   |  |                         | (7,929   | ) |      |   | 4,459    |      |  |   | 100      |  
|Other assets                                                                  |  |                         | (481     | ) |      |   | 360      |      |  |   | (1,427   | )
|Accounts payable and accrued liabilities                                      |  |                         | (3,906   | ) |      |   | 4,266    |      |  |   | 9,199    |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash used in operating activities                                         |  |                         | (71,031  | ) |      |   | (40,953  | )    |  |   | (8,132   | )
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash flows from investing activities:                                         |  |                         |          |   |      |   |          |      |  |   |          |  
|Purchases of investment securities                                            |  |                         | (76,791  | ) |      |   | (375,157 | )    |  |   | (291,499 | )
|Maturities of investment securities                                           |  |                         | 166,037  |   |      |   | 104,270  |      |  |   | 104,152  |  
|Sales of investment securities                                                |  |                         | 77,808   |   |      |   | 164,127  |      |  |   | 14,807   |  
|Acquisitions of property and equipment                                        |  |                         | (4,988   | ) |      |   | (6,219   | )    |  |   | (6,113   | )
|Proceeds from sale of partnership interests                                   |  |                         | 4,000    |   |      |   |         |      |  |   |         |  
|Investments in affiliates                                                     |  |                         | (86,350  | ) |      |   | (97,036  | )    |  |   | (71,601  | )
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) investing activities                           |  |                         | 79,716   |   |      |   | (210,015 | )    |  |   | (250,254 | )
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash flows from financing activities:                                         |  |                         |          |   |      |   |          |      |  |   |          |  
|Proceeds from stock options and warrants                                      |  |                         | 8,656    |   |      |   | 22,853   |      |  |   | 25,212   |  
|Borrowings under line of credit                                               |  |                         | 4,308    |   |      |   | 7,660    |      |  |   | 2,326    |  
|Proceeds from issuance of convertible subordinated debt, net of related costs |  |                         | 269,940  |   |      |   |         |      |  |   |         |  
|Proceeds from stock offering, net of related costs                            |  |                         |         |   |      |   |         |      |  |   | 297,045  |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash provided by financing activities                                     |  |                         | 282,904  |   |      |   | 30,513   |      |  |   | 324,583  |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net increase (decrease) in cash and cash equivalents                          |  |                         | 291,589  |   |      |   | (220,455 | )    |  |   | 66,197   |  
|Cash and cash equivalents at beginning of year                                |  |                         | 40,450   |   |      |   | 260,905  |      |  |   | 194,708  |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents at end of year                                      |  | $                       | 332,039  |   |      | $ | 40,450   |      |  | $ | 260,905  |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Supplemental disclosure of cash flow information:                             |  |                         |          |   |      |   |          |      |  |   |          |  
|Debt forgiveness upon achievement of clinical milestones                      |  | $                       | 5,294    |   |      | $ | 6,674    |      |  | $ | 2,326    |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Note receivable from sale of partnership interests                            |  | $                       | 6,000    |   |      | $ |         |      |  | $ |         |  
|                                                                              |  |                         |          |   |      |   |          |      |  |   |          |  



See accompanying notes
to consolidated financial statements.



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(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
biotechnology company that is dedicated to bringing innovative therapeutic products to patients. We are marketing our first product, Cialis (tadalafil), for the treatment of erectile dysfunction, through Lilly ICOS, our joint venture with Lilly. Our
goal is to develop and commercialize treatments for serious unmet medical conditions such as chronic obstructive pulmonary disease, cancer and inflammatory diseases.



(b) Principles of Consolidation



The consolidated financial statements include the accounts of ICOS Corporation and its subsidiaries (collectively, ICOS), all of which are wholly-owned.
All significant intercompany transactions and balances have been eliminated in consolidation.



Our investments in affiliates 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. Losses relating to our affiliates
are recognized to the extent we have made, or are committed to make, capital contributions to the affiliate. Operating results of our affiliates include expenses related to research, development, marketing and sales, and administrative services that
we provide to them, and that we recognize as cost reimbursement revenue.



(c) 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.



(d) 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 and are carried at market value. Our cash equivalents consist of money market accounts, short-term obligations of U.S. government agencies and government-sponsored enterprises, commercial paper,
floating rate notes and auction rate and asset backed securities.



(e)
Investment Securities



Our investment securities
consist of corporate debt, U.S. treasury securities and obligations of U.S. government agencies and government-sponsored enterprises. 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). Management determines the appropriate classification of marketable investment securities at the time of
purchase. Realized gains and losses on sales of investment securities are determined on the specific identification



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



method and included in interest and other income. We do not have any derivative financial instruments in our investment portfolio.



(f) 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 determined using the straight-line method over 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 estimated useful lives or the term of the lease. Building improvements are amortized over the
shorter of their estimated useful lives or the estimated remaining economic life of the building.



(g) Deferred Financing Costs



In connection with the issuance of our convertible subordinated notes, we incurred $8.7 million of debt issuance costs, which have been deferred and are being amortized to interest expense using the effective interest
method through July 1, 2010, the earliest date on which note holders may require us to repurchase the notes.



(h) Fair Value of Financial Instruments



Our financial instruments include, among other items, cash, cash equivalents, marketable investment securities, a note receivable and convertible subordinated debt. Marketable investment securities are carried at fair
value on our consolidated balance sheets based on quoted market prices. Our convertible subordinated debt is carried at cost on our consolidated balance sheets. The fair value of our convertible subordinated notes was $275.5 million at December 31,
2003, with a carrying amount of $278.7 million at that date. Fair value of the convertible subordinated notes was determined by obtaining quotes from a market maker for the notes. The carrying amounts reflected in the consolidated balance sheets for
the remaining items approximate fair value due to their market rates of interest and/or their short-term maturities.



(i) Impairment of Long-Lived Assets



Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be
recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover
the carrying amount of the asset, the asset is written-down to its estimated fair value in accordance with Financial Accounting Standards Board Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.



(j) Revenue Recognition



We recognize revenue from our contracts for research, development, marketing
and sales services, including those under collaborative agreements, as the related costs are incurred. We refer to this revenue as cost reimbursement revenue. Payments received, that are related to future performance, are deferred and
recognized as revenue when the future performance occurs.



Nonrefundable upfront technology license fees, for product candidates where we are providing continuing services related to product development, are deferred, and recognized as revenue as we provide the services required under the
agreement. We recognize revenue for nonrefundable upfront technology fees based on the



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



ratio of current development costs to total estimated current and future development costs through the date we file an NDA (or an equivalent) with the FDA.
We believe this method appropriately matches revenue with the estimated costs of the development effort. We also believe that development costs are the best available surrogate for benefits obtained as data is collected and other research and
development activities progress in the collaboration.



We
estimate the total projected development costs based on the specific terms of each agreement, our judgment and experience and, when appropriate, the expertise of our collaboration partners. The ability to estimate total development effort and costs
can vary significantly for each product candidate due to the inherent complexities and uncertainties of drug development. In the past, we have been able to estimate total expected development costs, for certain product candidates, because they were
in later stages of clinical development at the time such estimates were prepared or our partner had substantial previous experience in the relevant field of study. However, we may not be able to reasonably estimate total expected development costs
for product candidates in the future, particularly if such product candidates are in earlier stages of clinical development. To the extent we cannot estimate the costs to complete development, but can estimate an expected NDA filing date, we will
recognize license fee revenue ratably through the NDA filing date. If we are unable to reasonably estimate either total costs to complete development or an expected NDA filing date (performance period), we will defer revenue recognition until one of
those estimates can be made or the project is discontinued.



Milestones, in the form of additional license fees, typically represent nonrefundable payments to be received in conjunction with the achievement of a specific event identified in the contract, such as initiation or completion of specified
clinical development activities. We believe that a milestone represents the culmination of a distinct earnings process when it is not associated with ongoing research, development or other performance on our part. We recognize such milestones as
revenue when they become due and collectibility is reasonably assured. When a milestone does not represent the culmination of a distinct earnings process, we recognize revenue at the time such payments are due, provided collectibility is reasonably
assured, based on the ratio of effort to date (in terms of costs or time, as discussed above) to total estimated development effort. Any remaining balance is deferred and recognized as revenue over the estimated remaining product development period,
in the same manner as our upfront technology license fees.



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



Contract manufacturing revenue, including fees earned for process development and manufacturing services performed for third parties, is recognized when the manufacturing obligation is fulfilled or manufacturing services are performed, as
appropriate, based on the terms of the agreement, and collectibility is reasonably assured. Payments received in excess of amounts earned are recorded as deferred revenue.



(k) Cost of Contract Manufacturing



Contract manufacturing expenses are principally comprised of costs for: personnel, including salaries and benefits; occupancy; raw materials and
consumables used in process development and manufacturing; testing



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



services provided by third parties; facility overhead, including taxes, depreciation, utilities and maintenance of manufacturing equipment; and other shared
services, including information systems and staff support. Contract manufacturing costs generally are expensed when the related revenue is recognized.



(l) Research and Development Costs



Research and development expenses are principally comprised of costs for: personnel, including salaries and benefits; occupancy; clinical studies
performed by third parties; materials and supplies to support our clinical programs; contract research; manufacturing; consulting arrangements; in-licensing fees; and other expenses incurred to sustain our overall research and development program.
Research and development costs are expensed as incurred.



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



(m) 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, 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.



(n) Net Loss Per Common Share



Net loss per common share (basic and diluted) is calculated using the weighted-average number of common shares outstanding during the period.



(o) Stock Based Compensation



We apply the provisions of Accounting Principles Board 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 options granted to employees with an exercise price equal
to or in excess of the fair value of the underlying common shares at the date of grant. We recognize compensation expense for restricted stock grants over the applicable vesting period.



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 loss and net loss per share would have been the following pro forma amounts:



|                                                                                                          |  |                         |          |   |      |   |          |      |  |   |          |  
|--------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                                          |  | Year Ended December 31, |         
|                                                                                                          |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Net loss:                                                                                                 |  |                         |          |   |      |   |          |      |  |   |          |  
|As reported                                                                                               |  | $                       | (125,507 | ) |      | $ | (161,617 | )    |  | $ | (80,173  | )
|Add: Stock based employee compensation expense included in reported net loss                              |  |                         | 275      |   |      |   | 92       |      |  |   |         |  
|Deduct: Stock based employee compensation expense determined under fair value based method for all awards |  |                         | (47,422  | ) |      |   | (38,159  | )    |  |   | (30,053  | )
|                                                                                                          |  |                         |          |   |      |   |          |      |  |   |          |  
|Pro forma                                                                                                 |  | $                       | (172,654 | ) |      | $ | (199,684 | )    |  | $ | (110,226 | )
|                                                                                                          |  |                         |          |   |      |   |          |      |  |   |          |  
|Net loss per share  basic and diluted:                                                                   |  |                         |          |   |      |   |          |      |  |   |          |  
|As reported                                                                                               |  | $                       | (2.01    | ) |      | $ | (2.64    | )    |  | $ | (1.48    | )
|                                                                                                          |  |                         |          |   |      |   |          |      |  |   |          |  
|Pro forma                                                                                                 |  | $                       | (2.76    | ) |      | $ | (3.26    | )    |  | $ | (2.04    | )
|                                                                                                          |  |                         |          |   |      |   |          |      |  |   |          |  



The estimated per
share weighted-average grant date fair value of stock options awarded during 2003, 2002 and 2001 was $21.03, $22.29, and $37.06, respectively. Amounts were determined using the Black-Scholes option pricing model based on the following assumptions:



|                        |  |                         |   |  |      |   |  |      |  
|----------------------- |  | ----------------------- | - |  | ---- | - |  | ---- | -
|                        |  | Year Ended December 31, |  
|                        |  | 2003                    |   |  | 2002 |   |  | 2001 |  
|Expected dividend yield |  | 0.0                     | % |  | 0.0  | % |  | 0.0  | %
|Risk-free interest rate |  | 3.5                     | % |  | 4.1  | % |  | 5.0  | %
|Expected volatility     |  | 69.1                    | % |  | 68.8 | % |  | 73.0 | %
|Expected life in years  |  | 6.5                     |   |  | 6.3  |   |  | 6.3  |  



(p) Operating Segments



We have one operating segment, the discovery,
development and commercialization of proprietary pharmaceuticals for the treatment of serious medical conditions.



(q) Reclassifications



Certain amounts reported in prior years have been reclassified to conform to the 2003 presentation.



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(2) Collaborations



The following tables summarize our revenue from collaborations with related parties and licenses of technology, equity in losses of affiliates and cash
invested in affiliates during the periods presented.



|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|                                            |  | Year Ended December 31, |        
|                                            |  | 2003                    |         |   | 2002 |   |          | 2001 | 
|Collaboration revenue from related parties: |  |                         |         |   |      |   |          |      |  |   |         |  
|Lilly ICOS                                  |  | $                       | 22,093  |   |      | $ | 6,615    |      |  | $ | 9,965   |  
|Suncos                                      |  |                         | 2,450   |   |      |   | 56,478   |      |  |   | 30,373  |  
|ICOS-TBC                                    |  |                         | 1,400   |   |      |   | 14,635   |      |  |   | 12,676  |  
|ICOS Clinical Partners                      |  |                         |        |   |      |   |         |      |  |   | 1,740   |  
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|                                            |  | $                       | 25,943  |   |      | $ | 77,728   |      |  | $ | 54,754  |  
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|Licenses of technology:                     |  |                         |         |   |      |   |          |      |  |   |         |  
|Lilly ICOS                                  |  | $                       | 15,031  |   |      | $ | 1,557    |      |  | $ | 29,416  |  
|ICOS Clinical Partners                      |  |                         |        |   |      |   | 3,160    |      |  |   | 981     |  
|Biogen                                      |  |                         | 21,945  |   |      |   | 1,900    |      |  |   | 449     |  
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|                                            |  | $                       | 36,976  |   |      | $ | 6,617    |      |  | $ | 30,846  |  
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|Equity in losses of affiliates:             |  |                         |         |   |      |   |          |      |  |   |         |  
|Lilly ICOS                                  |  | $                       | (87,320 | ) |      | $ | (65,669  | )    |  | $ | (38,219 | )
|Suncos                                      |  |                         | 140     |   |      |   | (29,933  | )    |  |   | (15,200 | )
|ICOS-TBC                                    |  |                         |        |   |      |   | (8,558   | )    |  |   | (11,461 | )
|ICOS Clinical Partners                      |  |                         |        |   |      |   |         |      |  |   | (22     | )
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|                                            |  | $                       | (87,180 | ) |      | $ | (104,160 | )    |  | $ | (64,902 | )
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|Cash invested in affiliates:                |  |                         |         |   |      |   |          |      |  |   |         |  
|Lilly ICOS                                  |  | $                       | 83,733  |   |      | $ | 59,685   |      |  | $ | 47,228  |  
|Suncos                                      |  |                         |        |   |      |   | 27,881   |      |  |   | 15,000  |  
|ICOS-TBC                                    |  |                         | 2,617   |   |      |   | 9,470    |      |  |   | 9,373   |  
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  
|                                            |  | $                       | 86,350  |   |      | $ | 97,036   |      |  | $ | 71,601  |  
|                                            |  |                         |         |   |      |   |          |      |  |   |         |  



Lilly ICOS



In October 1998, ICOS and Lilly formed Lilly ICOS, which is 50/50-owned,
to develop and commercialize PDE5 inhibitors, including Cialis (tadalafil). We received, from Lilly ICOS, a $75.0 million payment upon formation of the joint venture, a $15.0 million payment in 1999 upon initiation of a Phase 3 clinical study
program for Cialis, a $15.0 million payment in 2001 following the filing of the NDA with the FDA, and a $15.0 million payment in December 2003 following the first commercial sale of Cialis in the United States. We could receive up to $30.0 million
in additional payments based on the achievement of further development and commercialization objectives for tadalafil. Lilly ICOS was initially capitalized through cash contributions from Lilly and our contribution of an exclusive worldwide license
to intellectual property relating to PDE5 inhibitors, including intellectual property associated with tadalafil and its research platform. Subsequent capital contributions have been made, as needed to fund operations, by both Lilly and ICOS. ICOS
and Lilly jointly manage Lilly ICOS and provide it with services required for research, development and commercialization. Lilly is the sole manufacturer of Cialis, under contract with Lilly ICOS.



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 its activities were funded exclusively by Lilly. We began recognizing our share of Lilly
ICOS losses in the third quarter of 2000, because we were responsible for funding our proportionate share of Lilly ICOS operations. We do not recognize any Lilly ICOS expenses associated with the valuation of technology that we
contributed, as those expenses are solely applicable to Lilly.



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



Lilly ICOS first commercial product, Cialis, for the treatment of
erectile dysfunction, is being marketed around the world. Lilly ICOS has rights to market Cialis in North America and Europe. In the context of Lilly ICOS territories, North America includes the United States, Canada and Mexico. Europe includes the
current fifteen member countries of the European Union  Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, Switzerland and the United Kingdom  plus Finland, Iceland, and
Norway. Lilly has exclusive rights to market Cialis in territories in the remainder of the world, and pays royalties to Lilly ICOS, equal to 20% of net sales in those territories.



During the first quarter of 2003, Lilly ICOS launched Cialis in Europe, followed by additional launches later in the year in
North America. Cialis became available in Mexico, in August 2003, and Canada, in November 2003. Lilly ICOS received FDA approval, to market Cialis in the United States, on November 21, 2003. The product was available in pharmacies throughout the
United States by early December 2003.



Summarized unaudited
financial information for Lilly ICOS follows:



|                                       |  |              |         |   |      |   |         |  
|-------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                       |  | December 31, |        
|                                       |  | 2003         |         |   | 2002 |  
|Financial position:                    |  |              |         |   |      |   |         |  
|Total current assets                   |  | $            | 63,293  |   |      | $ | 9,335   |  
|Total noncurrent assets                |  |              | 16,673  |   |      |   | 1,413   |  
|                                       |  |              |         |   |      |   |         |  
|Total assets                           |  | $            | 79,966  |   |      | $ | 10,748  |  
|                                       |  |              |         |   |      |   |         |  
|Total liabilities  all current        |  | $            | 113,417 |   |      | $ | 51,922  |  
|Members deficit                       |  |              | (33,451 | ) |      |   | (41,174 | )
|                                       |  |              |         |   |      |   |         |  
|Total liabilities and members deficit |  | $            | 79,966  |   |      | $ | 10,748  |  
|                                       |  |              |         |   |      |   |         |  



|                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                              |  | Year Ended December 31, |         
|                                                              |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Operating results:                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Revenue                                                       |  | $                       | 144,533  |   |      | $ |         |      |  | $ |         |  
|Cost of sales                                                 |  |                         | 12,543   |   |      |   |         |      |  |   |         |  
|Selling, general and administrative expenses, related parties |  |                         | 243,110  |   |      |   | 75,697   |      |  |   | 40,136   |  
|Research and development expenses, related parties            |  |                         | 63,622   |   |      |   | 55,641   |      |  |   | 36,496   |  
|Contribution of technology, related party                     |  |                         |         |   |      |   |         |      |  |   | 30,000   |  
|Interest income                                               |  |                         |         |   |      |   |         |      |  |   | 196      |  
|                                                              |  |                         |          |   |      |   |          |      |  |   |          |  
|Net loss                                                      |  | $                       | (174,742 | ) |      | $ | (131,338 | )    |  | $ | (106,436 | )
|                                                              |  |                         |          |   |      |   |          |      |  |   |          |  



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ICOS CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Biogen



In July 2001, we entered into an agreement with Biogen to jointly develop and globally commercialize orally active, small molecule LFA-1 antagonists for
the treatment of inflammatory diseases and conditions, including psoriasis, and other autoimmune diseases. Under the terms of this agreement, we and Biogen cross-licensed LFA-1 antagonist technology and patents, including those related to IC747 and
other LFA-1 antagonists, and equally shared in costs of development activities for the collaboration.



We received an $8.0 million upfront fee upon executing the agreement with Biogen in 2001, and received an additional $2.0 million license fee in 2002,
upon the initiation of a Phase 2 clinical program. In 2003, 2002 and 2001, we also received $4.3 million, $7.7 million and $2.3 million, respectively, in loans from Biogen to help fund our share of the related development costs, of which $5.3
million, $6.7 million and $2.3 million was forgiven in 2003, 2002 and 2001, respectively, upon the achievement of certain objectives. Loans forgiven were treated as license fees and recorded as revenue at the time of forgiveness, based on the ratio
of cumulative costs incurred to date, to total estimated development costs. Any remaining forgiven balance was reported as deferred revenue to be recognized as revenue over the estimated remaining product development period.



In June 2003, we announced that the LFA-1 antagonist collaboration with
Biogen would be concluded and that we would reacquire sole development rights to the program. At that time, we recognized, as revenue, the remaining $21.3 million of deferred upfront fees and forgiven loans received from Biogen under the
collaboration arrangement.



Suncos



In February 1997, ICOS and Suntory Ltd. (the predecessor to Daiichi Suntory
Pharma Co., Ltd.) formed Suncos, a 50/50-owned corporation, to develop and commercialize Pafase. Suncos was established with a $30.0 million cash investment by Suntory Ltd., and ICOS contribution of an exclusive license for Pafase technology.
Subsequent capital contributions have been made by Suntory Ltd. and ICOS in equal amounts. Both Suntory Ltd. and ICOS provided Suncos with research and development services in support of the Pafase development program. In December 2002, the Pafase
development program was discontinued after an interim analysis did not demonstrate clinical benefit in a Phase 3 study for severe sepsis. Upon discontinuation of the Pafase program, Suncos accrued estimated close-out costs, primarily associated with
the programs clinical and manufacturing activities. During 2003, the accrual for estimated close-out costs was adjusted, by an immaterial amount, to reflect actual close-out costs.



ICOS-TBC



In June 2000, ICOS and Encysive formed ICOS-TBC, a 50/50-owned limited partnership, to develop and commercialize endothelin receptor antagonists, such as
sitaxsentan. Under the terms of this arrangement, ICOS and Encysive equally funded the development of endothelin receptor antagonists and were entitled to equally share in the profits of the partnership. We made an initial $2.0 million payment to
Encysive upon formation of the partnership and made an additional $2.0 million payment in October 2001. Encysive 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.



In January 2003, we announced that joint development of endothelin receptor antagonists, through ICOS-TBC, would not continue. Encysive agreed to be responsible for all costs and expenses of ICOS-TBC incurred
subsequent to December 31, 2002. On April 22, 2003, Encysive acquired all of our interests in ICOS-TBC for



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



$10.0 million, with $4.0 million paid on that date and the balance payable, with interest, over an 18-month period. Future payments due from Encysive are
secured by an irrevocable standby letter of credit from a major U.S. bank. Other income, in 2003, includes a gain of $10.0 million from this transaction.



Other Collaborative Arrangements



We have entered into other collaborative arrangements under which we may be obligated to pay royalties or milestones 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.



(3) Investment Securities



The following table summarizes our investment securities at December 31, 2003 and 2002:



|                                                                                                          |  |              |         |                        |   |                         |  |                |     |  |   |        
|--------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---------------------- | - | ----------------------- |  | -------------- | --- |  | - | -------
|                                                                                                          |  | Market Value |         | Gross Unrealized Gains |   | Gross Unrealized Losses |  | Amortized Cost
|December 31, 2003:                                                                                        |  |              |         |                        |   |                         |  |                |     |  |   |        
|Corporate debt securities                                                                                 |  | $            | 111,202 |                        | $ | 874                     |  | $              | 171 |  | $ | 110,499
|U.S. treasury securities and obligations of U.S. government agencies and government-sponsored enterprises |  |              | 23,616  |                        |   | 50                      |  |                |    |  |   | 23,566 
|                                                                                                          |  |              |         |                        |   |                         |  |                |     |  |   |        
|Total                                                                                                     |  | $            | 134,818 |                        | $ | 924                     |  | $              | 171 |  | $ | 134,065
|                                                                                                          |  |              |         |                        |   |                         |  |                |     |  |   |        
|December 31, 2002:                                                                                        |  |              |         |                        |   |                         |  |                |     |  |   |        
|Corporate debt securities                                                                                 |  | $            | 252,406 |                        | $ | 3,048                   |  | $              | 13  |  | $ | 249,371
|U.S. treasury securities and obligations of U.S. government agencies and government-sponsored enterprises |  |              | 56,070  |                        |   | 245                     |  |                |    |  |   | 55,825 
|                                                                                                          |  |              |         |                        |   |                         |  |                |     |  |   |        
|Total                                                                                                     |  | $            | 308,476 |                        | $ | 3,293                   |  | $              | 13  |  | $ | 305,196
|                                                                                                          |  |              |         |                        |   |                         |  |                |     |  |   |        



At December 31, 2003,
gross unrealized losses on our investment securities relate to certain corporate debt securities, with an aggregate fair market value of $20.6 million, which we intend to hold to maturity.



Market value and amortized cost of investment securities at December 31,
2003, by contractual maturity, are shown below.



|                 |  |              |         |                |   |        
|---------------- |  | ------------ | ------- | -------------- | - | -------
|Maturing:        |  | Market Value |         | Amortized Cost
|Less than 1 year |  | $            | 83,049  |                | $ | 83,004 
|1 to 2 years     |  |              | 51,769  |                |   | 51,061 
|                 |  |              |         |                |   |        
|                 |  | $            | 134,818 |                | $ | 134,065
|                 |  |              |         |                |   |        



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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(4) Receivables from Affiliates



|           |  |              |        |      |   |      
|---------- |  | ------------ | ------ | ---- | - | -----
|           |  | December 31,
|           |  | 2003         |        | 2002
|Lilly ICOS |  | $            | 14,360 |      | $ | 2,631
|Suncos     |  |              | 3,321  |      |   | 337  
|ICOS-TBC   |  |              |       |      |   | 4,841
|Other      |  |              |       |      |   | 150  
|           |  |              |        |      |   |      
|           |  | $            | 17,681 |      | $ | 7,959
|           |  |              |        |      |   |      



Substantially all of
the above balances represent amounts due under collaborative research, development, marketing and sales arrangements.



(5) Property and Equipment, Net



|                                               |  |              |         |   |      |   |         |  
|---------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                               |  | December 31, |        
|                                               |  | 2003         |         |   | 2002 |  
|Land                                           |  | $            | 2,310   |   |      | $ | 2,310   |  
|Building and improvements                      |  |              | 10,172  |   |      |   | 10,088  |  
|Leasehold improvements                         |  |              | 15,200  |   |      |   | 14,310  |  
|Furniture and equipment                        |  |              | 38,695  |   |      |   | 34,681  |  
|                                               |  |              |         |   |      |   |         |  
|Total cost                                     |  |              | 66,377  |   |      |   | 61,389  |  
|Less accumulated depreciation and amortization |  |              | (47,407 | ) |      |   | (41,180 | )
|                                               |  |              |         |   |      |   |         |  
|                                               |  | $            | 18,970  |   |      | $ | 20,209  |  
|                                               |  |              |         |   |      |   |         |  



(6) Due to Affiliates



|           |  |              |        |      |   |       
|---------- |  | ------------ | ------ | ---- | - | ------
|           |  | December 31,
|           |  | 2003         |        | 2002
|Lilly ICOS |  | $            | 24,174 |      | $ | 20,587
|Suncos     |  |              | 1,668  |      |   | 1,808 
|ICOS-TBC   |  |              |       |      |   | 2,617 
|           |  |              |        |      |   |       
|           |  | $            | 25,842 |      | $ | 25,012
|           |  |              |        |      |   |       



Due to affiliates
represents obligations to fund our share of the losses of Lilly ICOS, Suncos and ICOS-TBC that are in excess of our investment.



(7) Deferred Revenue



At December 31, 2003, deferred revenue consists solely of cash receipts, in excess of amounts earned, under various contract manufacturing agreements with
third-parties. Substantially all deferred revenue at December 31, 2002, arose from upfront license fees, milestones and debt forgiven under our line of credit with Biogen.



(8) Convertible Subordinated Debt



On June 20, 2003, we completed a private offering of $250.0 million of convertible subordinated notes, which accrue interest at 2% per annum, payable
semiannually each January and July 1. On July 18, 2003, the initial



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



purchasers exercised, in part, their option to purchase additional convertible subordinated notes in the principal amount of $28.7 million. The notes are
unsecured, subordinated to any senior indebtedness, and convertible, at the option of the holder, into our common stock at a conversion price of $61.50 per share, subject to adjustment in certain circumstances. The notes will mature on July 1, 2023.
Note holders may require us to purchase, for cash, all or a portion of their notes on July 1, 2010, 2013 or 2018, at a price equal to the principal amount of the notes being repurchased. We may redeem all or a portion of the notes, at par, for cash
at any time on or after July 5, 2010. The net proceeds of the offering are expected to be used to fund costs associated with the U.S. commercial launch of Cialis, research and development activities, working capital and other general corporate
purposes.



(9) Leases



We lease certain property and equipment under noncancelable operating leases
which, in the aggregate, obligate us through 2009. 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 $6.1 million, $5.0 million and $4.0
million for 2003, 2002 and 2001, respectively.



Future minimum
payments due under noncancelable operating leases are as follows:



|           |  |   |       
|---------- |  | - | ------
|2004       |  | $ | 7,171 
|2005       |  |   | 6,786 
|2006       |  |   | 5,951 
|2007       |  |   | 5,261 
|2008       |  |   | 3,715 
|Thereafter |  |   | 216   
|           |  |   |       
|           |  | $ | 29,100
|           |  |   |       



(10) Federal Income Taxes



Income tax 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:



|                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                      |  | Year Ended December 31, |        
|                                                      |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Estimated federal income tax benefit                  |  | $                       | (43,927 | ) |      | $ | (56,566 | )    |  | $ | (28,061 | )
|Research and experimentation tax credit carryforwards |  |                         | (3,172  | ) |      |   | (2,866  | )    |  |   | (2,905  | )
|Other                                                 |  |                         | 71      |   |      |   | 61      |      |  |   | 223     |  
|Change in valuation allowance                         |  |                         | 46,416  |   |      |   | 59,371  |      |  |   | 30,743  |  
|                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                      |  | $                       | (612    | ) |      | $ |        |      |  | $ |        |  
|                                                      |  |                         |         |   |      |   |         |      |  |   |         |  



The change in
valuation allowance shown above excludes, in each year, the tax benefit of deductions generated by non-qualified stock option exercises. Those tax benefits will be credited directly to stockholders equity upon realization.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Deferred tax assets arising from temporary differences and carryforwards are as follows:



|                                                      |  |              |          |   |      |   |          |  
|----------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                      |  | December 31, |         
|                                                      |  | 2003         |          |   | 2002 |  
|Depreciation                                          |  | $            | 4,862    |   |      | $ | 4,212    |  
|Deferred revenue                                      |  |              |         |   |      |   | 5,961    |  
|Net operating loss carryforwards                      |  |              | 203,011  |   |      |   | 144,635  |  
|Research and experimentation tax credit carryforwards |  |              | 18,704   |   |      |   | 15,213   |  
|Alternative minimum tax credit carryforward           |  |              |         |   |      |   | 612      |  
|Investments in affiliates                             |  |              | 26,454   |   |      |   | 30,447   |  
|Other                                                 |  |              | 3,273    |   |      |   | 2,655    |  
|                                                      |  |              |          |   |      |   |          |  
|Gross deferred tax assets                             |  |              | 256,304  |   |      |   | 203,735  |  
|Valuation allowance                                   |  |              | (256,304 | ) |      |   | (203,735 | )
|                                                      |  |              |          |   |      |   |          |  
|                                                      |  | $            |         |   |      | $ |         |  
|                                                      |  |              |          |   |      |   |          |  



The increases in the
valuation allowance for deferred tax assets of $52.6 million, $61.3 million and $42.5 million, in 2003, 2002 and 2001, respectively, are attributable primarily to net operating loss carryforwards and investments in affiliates.



At December 31, 2003, we have net operating loss carryforwards available to
offset future taxable income as follows:



|                   |  |   |        
|------------------ |  | - | -------
|Year of Expiration |  |  
|2009               |  | $ | 5,060  
|2010               |  |   | 21,507 
|2011               |  |   | 21,039 
|2012               |  |   | 26,774 
|2013               |  |   | 7,688  
|2018               |  |   | 359    
|2019               |  |   | 36,832 
|2020               |  |   | 71,234 
|2021               |  |   | 92,848 
|2022               |  |   | 130,396
|2023               |  |   | 166,294
|                   |  |   |        
|                   |  | $ | 580,031
|                   |  |   |        



Approximately $101.0
million of the net operating loss carryforwards as of December 31, 2003, result from stock option deductions, the realization of which would result in a credit to stockholders equity. At December 31, 2003, we also had available approximately
$18.7 million of research and experimentation tax credit carryforwards to offset future tax liabilities. These credits expire from 2009 to 2023.



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 has occurred or were to occur in the future.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(11) Preferred Stock



We have the authority to issue up to 2.0 million shares of preferred stock in one or more series, but have not issued any to date. 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. In the future, we may issue preferred stock as part of our overall financing strategy or pursuant to our Stockholder Rights Plan as described below.



Stockholder Rights Plan



In August 2002, we implemented a Stockholder Rights Plan (Rights Plan) under
which the Board of Directors declared a dividend of one preferred share purchase Right for each outstanding share of our common stock. Each Right entitles its registered holder, under certain circumstances and upon the occurrence of certain events,
to purchase from us one one-hundredth of a share of our Series A Junior Participating Preferred Stock, at a price of $250.00 per one one-hundredth of a preferred share, subject to adjustment. The Rights are not exercisable until the distribution
date. Until the distribution date, or earlier redemption or expiration of the Rights, the Rights may only be transferred with the shares of our common stock.



If a person or group (collectively, an Acquiring Person) acquires beneficial ownership of 15% or more of our outstanding shares of common stock, then each
Right (other than those held by an Acquiring Person, an affiliate, or an associate of that person) will entitle the holder to purchase, for the purchase price, the number of shares of common stock which at the time of the transaction would have a
market value of twice the purchase price. Any Rights owned by an Acquiring Person, an affiliate, or an associate of that person, will be void and non-transferable. The Board of Directors may also elect to exchange each Right, other than those which
become void and non-transferable as described above, for shares of common stock, without payment of the purchase price. Should the Board of Directors make this election, the exchange rate would be one-half of the number of shares of common stock
that would otherwise be issuable at that time upon the exercise of one Right.



(12) Common Stock Options and Warrants



Stock Option Plan



Under our amended and restated 1999 Stock Option Plan,
a total of 17.4 million shares of common stock were reserved for grant to employees, nonemployee directors and certain outside parties. The 1999 Stock Option Plan replaced our 1989 Stock Option Plan and our 1991 Stock Option Plan for Nonemployee
Directors.



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 granted with an exercise price equal to 100% of the fair market value of the common stock on the grant date. 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.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



A summary of stock options is presented below:



|                             |  |                           |   |  |                                            |      
|---------------------------- |  | ------------------------- | - |  | ------------------------------------------ | -----
|                             |  | Stock Options Outstanding
|                             |  | Number of Shares          |   |  | Weighted- Average Exercise Price Per Share
|                             |  | (in thousands)            |   |  |                                           
|Balance at December 31, 2000 |  | 7,702                     |   |  | $                                          | 21.39
|Options granted              |  | 1,321                     |   |  |                                            | 53.41
|Cancellations                |  | (189                      | ) |  |                                            | 43.87
|Options exercised            |  | (977                      | ) |  |                                            | 11.94
|                             |  |                           |   |  |                                            |      
|Balance at December 31, 2001 |  | 7,857                     |   |  |                                            | 27.41
|Options granted              |  | 3,756                     |   |  |                                            | 33.70
|Cancellations                |  | (130                      | ) |  |                                            | 43.98
|Options exercised            |  | (500                      | ) |  |                                            | 10.25
|                             |  |                           |   |  |                                            |      
|Balance at December 31, 2002 |  | 10,983                    |   |  |                                            | 30.15
|Options granted              |  | 690                       |   |  |                                            | 31.84
|Cancellations                |  | (251                      | ) |  |                                            | 40.29
|Options exercised            |  | (908                      | ) |  |                                            | 9.58 
|                             |  |                           |   |  |                                            |      
|Balance at December 31, 2003 |  | 10,514                    |   |  | $                                          | 31.78
|                             |  |                           |   |  |                                            |      



At December 31, 2003,
2.4 million shares were reserved and remain available for grant under the 1999 Stock Option Plan.



The following table summarizes information about stock options outstanding and exercisable at December 31, 2003 (shares stated in thousands):



|                         |  |                           |  |                                                        |  |                                           |       |        |       |                                           |   |      
|------------------------ |  | ------------------------- |  | ------------------------------------------------------ |  | ----------------------------------------- | ----- | ------ | ----- | ----------------------------------------- | - | -----
|                         |  | Stock Options Outstanding |  | Stock Options Exercisable                             
|Range of Exercise Prices |  | Number                    |  | Weighted-Average Remaining Contractual Life (In Years) |  | Weighted-Average Exercise Price Per Share |       | Number |       | Weighted-Average Exercise Price Per Share
|$  3.75    $17.06       |  | 2,100                     |  | 2.8                                                    |  | $                                         | 10.12 |        | 2,091 |                                           | $ | 10.10
|17.38      29.73        |  | 2,289                     |  | 7.7                                                    |  |                                           | 26.42 |        | 1,205 |                                           |   | 26.31
|29.74      31.12        |  | 1,884                     |  | 8.3                                                    |  |                                           | 30.06 |        | 770   |                                           |   | 30.08
|32.09      42.88        |  | 2,081                     |  | 5.6                                                    |  |                                           | 41.62 |        | 1,935 |                                           |   | 41.73
|42.93      66.53        |  | 2,160                     |  | 7.7                                                    |  |                                           | 50.54 |        | 1,341 |                                           |   | 51.17
|                         |  |                           |  |                                                        |  |                                           |       |        |       |                                           |   |      
|$  3.75    $66.53       |  | 10,514                    |  | 6.4                                                    |  | $                                         | 31.78 |        | 7,342 |                                           | $ | 30.69
|                         |  |                           |  |                                                        |  |                                           |       |        |       |                                           |   |      



Warrants To Purchase Common
Stock



In connection with the 1997 sale of limited
partnership units in ICOS Clinical Partners, we issued Series A and Series B warrants. The Series A warrants entitled the holder to purchase an aggregate of 7.6 million shares of our common stock at a weighted-average exercise price of $9.45 per
share. Substantially all of the Series A warrants were exercised prior to expiration on May 31, 2002. On June 30, 1999, we issued Series B warrants, exercisable through June 30, 2004, to purchase an aggregate of 7.6 million shares of our common
stock at $52.49 per share.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



None of the Series B warrants were exercised in 2003. During 2002, Series A and B warrants to
purchase 1.8 million shares were exercised at a weighted-average exercise price of $9.58 per share. During 2001, Series A and B warrants to purchase 0.9 million shares were exercised at a weighted-average exercise price of $14.68 per share. At
December 31, 2003, Series B warrants to purchase 7.4 million shares were outstanding.



(13) Net Loss per Common Share



|                                                     |  |                         |          |   |      |   |          |      |  |   |         |  
|---------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|                                                     |  | Year Ended December 31, |         
|                                                     |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Net loss per share computations  basic and diluted: |  |                         |          |   |      |   |          |      |  |   |         |  
|Numerator:                                           |  |                         |          |   |      |   |          |      |  |   |         |  
|Net loss                                             |  | $                       | (125,507 | ) |      | $ | (161,617 | )    |  | $ | (80,173 | )
|Denominator:                                         |  |                         |          |   |      |   |          |      |  |   |         |  
|Weighted-average common shares                       |  |                         | 62,561   |   |      |   | 61,304   |      |  |   | 54,073  |  
|                                                     |  |                         |          |   |      |   |          |      |  |   |         |  
|Net loss per share  basic and diluted               |  | $                       | (2.01    | ) |      | $ | (2.64    | )    |  | $ | (1.48   | )
|                                                     |  |                         |          |   |      |   |          |      |  |   |         |  



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



|                                |  |                         |  |        |  |      
|------------------------------- |  | ----------------------- |  | ------ |  | -----
|                                |  | Year Ended December 31,
|                                |  | 2003                    |  | 2002   |  | 2001 
|Shares issuable upon:           |  |                         |  |        |  |      
|Exercise of stock options       |  | 10,514                  |  | 10,983 |  | 7,857
|Exercise of stock warrants      |  | 7,429                   |  | 7,429  |  | 9,273
|Conversion of subordinated debt |  | 4,531                   |  |       |  |     



(14) Legal Proceedings



In October 2002, Pfizer Inc., Pfizer Limited, and Pfizer
Ireland Pharmaceuticals filed a patent infringement lawsuit against ICOS, Lilly ICOS, and Lilly in the United States District Court for the District of Delaware. The complaint alleges that the intended and imminent use, offering for sale, selling,
manufacture, or importing into the United States upon FDA approval of Cialis for the treatment of erectile dysfunction by ICOS, Lilly ICOS and Lilly will constitute infringement of plaintiffs U.S. Patent No. 6,469,012. The plaintiffs seek a
judgment declaring that the defendants using, selling, offering for sale, making or importing of Cialis for the treatment of erectile dysfunction will infringe this patent. The plaintiffs also seek a permanent injunction, attorneys fees,
costs and expenses. In January 2003, we filed an answer denying the central allegations of plaintiffs complaint and setting forth various affirmative defenses. In September 2003, the PTO ordered the reexamination of U.S. Patent No. 6,469,012.
The reexamination process is provided for by law and requires the PTO to consider the validity of the patent based on substantial new questions of patentability raised by the PTO. In October 2003, ICOS, Lilly ICOS and Lilly filed a motion for a stay
with the District Court, to suspend the patent infringement lawsuit, pending the outcome of the reexamination. In November 2003, the judge granted the requested stay. In December 2003, Lilly ICOS filed its own reexamination request, related to U.S.
Patent No. 6,469,012, with the PTO.



Pfizers
corresponding European method-of-use patent was previously held invalid in the first stage of an opposition proceeding in the European Patent Office. Pfizer is now appealing that decision to the Technical Board of Appeal of the European Patent
Office. A hearing is expected in the second half of 2004. The United Kingdom Court of Appeal has previously held the United Kingdom counterpart to this patent invalid. Litigation relating to the corresponding patent is pending in Canada and Mexico.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Litigation is inherently unpredictable and the eventual outcome in a particular case is impossible to
determine in advance. We believe that Pfizers suit lacks merit and intend to vigorously pursue our various defenses. If Pfizer were to prevail in one or more countries, however, we might be subject to substantial damages, prohibited from
marketing Cialis for the treatment of erectile dysfunction in those countries, or required to enter into a licensing agreement to market Cialis in those countries. Any such adverse result could have a material adverse effect on our business,
financial position, results of operations and cash flows.



(15) Quarterly
Financial Data (Unaudited)



Summary operating data for each
quarter of the years ended December 31, 2003 and 2002 follows:



|                          |  |          |         |   |        |   |         |       |  |   |         |   |  |       |         |   |  |   |          |  
|------------------------- |  | -------- | ------- | - | ------ | - | ------- | ----- |  | - | ------- | - |  | ----- | ------- | - |  | - | -------- | -
|                          |  | Quarters |         |   |        |  
|                          |  | First    |         |   | Second |   |         | Third |  |   | Fourth  |   |  | Total |        
|2003:                     |  |          |         |   |        |   |         |       |  |   |         |   |  |       |         |   |  |   |          |  
|Revenue                   |  | $        | 7,081   |   |        | $ | 26,707  |       |  | $ | 12,103  |   |  | $     | 29,213  |   |  | $ | 75,104   |  
|Net loss                  |  |          | (40,492 | ) |        |   | (11,548 | )     |  |   | (39,309 | ) |  |       | (34,158 | ) |  |   | (125,507 | )
|Net loss per common share |  | $        | (0.65   | ) |        | $ | (0.19   | )     |  | $ | (0.63   | ) |  | $     | (0.54   | ) |  | $ | (2.01    | )
|                          |  |          |         |   |        |   |         |       |  |   |         |   |  |       |         |   |  |   |          |  
|2002:                     |  |          |         |   |        |   |         |       |  |   |         |   |  |       |         |   |  |   |          |  
|Revenue                   |  | $        | 22,536  |   |        | $ | 21,975  |       |  | $ | 22,210  |   |  | $     | 26,156  |   |  | $ | 92,877   |  
|Net loss                  |  |          | (39,220 | ) |        |   | (40,405 | )     |  |   | (34,531 | ) |  |       | (47,461 | ) |  |   | (161,617 | )
|Net loss per common share |  | $        | (0.65   | ) |        | $ | (0.66   | )     |  | $ | (0.56   | ) |  | $     | (0.76   | ) |  | $ | (2.64    | )



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|Item 9A. |  | Controls and Procedures
|-------- |  | -----------------------



(a) Evaluation of disclosure controls and procedures.    Our chief executive officer and our chief financial officer, after
evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this annual report, have concluded that, as of that date,
our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in this annual report is accumulated and communicated by our management, to allow timely decisions regarding required disclosure.



(b) Changes in internal
controls.    There were no significant changes in our internal controls during the fourth quarter of 2003 that have materially affected, or are reasonably likely to materially affect, our internal controls.



PART III



|Item 10. |  | Directors and Executive Officers of the Registrant
|-------- |  | --------------------------------------------------



The information required by this item is incorporated by reference from the sections entitled Security Ownership of Principal Stockholders and
Management, Election of Directors, Executive Officers and Section 16(a) Beneficial Ownership Reporting Compliance in ICOS Proxy Statement for the Annual Meeting of Stockholders to be held on May 14,
2004.



Code of Ethics



We have adopted our Code of Conduct, which applies to all employees and
directors of ICOS. Our Code of Conduct meets the requirements of a code of ethics as defined by Item 406 of Regulation S-K, and applies to our Chief Executive Officer and Chief Financial Officer (who is both our principal financial and
principal accounting officer), as well as all other employees, as indicated above. Our Code of Conduct also meets the requirements of a code of conduct under Marketplace Rule 4350(n) of the National Association of Securities Dealers. Our Code of
Conduct is available on our website at www.icos.com.



|Item 11. |  | Executive Compensation
|-------- |  | ----------------------



The information required by this item is incorporated by reference from the sections entitled Election of Directors, Executive
Compensation, Report of the Compensation Committee on Executive Compensation, Stock Price Performance Graph and Employment Contracts, Termination of Employment and Change of Control Arrangements in
ICOS Proxy Statement for the Annual Meeting of Stockholders to be held on May 14, 2004.



|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- |  | ----------------------------------------------------------------------------------------------



The following table sets forth information as of December 31, 2003, with respect to our compensation plans, for which our
common stock is authorized for issuance. All of our compensation plans have been approved by security holders (see Note 12 in the Notes to Consolidated Financial Statements for a description of our plans).



|                                                       |  |                                                                        |  |                                                                   |  |                                                                                             
|------------------------------------------------------ |  | ---------------------------------------------------------------------- |  | ----------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------
|                                                       |  | Number of Securities to be Issued Upon Exercise of Outstanding Options |  | Weighted- Average Exercise Price per Share of Outstanding Options |  | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans
|Equity compensation plans approved by security holders |  | 10,513,754                                                             |  | $31.78                                                            |  | 2,438,416                                                                                   



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The other information required by this item is incorporated by reference from the section entitled
Security Ownership of Principal Stockholders and Management in ICOS Proxy Statement for the Annual Meeting of Stockholders to be held on May 14, 2004.



|Item 13. |  | Certain Relationships and Related Transactions
|-------- |  | ----------------------------------------------



The information required by this item is incorporated by reference from the section entitled Related Party Transactions in ICOS Proxy
Statement for the Annual Meeting of Stockholders to be held on May 14, 2004.



|Item 14. |  | Principal Accounting Fees and Services
|-------- |  | --------------------------------------



The information required by this item is incorporated by reference from the section entitled Ratification of the Appointment of the Independent
Auditors in ICOS Proxy Statement for the Annual Meeting of Stockholders to be held on May 14, 2004.



PART IV



|Item 15. |  | 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, 2003 and 2002, and the related statements of operations, members deficit, and cash flows for each of the years in the three-year period ended December 31, 2003.



Independent Auditors Reports



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



3.Exhibits



See Index
to Exhibits filed herewith.



(b)Reports Filed on Form 8-K



No reports on Form 8-K were filed during the fourth quarter of the fiscal year ended December 31, 2003.



Reports Furnished on Form 8-K



The following reports on Form 8-K were furnished during the fourth quarter of the fiscal year ended December 31, 2003:



On October 22, 2003, ICOS furnished a report on Form 8-K reporting the
issuance of a Lilly ICOS LLC press release announcing Lilly ICOS LLCs financial results for the quarter ended September 30, 2003.



On November 4, 2003, ICOS furnished a report on Form 8-K reporting the issuance of a press release announcing its financial results for the quarter ended
September 30, 2003.



(d)Lilly ICOS
LLC Financial Statements



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LILLY ICOS LLC



TABLE OF CONTENTS



|                                                                                    |  |     
|----------------------------------------------------------------------------------- |  | ----
|                                                                                    |  | Page
|Independent Auditors Report                                                        |  | 68  
|                                                                                    | 
|Balance Sheets as of December 31, 2003 and 2002                                     |  | 69  
|                                                                                    | 
|Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001       |  | 70  
|                                                                                    | 
|Statements of Members Deficit for the Years Ended December 31, 2003, 2002 and 2001 |  | 71  
|                                                                                    | 
|Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001       |  | 72  
|                                                                                    | 
|Notes to Financial Statements                                                       |  | 73  



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INDEPENDENT AUDITORS REPORT



The Board of
Directors

Lilly ICOS LLC:



We have audited the accompanying balance sheets of Lilly ICOS LLC as of December 31, 2003 and 2002, and the related statements of operations,
members deficit, and cash flows for each of the years in the three-year period ended December 31, 2003. 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, 2003 and 2002, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.



/s/ KPMG LLP



Seattle, Washington

January 23, 2004



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LILLY ICOS LLC



BALANCE SHEETS



(In thousands)



|                                 |  |              |         |   |      |   |         |  
|-------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                 |  | December 31, |        
|                                 |  | 2003         |         |   | 2002 |  
|ASSETS                           |  |              |         |   |      |   |         |  
|Current assets:                  |  |              |         |   |      |   |         |  
|Cash and cash equivalents        |  | $            | 43      |   |      | $ | 1       |  
|Accounts receivable, trade       |  |              | 47,910  |   |      |   |        |  
|Deposit                          |  |              | 515     |   |      |   | 2,142   |  
|Prepaid expenses                 |  |              | 14,825  |   |      |   | 7,192   |  
|                                 |  |              |         |   |      |   |         |  
|Total current assets             |  |              | 63,293  |   |      |   | 9,335   |  
|Property and equipment, net      |  |              | 1,776   |   |      |   | 1,413   |  
|License fee, net                 |  |              | 14,897  |   |      |   |        |  
|                                 |  |              |         |   |      |   |         |  
|                                 |  | $            | 79,966  |   |      | $ | 10,748  |  
|                                 |  |              |         |   |      |   |         |  
|LIABILITIES AND MEMBERS DEFICIT |  |              |         |   |      |   |         |  
|Current liabilities:             |  |              |         |   |      |   |         |  
|Payables to members, net         |  | $            | 107,791 |   |      | $ | 51,922  |  
|Coupon redemption accrual        |  |              | 5,626   |   |      |   |        |  
|                                 |  |              |         |   |      |   |         |  
|Total current liabilities        |  |              | 113,417 |   |      |   | 51,922  |  
|Members deficit:                |  |              |         |   |      |   |         |  
|Eli Lilly and Company            |  |              | (9,277  | ) |      |   | (20,587 | )
|ICOS Corporation                 |  |              | (24,174 | ) |      |   | (20,587 | )
|                                 |  |              |         |   |      |   |         |  
|Total members deficit           |  |              | (33,451 | ) |      |   | (41,174 | )
|                                 |  |              |         |   |      |   |         |  
|                                 |  | $            | 79,966  |   |      | $ | 10,748  |  
|                                 |  |              |         |   |      |   |         |  



See accompanying notes
to financial statements.



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LILLY ICOS LLC



STATEMENTS OF
OPERATIONS



(In thousands)



|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|---------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                     |  | Year Ended December 31, |         
|                                                     |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Revenue:                                             |  |                         |          |   |      |   |          |      |  |   |          |  
|Product sales, net                                   |  | $                       | 129,828  |   |      | $ |         |      |  | $ |         |  
|Royalties, related party                             |  |                         | 14,705   |   |      |   |         |      |  |   |         |  
|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Total revenue                                        |  |                         | 144,533  |   |      |   |         |      |  |   |         |  
|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Expenses:                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Cost of sales                                        |  |                         | 12,543   |   |      |   |         |      |  |   |         |  
|Selling, general and administrative:                 |  |                         |          |   |      |   |          |      |  |   |          |  
|Eli Lilly and Company                                |  |                         | 229,130  |   |      |   | 72,436   |      |  |   | 37,481   |  
|ICOS Corporation                                     |  |                         | 13,980   |   |      |   | 3,261    |      |  |   | 2,655    |  
|Research and development:                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Contributed technology license from ICOS Corporation |  |                         |         |   |      |   |         |      |  |   | 30,000   |  
|Eli Lilly and Company                                |  |                         | 55,509   |   |      |   | 52,287   |      |  |   | 29,186   |  
|ICOS Corporation                                     |  |                         | 8,113    |   |      |   | 3,354    |      |  |   | 7,310    |  
|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Total expenses                                       |  |                         | 319,275  |   |      |   | 131,338  |      |  |   | 106,632  |  
|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Interest income                                      |  |                         |         |   |      |   |         |      |  |   | 196      |  
|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  
|Net loss                                             |  | $                       | (174,742 | ) |      | $ | (131,338 | )    |  | $ | (106,436 | )
|                                                     |  |                         |          |   |      |   |          |      |  |   |          |  







See accompanying notes to financial statements.



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LILLY ICOS LLC



STATEMENTS OF
MEMBERS DEFICIT



(In thousands)



|                              |  |                       |         |   |                 |   |         |                        |  |   |          |  
|----------------------------- |  | --------------------- | ------- | - | --------------- | - | ------- | ---------------------- |  | - | -------- | -
|                              |  | Eli Lilly and Company |         |   | ICOSCorporation |   |         | Total Members Deficit | 
|Balances at December 31, 2000 |  | $                     | (23,613 | ) |                 | $ | (23,613 | )                      |  | $ | (47,226  | )
|Member contributions:         |  |                       |         |   |                 |   |         |                        |  |   |          |  
|Cash                          |  |                       | 62,228  |   |                 |   | 47,228  |                        |  |   | 109,456  |  
|Technology license            |  |                       |        |   |                 |   | 30,000  |                        |  |   | 30,000   |  
|Capital distribution          |  |                       |        |   |                 |   | (15,000 | )                      |  |   | (15,000  | )
|Net loss                      |  |                       | (53,218 | ) |                 |   | (53,218 | )                      |  |   | (106,436 | )
|                              |  |                       |         |   |                 |   |         |                        |  |   |          |  
|Balances at December 31, 2001 |  |                       | (14,603 | ) |                 |   | (14,603 | )                      |  |   | (29,206  | )
|Member contributions:         |  |                       |         |   |                 |   |         |                        |  |   |          |  
|Cash                          |  |                       | 59,685  |   |                 |   | 59,685  |                        |  |   | 119,370  |  
|Net loss                      |  |                       | (65,669 | ) |                 |   | (65,669 | )                      |  |   | (131,338 | )
|                              |  |                       |         |   |                 |   |         |                        |  |   |          |  
|Balances at December 31, 2002 |  |                       | (20,587 | ) |                 |   | (20,587 | )                      |  |   | (41,174  | )
|Member contributions:         |  |                       |         |   |                 |   |         |                        |  |   |          |  
|Cash                          |  |                       | 98,733  |   |                 |   | 83,732  |                        |  |   | 182,465  |  
|Technology license            |  |                       |        |   |                 |   | 15,000  |                        |  |   | 15,000   |  
|Capital distribution          |  |                       |        |   |                 |   | (15,000 | )                      |  |   | (15,000  | )
|Net loss                      |  |                       | (87,423 | ) |                 |   | (87,319 | )                      |  |   | (174,742 | )
|                              |  |                       |         |   |                 |   |         |                        |  |   |          |  
|Balances at December 31, 2003 |  | $                     | (9,277  | ) |                 | $ | (24,174 | )                      |  | $ | (33,451  | )
|                              |  |                       |         |   |                 |   |         |                        |  |   |          |  



See accompanying notes
to financial statements.



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LILLY ICOS LLC



STATEMENTS OF
CASH FLOWS



(In thousands)



|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|--------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                            |  | Year Ended December 31, |         
|                                                                            |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|Cash flows from operating activities:                                       |  |                         |          |   |      |   |          |      |  |   |          |  
|Net loss                                                                    |  | $                       | (174,742 | ) |      | $ | (131,338 | )    |  | $ | (106,436 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                         |          |   |      |   |          |      |  |   |          |  
|Contributed technology license                                              |  |                         |         |   |      |   |         |      |  |   | 30,000   |  
|Depreciation and amortization                                               |  |                         | 452      |   |      |   | 232      |      |  |   |         |  
|Changes in operating assets and liabilities:                                |  |                         |          |   |      |   |          |      |  |   |          |  
|Accounts receivable, trade                                                  |  |                         | (47,910  | ) |      |   |         |      |  |   |         |  
|Prepaid expenses and deposits                                               |  |                         | (6,006   | ) |      |   | (9,334   | )    |  |   | 1,043    |  
|Payables to members, net                                                    |  |                         | 55,869   |   |      |   | 22,716   |      |  |   | (26,206  | )
|Coupon redemption accrual                                                   |  |                         | 5,626    |   |      |   |         |      |  |   |         |  
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash used in operating activities                                       |  |                         | (166,711 | ) |      |   | (117,724 | )    |  |   | (101,599 | )
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash flows from investing activities:                                       |  |                         |          |   |      |   |          |      |  |   |          |  
|Acquisitions of property and equipment                                      |  |                         | (712     | ) |      |   | (1,645   | )    |  |   |         |  
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash used in investing activities                                       |  |                         | (712     | ) |      |   | (1,645   | )    |  |   |         |  
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash flows from financing activities:                                       |  |                         |          |   |      |   |          |      |  |   |          |  
|Member contributions                                                        |  |                         | 182,465  |   |      |   | 119,370  |      |  |   | 109,456  |  
|Capital distributions                                                       |  |                         | (15,000  | ) |      |   |         |      |  |   | (15,000  | )
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Net cash provided by financing activities                                   |  |                         | 167,465  |   |      |   | 119,370  |      |  |   | 94,456   |  
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Net increase (decrease) in cash and cash equivalents                        |  |                         | 42       |   |      |   | 1        |      |  |   | (7,143   | )
|Cash and cash equivalents at beginning of period                            |  |                         | 1        |   |      |   |         |      |  |   | 7,143    |  
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents at end of period                                  |  | $                       | 43       |   |      | $ | 1        |      |  | $ |         |  
|                                                                            |  |                         |          |   |      |   |          |      |  |   |          |  



See accompanying notes
to financial statements.



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LILLY ICOS LLC



NOTES TO
FINANCIAL STATEMENTS



(Dollars in thousands, unless
otherwise noted)



(1) Organization and Operations



Lilly ICOS LLC (Company), a 50/50-owned limited liability company, was formed
in October 1998 by Eli Lilly and Company (Lilly) and ICOS Corporation (ICOS) to develop and commercialize phosphodiesterase type 5 (PDE5) inhibitors. Profits, losses and distributions, except for distributions for payment of license fees to ICOS
(see Note 3), are allocated based on ownership interests. The Company owns the rights to Cialis® (tadalafil) as an oral therapeutic agent for the treatment of erectile dysfunction and is evaluating tadalafil for the treatment of other medical conditions.



Prior to January 1, 2003, the Companys principal activities were
clinical research and development, market research, and sales and marketing activities in anticipation of the commercial launch of Cialis. Accordingly, the Companys financial statements for all periods prior to January 1, 2003, were presented
as a development stage company, as prescribed by Statement of Financial Accounting Standards No. 7, Accounting and Reporting by Development Stage Enterprises. In the first quarter of 2003, the Company began selling its first commercial
product, Cialis, for the treatment of erectile dysfunction. As a result, the Company exited the development stage in the 2003 first quarter and became an operating company.



Cialis is being marketed worldwide for the treatment of erectile dysfunction. Cialis is marketed by the Company in North
America and Europe (Lilly ICOS territory), using the services of both Lilly and ICOS. In the context of the Lilly ICOS territory, North America includes the United States, Canada and Mexico. Europe includes the current fifteen member countries of
the European Union  Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, Switzerland and the United Kingdom  plus Finland, Iceland, and Norway. Lilly has exclusive rights
to commercialize any PDE5 inhibitor products in the remainder of the world (Lilly territory), and pays royalties to Lilly ICOS, equal to 20% of net sales in those territories. Lilly and ICOS jointly manage the Company and provide it with services
and continued funding as required for research, development and commercialization. Lilly is the sole manufacturer of Cialis, under contract with the Company.



(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) Property
and Equipment



Property and equipment are stated at
cost. Significant additions and improvements to property and equipment are capitalized. Maintenance and repairs are expensed as incurred. Depreciation of property and equipment, including software, is determined using the straight-line method over
an estimated useful life of 3 years.



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LILLY ICOS LLC



NOTES TO FINANCIAL STATEMENTS  (Continued)



(c) License Fee, Net



In December 2003, in connection with the first commercial sale of Cialis in the United States, the Company received a $15
million capital contribution from Lilly and made a subsequent license fee payment to ICOS in the same amount. As the license fee payment was incurred in connection with product commercialization, the amount has been recorded as an intangible asset,
and is being amortized over 12 years on a straight-line basis, with yearly amortization in the amount of $1,250. Amortization expense totaling $103 in 2003 is included in cost of sales.



(d) Revenue Recognition



Product sales consist exclusively of sales of Cialis for the treatment of erectile dysfunction. The Company recognizes revenue upon shipment and transfer
of title and risk of loss to the customer. Applicable allowances and discounts are recorded as a reduction of product sales when revenue is recognized. Accruals for coupons which are redeemed through pharmacies are recorded as a reduction of revenue
when the coupons are distributed, based on the expected redemption rate.



The Company receives a royalty, equal to 20% of the net sales of Cialis sold by Lilly, or any of its affiliates or sublicensees, in the Lilly territory. Royalty revenue is recognized in the same period in which Lilly
makes the corresponding sale.



(e) Research and Development Costs



Research and development costs, which all relate to
PDE5 inhibitors, including Cialis, are principally comprised of: hourly based fees for services provided by Lilly and ICOS; clinical studies performed by third parties; materials and supplies to support clinical programs; research-related
manufacturing; consulting services; and other expenses incurred to support the Companys overall research and development program. Research and development costs are expensed as incurred.



(f) Advertising Costs



Advertising production costs are expensed as incurred. The costs of radio
time, television time and space in publications are expensed when the related advertising occurs.



(g) 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.



(h) Foreign Currency Transactions



The Company operates in the U.S., Europe, Canada and Mexico. Product sales and operating expenses are denominated in the currencies of the countries in
which they are sold or incurred. Foreign currency transaction gains and losses (which have not been significant) are included in the Companys statement of operations, to the extent the foreign exchange rates on the transaction dates differ
from the rates when associated assets or liabilities are settled.



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LILLY ICOS LLC



NOTES TO FINANCIAL STATEMENTS  (Continued)



(i) Concentrations of Risk



The Company is subject to credit risk from its accounts receivable related to product sales, and periodically assesses the
financial strength of its customers and establishes allowances for anticipated losses, when necessary. The Company sells its products principally to distributors and wholesalers of pharmaceutical products who in turn sell to retail pharmacy outlets.



Lilly manufactures and distributes Cialis for the Company, and
provides certain sales and customer service processing functions. If Lilly were unable to provide these services, or did not provide these services on a timely and accurate basis, the Company may be unable to meet market demand for its products and
could be materially and adversely affected.



(j) Reclassifications



Certain amounts reported in prior years have been
reclassified to conform to the 2003 presentation.



(3) Equity Transactions



ICOS contributed an exclusive license for the PDE5
technology to the Company in October 1998, and Lilly contributed $180 million to the Company  $100 million in October 1998 and $40 million in both October 1999 and October 2000. ICOS and Lilly each acquired 50% ownership interests in the
Company upon its formation. Subsequent to depletion of the Lilly contribution of $180 million, in the third quarter of 2000, ICOS and Lilly each became responsible for funding 50% of the Companys activities.



The technology license contributed by ICOS was valued based on the cash
contributions from Lilly and concurrent capital distributions to ICOS discussed below. The contributed technology license was initially valued at $255 million, of which $175 million was charged to development expense in 1998, and $40 million was
charged to development expense in both 1999 and 2000. An additional $30 million was recorded as development expense in 1999 related to the initial valuation of the contributed technology license, upon initiation of a Phase 3 clinical study program
for Cialis, and $30 million in 2001, following the filing of the New Drug Application (NDA) with the United States Food and Drug Administration (FDA).



Under the terms of the Limited Liability Company Agreement (LLC Agreement), ICOS received a capital distribution of $75 million in October 1998, and $15
million each upon the initiation of a Phase 3 clinical study program in September 1999 and following the filing of an NDA with the FDA in June 2001. The $15 million capital distributions were funded by additional capital contributions from Lilly.
Additionally, in December 2003, a $15 million license fee was paid to ICOS following the first commercial sale of Cialis in the United States. The December 2003 payment was recorded as a license fee on the balance sheet and funded by an additional
$15 million capital contribution from Lilly. Amortization of the associated intangible asset is allocated 100% to Lilly.



ICOS may receive up to $30 million in further technology license fee payments based on the achievement of certain objectives as specified in the LLC
Agreement. Any further technology license fee payments are to be funded by additional capital contributions from Lilly.



(4) License Agreements



In October 1998, 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



75



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LILLY ICOS LLC



NOTES TO FINANCIAL STATEMENTS  (Continued)



inhibitors for human therapeutic use. The value of the license was charged to development expense, as the underlying technology represented incomplete
product research and development.



Also, in October 1998, the
Company entered into a license agreement with Lilly (License Agreement), under which the Company granted to Lilly an exclusive right and license to the PDE5 technology in order to develop, manufacture, market and sell PDE5 inhibitor products in the
Lilly territory. Under the License Agreement, Lilly will pay to the Company a royalty equal to 20% of the net sales of PDE5 inhibitor products that are sold by Lilly, or any of its affiliates or sublicensees, in the Lilly territory.



(5) Royalty Obligation



Pursuant to a license agreement with a third party, the Company is obligated to pay a 5% royalty based on the net sales of
its PDE5 inhibitor products in the Lilly ICOS territory. Lilly is obligated to pay the royalty based on sales in the Lilly territory. Royalty expenses directly related to product sales are included in cost of sales.



(6) Research and Development Service Agreement



In October 1998, the Company entered into a Research and Development Service
Agreement (R&D Agreement) with Lilly and ICOS. Under the terms of the R&D Agreement, to the extent requested by the Company, Lilly and ICOS will perform research and development activities to evaluate PDE5 inhibitor product candidates. The
Company reimburses Lilly and ICOS a per-hour amount, calculated on the basis of actual hours incurred by Lilly and ICOS personnel, plus certain development and administrative expenses. The Company can contract with other parties to provide research
and development services.



(7) Marketing and Sales Service Agreement



In October 1998, the Company entered into a Marketing and
Sales Service Agreement (Marketing Agreement) with Lilly and ICOS to jointly promote the Companys future products. Under the terms of the Marketing Agreement, the Company reimburses Lilly and ICOS for certain marketing and sales expenses. The
Company, Lilly or ICOS may also contract with other parties to provide marketing and sales services.



(8) Manufacturing Agreement



In March 2002, the Company entered into a Manufacturing Agreement (Manufacturing Agreement) with Lilly to manufacture Cialis. Under the terms of the Manufacturing Agreement and related amendments, the Company reimburses Lilly for a variety
of services including, but not limited to, tablet production, packaging, storage, distribution and sales order processing.



(9) Deposit



The deposit of $515 and $2,142 at December 31, 2003 and 2002, respectively, represents amounts paid to a third party for future marketing services or to
be refunded to the Company.



(10) Prepaid Expenses



|                          |  |              |        |      |   |      
|------------------------- |  | ------------ | ------ | ---- | - | -----
|                          |  | December 31,
|                          |  | 2003         |        | 2002
|Marketing and advertising |  | $            | 8,863  |      | $ | 5,162
|Meetings and conferences  |  |              | 4,260  |      |   | 1,185
|Promotional items         |  |              | 819    |      |   | 845  
|Other                     |  |              | 883    |      |   |     
|                          |  |              |        |      |   |      
|                          |  | $            | 14,825 |      | $ | 7,192
|                          |  |              |        |      |   |      



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LILLY ICOS LLC



NOTES TO FINANCIAL STATEMENTS  (Continued)



(11) Property and Equipment, Net



|                                          |  |              |       |   |      |   |       |  
|----------------------------------------- |  | ------------ | ----- | - | ---- | - | ----- | -
|                                          |  | December 31, |      
|                                          |  | 2003         |       |   | 2002 |  
|Trade show booth                          |  | $            | 1,045 |   |      | $ | 1,045 |  
|Software                                  |  |              | 1,312 |   |      |   | 600   |  
|                                          |  |              |       |   |      |   |       |  
|Total cost                                |  |              | 2,357 |   |      |   | 1,645 |  
|Accumulated depreciation and amortization |  |              | (581  | ) |      |   | (232  | )
|                                          |  |              |       |   |      |   |       |  
|                                          |  | $            | 1,776 |   |      | $ | 1,413 |  
|                                          |  |              |       |   |      |   |       |  



(12) Segment Information



The Company operates in one segment, the development and
commercialization of pharmaceutical products for human therapeutic use. The Company currently derives its product revenues exclusively from sales of Cialis, and also generates royalty revenue, from Lilly, on sales of Cialis in the Lilly territories.



The Company sells Cialis in Europe and North America,
principally to distributors and wholesalers of pharmaceutical products.



Product sales are reported in the geographic area in which they originate as follows:



|                    |  |      |        
|------------------- |  | ---- | -------
|                    |  | 2003
|Product sales, net: |  |      |        
|United States       |  | $    | 27,923 
|Germany             |  |      | 25,580 
|Italy               |  |      | 16,567 
|France              |  |      | 15,501 
|Other countries     |  |      | 44,257 
|                    |  |      |        
|                    |  | $    | 129,828
|                    |  |      |        



All long-lived assets
are located in the United States.



(13) Legal Proceedings



In October 2002, Pfizer Inc., Pfizer Limited, and Pfizer Ireland
Pharmaceuticals filed a patent infringement lawsuit against ICOS, Lilly ICOS and Lilly in the United States District Court for the District of Delaware. The complaint alleges that the intended and imminent use, offering for sale, selling,
manufacture, or importing into the United States upon FDA approval of Cialis for the treatment of erectile dysfunction by ICOS, Lilly ICOS and Lilly will constitute infringement of plaintiffs U.S. Patent No. 6,469,012. The plaintiffs seek a
judgment declaring that the defendants using, selling, offering for sale, making or importing of Cialis for the treatment of erectile dysfunction will infringe this patent. The plaintiffs also seek a permanent injunction, attorneys fees,
costs and expenses. In January 2003, the Company filed an answer denying the central allegations of plaintiffs complaint and setting forth various affirmative defenses. In September 2003, the U.S. Patent and Trademark Office, or PTO, ordered
the reexamination of U.S. Patent No. 6,469,012. The reexamination process is provided for by law and requires the PTO to consider the validity of the patent based on substantial new questions of patentability raised by the PTO. In October 2003,
ICOS, Lilly ICOS and Lilly filed a motion for a stay with the



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LILLY ICOS LLC



NOTES TO FINANCIAL STATEMENTS  (Continued)



District Court, to suspend the patent infringement lawsuit, pending the outcome of the reexamination. In November 2003, the judge granted the requested stay.
In December 2003, the Company filed its own reexamination request, related to U.S. Patent No. 6,469,012, with the PTO.



Pfizers corresponding European method-of-use patent was previously held invalid in the first stage of an opposition proceeding in the European
Patent Office. Pfizer is now appealing that decision to the Technical Board of Appeal of the European Patent Office. A hearing is expected in the second half of 2004. The United Kingdom Court of Appeal has previously held the United Kingdom
counterpart to this patent invalid. Litigation relating to the corresponding patent is pending in Canada and Mexico.



Litigation is inherently unpredictable and the eventual outcome in a particular case is impossible to determine in advance. The Company believes that
Pfizers suit lacks merit and intends to vigorously pursue its various defenses. If Pfizer were to prevail in one or more countries, however, the Company might be subject to substantial damages, prohibited from marketing Cialis for the
treatment of erectile dysfunction in those countries, or required to enter into a licensing agreement to market Cialis in those countries. Any such adverse result could have a material adverse effect on the Companys business, financial
position, results of operations and cash flows.



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INDEX TO EXHIBITS



|      |  |                                                                                                                                                                                                                                       |  |     
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|      |  |                                                                                                                                                                                                                                       |  | Note
|3.1   |  | Restated Certificate of Incorporation of ICOS Corporation                                                                                                                                                                             |  | A   
|3.2   |  | Restated Bylaws of ICOS Corporation                                                                                                                                                                                                   |  | K   
|3.3   |  | Certificate of Designation of Series A Junior Participating Preferred Stock                                                                                                                                                           |  | M   
|4.1   |  | Indenture, dated as of June 20, 2003, between ICOS Corporation and Wells Fargo Bank, National Association, as Trustee, for 2% Convertible Subordinated Notes due July 1, 2023                                                         |  | O   
|10.1  |  | ICOS Corporation 1989 Stock Option Plan (Amended and Restated as of January 8, 1997)                                                                                                                                                  |  | D   
|10.2  |  | ICOS Corporation 1991 Stock Option Plan for Non-employee Directors (Amended and Restated as of January 8, 1997)                                                                                                                       |  | D   
|10.3  |  | ICOS Corporation 1999 Stock Option Plan (Amended and Restated as of January 21, 2004)                                                                                                                                                 |  | P   
|10.4  |  | Amended and Restated Stock Option Grant Program for Non-employee Directors under the ICOS Corporation 1999 Stock Option Plan                                                                                                          |  | P   
|10.5  |  | Employment Agreement dated as of September 16, 1993 between Gary Wilcox and ICOS Corporation                                                                                                                                          |  | C   
|10.6  |  | Employment Agreement between Paul N. Clark and ICOS Corporation dated June 11, 1999                                                                                                                                                   |  | I   
|10.7  |  | Rights Agreement dated as of August 9, 2002, between ICOS Corporation and Mellon Investor Services, LLC, as Rights Agent                                                                                                              |  | M   
|10.8  |  | Industrial Real Estate Lease dated February 6, 1992 between WRC Properties, Inc. and ICOS Corporation                                                                                                                                 |  | B   
|10.9  |  | First Amendment dated August 21, 1992 to Industrial Real Estate Lease Agreement between WRC Properties, Inc. and ICOS Corporation                                                                                                     |  | N   
|10.10 |  | Industrial Real Estate Lease Renewal and Amendment Agreement dated August 5, 1997 between WRC Properties, Inc. and ICOS Corporation                                                                                                   |  | F   
|10.11 |  | Third Amendment dated April 15, 2002 to Industrial Real Estate Lease Agreement dated February 6, 1992 between Teachers Insurance & Annuity Association of America, Inc., as successors to
WRC Properties, Inc., and ICOS Corporation  |  | N   
|10.12 |  | Real Estate Purchase and Sale Agreement dated October 30, 1992 between Canyon Park Business Center Limited Partnership and ICOS Corporation                                                                                           |  | B   
|10.13 |  | Industrial Real Estate Lease dated December 20, 1996 between WRC Properties, Inc. and ICOS Corporation                                                                                                                                |  | F   
|10.14 |  | First Amendment dated August 5, 1997 to Industrial Real Estate Lease Agreement between WRC Properties, Inc. and ICOS Corporation                                                                                                      |  | N   
|10.15 |  | 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                      |  | H   
|10.16 |  | Third Amendment dated April 15, 2002 to Industrial Real Estate Lease Agreement dated December 20, 1996 between Teachers Insurance & Annuity Association of America, Inc., as successors to
WRC Properties, Inc., and ICOS Corporation |  | N   
|10.17 |  | Industrial Real Estate Lease Agreement dated May 20, 1997 between Benaroya Capital Company, LLC and ICOS Corporation                                                                                                                  |  | F   
|10.18 |  | First Amendment dated February 18, 1998 to Industrial Real Estate Lease Agreement dated May 20, 1997 between Benaroya Capital Company, LLC and ICOS Corporation                                                                       |  | N   
|10.19 |  | Second Amendment dated August 13, 2001 to Industrial Real Estate Lease Agreement dated May 20, 1997 between Benaroya Capital Company, LLC and ICOS Corporation                                                                        |  | N   
|10.20 |  | Industrial Real Estate Lease Agreement dated September 6, 2000 between Benaroya Capital Company, LLC and ICOS Corporation                                                                                                             |  | J   
|10.21 |  | Industrial Real Estate Lease Agreement dated January 7, 1999 between CarrAmerica Realty Corporation and ICOS Corporation                                                                                                              |  | H   
|10.22 |  | First Amendment dated April 11, 2001 to Industrial Real Estate Lease Agreement dated January 7, 1999 between CarrAmerica Realty Corporation and ICOS Corporation                                                                      |  | L   



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##### Table of Contents

|      |  |                                                                                                                                                                                           |  |     
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|      |  |                                                                                                                                                                                           |  | Note
|10.23 |  | Industrial Real Estate Lease Agreement dated June 4, 2001, between Benaroya Capital Company, LLC and ICOS Corporation                                                                     |  | N   
|10.24 |  | Industrial Real Estate Lease Agreement dated November 1, 2002, between Bellevue Trade Center, LLC and ICOS Corporation                                                                    |  | N   
|10.25 |  | Shareholders Agreement, entered into December 18, 1996, among ICOS Corporation, Suntory Limited and Suncos Corporation                                                                    |  | D*  
|10.26 |  | rPAF-AH License Agreement, dated February 6, 1997, between ICOS Corporation and Suncos Corporation                                                                                        |  | D*  
|10.27 |  | Development and Supply Agreement, dated February 6, 1997, among ICOS Corporation, Suntory Limited and Suncos Corporation                                                                  |  | D*  
|10.28 |  | ICOS Services Agreement, dated February 6, 1997, between Suncos Corporation and ICOS Corporation                                                                                          |  | D*  
|10.29 |  | ICOS License Agreement, dated February 6, 1997, between Suncos Corporation and ICOS Corporation                                                                                           |  | D*  
|10.30 |  | 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 |  | E*  
|10.31 |  | Purchase Agreement dated as of June 5, 1997 between ICOS Corporation and each of the Limited Partners from time to time of ICOS Clinical Partners, L.P                                    |  | E*  
|10.32 |  | Product Development Agreement, dated as of June 5, 1997, by and between ICOS Corporation and ICOS Clinical Partners, L.P                                                                  |  | E*  
|10.33 |  | Limited Liability Company Agreement of Lilly ICOS LLC (LLC Agreement) dated September 30, 1998 between ICOS Corporation and Eli Lilly and Company, including Exhibit E thereto            |  | G*  
|10.34 |  | Lilly License Agreement, dated September 30, 1998, between Lilly ICOS LLC and Eli Lilly and Company (Exhibit A to the LLC Agreement)                                                      |  | G*  
|10.35 |  | PDE5 License Agreement, dated September 30, 1998, between ICOS Corporation and Lilly ICOS LLC (Exhibit B to the LLC Agreement)                                                            |  | G*  
|10.36 |  | 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)                           |  | G*  
|10.37 |  | 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)                     |  | G*  
|10.38 |  | Registration Rights Agreement, dated as of June 20, 2003, for 2% Convertible Subordinated Notes due July 1, 2023                                                                          |  | O   
|23.1  |  | Consent of KPMG LLP (ICOS Corporation)                                                                                                                                                    |  | P   
|23.2  |  | Consent of KPMG LLP (Lilly ICOS LLC)                                                                                                                                                      |  | P   
|31.1  |  | Section 302 Certification of Paul N. Clark                                                                                                                                                |  | P   
|31.2  |  | Section 302 Certification of Michael A. Stein                                                                                                                                             |  | P   
|32.1  |  | Certification of Paul N. Clark Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                   |  | P   
|32.2  |  | Certification of Michael A. Stein Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                |  | P   



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Legend to Exhibit Index:



|     |  |                                                                                                                                                                   
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note |  |                                                                                                                                                                   
|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 (File No. 000-19171) and incorporated herein by reference.                         
|C    |  | Filed as an exhibit to the Companys Form 10-Q Quarterly Report on November 2, 1993 (File No. 000-19171) and incorporated herein by reference.                    
|D    |  | Filed as an exhibit to the Companys Form 10-K Annual Report on March 31, 1997 (File No. 000-19171) and incorporated herein by reference.                         
|E    |  | Filed as an exhibit to the Companys Form 8-K Current Report on August 26, 1997 (File No. 000-19171) and incorporated herein by reference.                        
|F    |  | Filed as an exhibit to the Companys Form 10-Q Quarterly Report on November 17, 1997 (File No. 000-19171) and incorporated herein by reference.                   
|G    |  | Filed as an exhibit to the Companys Form 10-Q Quarterly Report on November 13, 1998 (File No. 000-19171) and incorporated herein by reference.                   
|H    |  | Filed as an exhibit to the Companys Form 10-K Annual Report on March 31, 1999 (File No. 000-19171) and incorporated herein by reference.                         
|I    |  | Filed as an exhibit to the Companys Form 10-Q Quarterly Report on August 13, 1999 (File No. 000-19171) and incorporated herein by reference.                     
|J    |  | Filed as an exhibit to the Companys Form 10-K Annual Report on March 29, 2001 (File No. 000-19171) and incorporated herein by reference.                         
|K    |  | Filed as an exhibit to the Companys Form 10-Q Quarterly Report on November 14, 2001 (File No. 000-19171) and incorporated herein by reference.                   
|L    |  | Filed as an exhibit to the Companys Form 10-K Annual Report on March 29, 2002 (File No. 000-19171) and incorporated herein by reference.                         
|M    |  | Filed as an exhibit to the Companys Registration Statement on Form 8-A filed on August 9, 2002 (Registration No. 000-19171) and incorporated herein by reference.
|N    |  | Filed as an exhibit to the Companys Form 10-K Annual Report on March 13, 2003 (File No. 000-19171) and incorporated herein by reference.                         
|O    |  | Filed as an exhibit to the Companys Form 10-Q Quarterly Report on August 5, 2003 (File No. 000-19171) and incorporated herein by reference.                      
|P    |  | Filed with this document.                                                                                                                                         
|*    |  | Confidential treatment has been granted with respect to portions of this exhibit.                                                                                 



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SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Bothell, State of Washington,
on the 12th day of March, 2004.



ICOS
CORPORATION

(Registrant)



By:

/s/    PAUL N. CLARKPaul N. Clark Chairman of the Board of Directors, Chief Executive Officer and
President (Principal Executive Officer)




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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, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                                                  |  |                                                                                                         |  |               
|------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                         |  | Title                                                                                                   |  | Date          
|                                                  |  |                                                                                                        
|/s/    PAUL N. CLARKPaul N. Clark                 |  | Chairman of the Board of Directors,
Chief Executive Officer and President (Principal Executive Officer) |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    MICHAEL A. STEINMichael A. Stein           |  | Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)                 |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    GARY L. WILCOXGary L. Wilcox               |  | Director and Executive Vice President, Operations                                                       |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    FRANK T. CARYFrank T. Cary                 |  | Director                                                                                                |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    JAMES L. FERGUSONJames L. Ferguson         |  | Director                                                                                                |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    WILLIAM H. GATES, IIIWilliam H. Gates, III |  | Director                                                                                                |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    DAVID V. MILLIGANDavid V. Milligan         |  | Director                                                                                                |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    ROBERT W. PANGIARobert W. Pangia           |  | Director                                                                                                |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    JACK W. SCHULERJack W. Schuler             |  | Director                                                                                                |  | March 12, 2004
|                                                  |  |                                                                                                        
|/s/    WALTER B. WRISTONWalter B. Wriston         |  | Director                                                                                                |  | March 12, 2004



83