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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-K

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

For the fiscal year ended December 31, 2002

Commission file number 0-19125

Isis Pharmaceuticals, Inc.
(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)		   33-0336973
(IRS Employer Identification No.)

2292 Faraday Ave., Carlsbad, CA 92008
(Address of principal executive offices, including zip code)

760-931-9200
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
 Common Stock, $.001 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 ý    No o

        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. ý

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

        The approximate aggregate market value of the voting common stock held by non-affiliates of the Registrant, based upon the last sale price of the common stock reported on the National Association of Securities Dealers Automated Quotation National Market System was $421,911,654 as of June 30, 2002.*

        The number of shares of voting common stock outstanding as of February 28, 2003 was 55,381,331.

DOCUMENTS INCORPORATED BY REFERENCE
(To the extent indicated herein)

        Registrant's definitive Proxy Statement filed on or about April 25, 2003, with the Securities and Exchange Commission in connection with Registrant's annual meeting of stockholders to be held on June 10, 2003, is incorporated by reference into Part III of this Report. The Exhibit Index (Item No. 15) located on pages 61 to 66 incorporates several documents by reference as indicated therein.

*
Excludes 9,826,723 shares of common stock held by directors and officers and by stockholders whose beneficial ownership is known by the Registrant to exceed 10% of the common stock outstanding at June 30, 2002. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant.

        This Form 10-K contains forward-looking statements regarding our business and the therapeutic and commercial potential of our technologies and products in development. Any statement describing our goals, expectations, intentions or beliefs is a forward-looking statement and should be considered an at-risk statement. Such statements are subject to certain risks and uncertainties, particularly those risks or uncertainties inherent in the process of discovering, developing and commercializing drugs that can be proven to be safe and effective for use as human therapeutics, in the process of conducting gene functionalization and target validation services, and in the endeavor of building a business around such products and services. Actual results could differ materially from those discussed in this Form 10-K. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Form 10-K including those identified in the section of Item 1 entitled "Risk Factors". As a result, you should not rely on these forward-looking statements.

        Vitravene® is a registered trademark of Novartis AG. Taxotere® is a registered trademark of Aventis Pharmaceuticals, Inc. GeneTrove™ and Ibis Therapeutics™ are trademarks of Isis Pharmaceuticals, Inc. Affinitak™, a trademark of Eli Lilly and Isis Pharmaceuticals, Inc. HepaSense™ is a trademark of HepaSense Ltd. Orasense™ is a trademark of Orasense Ltd.

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PART I

ITEM 1. Business

Overview

        We are a biopharmaceutical company exploiting proprietary RNA-based drug discovery technologies to identify and commercialize novel drugs to treat important diseases. RNA, or ribonucleic acid, is a molecule that provides to a cell the information the cell needs to produce proteins, including those proteins involved in disease. Interference with RNA can keep the body from producing proteins that are involved in disease. We have a strong proprietary position in RNA-based drug discovery technologies. With our primary technology, antisense, we create inhibitors, or oligonucleotides, designed to hybridize, or bind, with high specificity to their RNA target and modulate the production of proteins associated with diseases. With our Ibis technology, we use our expertise in RNA to design small molecule drugs that bind to RNA through mechanisms other than hybridization. We also use our antisense technology in collaborations with pharmaceutical companies to identify and prioritize attractive gene targets for their drug discovery programs. We are a leader in exploiting RNA as a target for drugs.

        We used our antisense technology to commercialize our first product, Vitravene. Vitravene demonstrates our ability to meet FDA and European regulatory requirements and to commercially manufacture antisense drugs. We currently have 12 antisense products in our development pipeline with eight in human clinical trials designed to assess safety and efficacy. Our products in development address numerous therapeutic areas with major market potential, including inflammatory, viral, metabolic and dermatological diseases, and cancer. We are expanding the therapeutic opportunities for antisense drugs by developing a variety of formulations to enhance patient convenience and compliance. Physician's may be able to dose our second-generation drugs, which represent over half of our drugs in development, as infrequently as once per month. We are also making progress on developing oral formulations of our second-generation drugs. Recent clinical trial data showed the potential feasibility of oral solid dosage forms for antisense drugs. This oral formulation platform will increase the commercial competitiveness of our antisense drugs in the marketplace and broaden its applicability.

        Affinitak, formerly LY900003 or ISIS 3521, is our most advanced product in development. We recently announced the results of our Phase III clinical trial of Affinitak to treat patients with non-small cell lung cancer. In this 616-patient trial, we observed no difference in overall survival of those patients who received Affinitak plus the chemotherapy regimen of carboplatin and paclitaxel compared to those patients who received the chemotherapy alone. Survival was the primary endpoint. The median survival for the Affinitak treated patients was ten months, compared to 9.7 months for those patients treated with the chemotherapy alone. Additional analyses of the data, however, suggest that Affinitak was active in this trial. For example, using an alternative statistical analysis of all 616 patients which considered predefined variables, including duration of treatment, survival of the Affinitak treated patients was greater than that of patients in the control group. This result was statistically significant. Lilly and we are performing an in-depth analysis of the data and expect to submit the complete findings from this trial for scientific presentation at an appropriate medical meeting later this year. Lilly plans to evaluate Affinitak's performance in its on-going Phase III trial, in which patients are being treated with Affinitak in combination with gemcitabine and cisplatin. As we proceed with these evaluations, Lilly and we will make a decision about the future development of Affinitak.

        We currently have two Phase III clinical trials for another product, ISIS 2302, or alicaforsen, in an inflammatory bowel disease known as Crohn's disease. These trials are being conducted in North America and Europe. We have five additional products undergoing Phase II clinical trials.

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        Our GeneTrove division uses our antisense technology as a tool to provide important information about the function of genes. We use this information to direct our own drug discovery research and that of our antisense drug discovery partners, such as Lilly and Amgen. We generate this information rapidly and efficiently using the same proprietary methods and systems that we developed to create antisense drugs. We offer anitsense-based gene function information to pharmaceutical company partners that are evaluating the genes as targets for their own drug discovery programs. Through the sale of this informaton, we generate revenue from our research efforts and increase industry experience with our technology. We are currently collaborating with ten major pharmaceutical partners, including Abbott Laboratories, Inc.; Amgen Inc.; Aventis; Celera Genomics Group; Chiron Corporation; Eli Lilly and Company; GlaxoSmithKline plc; Johnson & Johnson Pharmaceutical Research & Development, LLC; Merck & Co., Inc. and Pharmacia Corporation. We also license our antisense-based functional genomics patents to partners. Through these license agreements, GeneTrove partners gain access to our functional genomics suite of patents for use in their internal genomics programs. In August 2001, we added a subscription database product to GeneTrove's offerings. We were unsuccessful in generating customers for our database product and in November 2002 we announced its termination. This resulted in a reorganization of the GeneTrove division and a reduction in its workforce by approximately 25 people. The restructuring plan also provided for the write-down of certain intellectual property. Our GeneTrove division continues to generate near-term revenue while enhancing our own antisense drug discovery efforts and our patent portfolio.

        In our Ibis division we have developed technology that has the potential to revolutionize the detection and treatment of infectious disease. We are creating a sensor that can detect known and unknown infectious agents, and are working to discover small molecule drugs that work by binding to RNA. Our scientists have invented methods of identifying common binding sites in RNA that facilitate the identification of organisms or serve as targets for drug binding. We have also invented mass spectrometry-based screening methods for both diagnostic and drug discovery applications. In a program called Triangulation Identification Genetic Evaluation of biological Risks, or TIGER, we are applying our Ibis technology to develop a sensor to detect infectious agents that could be used in biological warfare. We are collaborating with San Diego-based Science Applications International Corporation, or SAIC, on this multi-year program funded by the Defense Advanced Research Projects Agency, or DARPA. Ibis expects to receive funding of up to $9.8 million for its efforts related to TIGER. Since the division's inception, Ibis has received significant financial support from various government agencies to use its technology to develop broad-spectrum anti-infective drugs that we believe will have usefulness in national defense. In early 2002, Ibis received a three-year contract to continue its drug discovery program with the U.S. Army Medical Research Institute of Infectious Diseases, or USAMRIID. The contract provides for funding of up to $2.4 million.

        In addition to the projects with government agencies, Ibis collaborated with Pfizer from June 2000 through June 2002 for the discovery and development of small molecule drugs against certain RNA targets. During this period, Ibis earned two research milestones totaling $4.0 million. This collaboration ended in June 2002 in accordance with its terms.

        We have a broad patent portfolio covering our technologies. We have rights to nearly 1,200 issued patents, which we believe represents the largest antisense and RNA-oriented patent estate in the pharmaceutical industry. Our intellectual property is a strategic asset that we are exploiting to generate near-term revenue and that we expect will also provide us with revenue in the future. The principal purpose of our intellectual property portfolio is to protect our inventions in RNA-based drug discovery. Our intellectual property estate also enables us to expand our pipeline by granting partners limited access to antisense technology, which includes licensing. Licensing partnerships may include antisense drug discovery alliances such as those we have with Lilly and Amgen, as well as GeneTrove functional genomics collaborations like those we have with Amgen, Chiron and Pharmacia. Licensing partnerships may also include Ibis drug discovery alliances like the one we had with Pfizer.

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        In addition, we have issued licenses to our functional genomics patents, like our licenses to Chiron, Amgen, Sequitur and atugen AG, as well as licenses to our non-antisense patents, like our license to Eyetech Pharmaceuticals, Inc. In 2002, we successfully defended our patent estate when we settled a patent infringement lawsuit against Sequitur on terms favorable to us.

Drug Discovery and Development

        From our progress in antisense we have developed a robust pipeline of promising new drugs and efficient genomics tools that unlock value from gene sequence data. Our earlier stage Ibis program has potential to become an important new approach to the detection and treatment of infectious diseases.

Antisense Technology Platform

        Proteins are essential, working molecules in a cell. Almost all human diseases result from inappropriate protein production or improper protein activity. Scientists use traditional drug discovery methods to design drugs to interact with the proteins in the body that are supporting or causing a disease. Antisense technology is different from traditional drug discovery because it specifically targets disease-causing proteins before the body produces them. We design our antisense drugs, or antisense inhibitors, to act earlier in the disease process than traditional drugs and to interrupt the production of disease causing proteins without disrupting proteins responsible for the body's normal functioning.

        Genes contain the information necessary to produce proteins. A gene is made up of bases, or nucleotides: Adenine, Thymine, Guanine, Cytosine, commonly known as A, T, G and C, which are linked together to form a two-stranded structure that resembles a twisted ladder, known as DNA or deoxyribonucleic acid. The nucleotides on one side of the ladder bind weakly to complementary nucleotides on the other strand according to specific rules, for example A pairs with T and G pairs with C, creating the ladder's rungs. This highly specific nucleotide pairing is called hybridization. The sequence or order of these nucleotides establishes the cell's recipe for making proteins.

        When a cell transcribes information from DNA into messenger RNA, or mRNA, the two complementary strands of the DNA partly uncoil. One strand acts as a template and information stored in the DNA strand is copied into a complementary mRNA. mRNA then carries the information to cellular structures called ribosomes, the cell's factories for manufacturing proteins. The ribosome reads the encoded information, its mRNA's nucleotide sequence, and in so doing, strings together amino acids to form a specific protein. This process is called translation. Antisense technology interrupts the cell's protein production process by preventing the RNA instructions from reaching the ribosome, thus inhibiting the production of the protein. The mRNA sequence of nucleotides that carries the information for protein production is called the "sense" strand. The complementary nucleotide chain that binds specifically to the sense strand is called the "antisense" strand.

        We use the information contained in mRNA to design chemical structures, called antisense oligonucleotides, which resemble DNA and RNA and are the complement of mRNA. These potent antisense oligonucleotides inhibit the production of disease-causing proteins. Antisense drugs can selectively inhibit one protein among a closely related group of proteins because antisense drugs interact selectively with the specific RNA and not with the closely related members of the group. It is easier to differentiate between closely related proteins at the RNA sequence level than by binding to the protein itself, as traditional drugs do. As a result, we can design antisense drugs that selectively inhibit the disease-causing member of the group without interfering with those members of the group necessary for normal bodily functions. This unique specificity means that antisense drugs may be far less toxic than traditional drugs, because we can design them to minimize the impact on unintended targets.

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        Further, the design of antisense compounds is less complex, more rapid and more efficient than traditional drug design directed at protein targets. Traditional drug design requires companies to identify a small molecule that will interact with protein structures to affect the disease-causing process. Since predicting which small molecules will do this has proven to be difficult, traditional drug discovery involves testing hundreds of thousands of small molecules for their ability to interfere with protein function. As a result, traditional drug discovery is a labor intensive, low probability endeavor. On the other hand, we design our antisense compounds to bind to mRNA structures through well understood processes. We can design prototype antisense drugs as soon as we identify the sequence for the mRNA receptor.

        We are the leader in the discovery and development of this exciting new class of therapeutic compounds. Our proprietary technology to discover and characterize novel antisense inhibitors has enabled our scientists to modify the properties of our antisense drug candidates for optimal use with particular targets and thus to produce a broad proprietary portfolio of compounds applicable to many disease targets. Further, over the past decade, our scientists have made great advancements in chemistries, which we call our second-generation antisense drugs, that have increased the potency, stability, oral bioavailability and side effect profile of this new class of drugs. We have also made significant progress in developing new formulations, like oral, topical cream, subcutaneous, intravitreal, aerosol and enema, of antisense drugs that further expand the potential for antisense technology.

        In our functional genomics division, GeneTrove, we use antisense technology to generate information about the function of genes and to determine the value of genes as drug discovery targets. This information forms the basis of the first step of our antisense drug discovery program. We use this information to direct our own antisense drug discovery research, and that of our antisense drug discovery partners, Lilly and Amgen.

        Due to its specificity, versatility and efficiency, antisense is an important technology platform for conducting biological studies to identify what a gene does, called gene functionalization, and to determine whether a specific gene is a good target for drug discovery, called target validation. We produce optimized, target-specific antisense inhibitors to genes based on a variety of specialized technologies that we have created and/or integrated, including a proprietary automated rapid throughput screening process.

        Through our streamlined process, we can produce antisense inhibitors to a particular gene for use in cell culture studies in a matter of days. Scientists can use these antisense inhibitors in cellular assays and in animal models of disease to rapidly determine the pharmacological impact of inhibiting the expression of a single gene target and to determine the role of the targeted gene in human disease. We have created inhibitors to thousands of genes, validated many targets and dissected numerous disease pathways. Additionally, we have created libraries of antisense inhibitors to identify novel gene function.

        We have commercialized this first step in our antisense drug discovery program through our GeneTrove division by providing valuable gene functionalization and target validation services to pharmaceutical and biotechnology companies. Our collaborators use the information we generate to enhance and expedite their drug discovery decisions. Our GeneTrove collaborations generate near-term revenue for us, and broaden the industry's exposure to antisense technology.

        Our business strategy for GeneTrove involves three components. The first is the use of antisense-based functional genomics to facilitate the discovery and development of antisense drugs for ourselves and for our partners. Second, we offer custom target validation collaborations to partners, in which research is focused on identifying the role and value of specific genes as drug targets for their own drug discovery programs. Current collaborators include Abbott, Amgen, Celera Genomics, Chiron, GlaxoSmithKline, Johnson & Johnson, Lilly and Merck. The third component, functional genomics

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intellectual property licensing, encourages industry partners to work with GeneTrove for antisense-based gene functionalizaton and target validation. Partners may access our intellectual property as part of a target validation collaboration, as in the case of Amgen, Chiron and Pharmacia. Companies may choose to license our technology to support their use of antisense, independent of a collaboration with us. Sequitur, Pfizer and atugen AG, are examples of such licensees. In August 2001, we added a subscription database product to GeneTrove's offerings. However, we were unsuccessful in generating subscription customers for our database product. In November 2002 we announced the termination of the database offering, and the reorganization of the GeneTrove division. The restructuring plan resulted in a reduction in our workforce of approximately 25 people and also provided for the write-down of certain intellectual property.

        Our GeneTrove division enhances our own antisense drug discovery efforts and our patent portfolio through custom target validation collaborations and intellectual property licenses while generating near-term revenue for us.

Ibis Technology Platform

        In our Ibis division we have developed technology that has the potential to revolutionize the detection and treatment of infectious disease. Our Ibis technology uses our success in RNA-targeted drug discovery and development and expands on our ability to convert genomics data into information for diagnostics and drug discovery.

        In Ibis, we have developed proprietary technologies in four key areas:

Based on this expertise, we are developing a diagnostic instrument to detect infectious agents that may be used in biological attacks, and we are working to discover drugs that work by binding to RNA targets.

        In the area of diagnostics, Ibis is applying its core technology to a DARPA-sponsored research program called TIGER. In the TIGER program we are developing a sensor to detect infectious organisms, including known, unknown, unculturable or bioengineered agents that could be used in biological attacks. We received our initial TIGER funding from DARPA in October 2001. The TIGER contract builds on the biological warfare countermeasure research Ibis conducted in two previous DARPA programs. The preceding studies, initiated in 1997 and 1999, focused on creating a strategy to identify common binding sites, or structured regions within RNA, to a wide range of infectious agents in order to develop small molecules to combat infectious pathogens. Ibis is working with SAIC on TIGER. The SAIC and Ibis partnership combines Ibis' expertise in microbial genome sequence analysis and advanced mass spectrometry technology with SAIC's advanced signal processing capabilities. The original TIGER contract included funding of up to $8.9 million. During 2002, DARPA increased the contract amount to $9.8 million.

        Ibis' therapeutic focus is the discovery of novel, potentially orally bioavailable, low molecular weight, or small molecule, drugs to treat infectious disease and cancer. Since its inception, Ibis has received significant financial support from government-funded grants and contracts to use its technology to assist in national defense. In March 2002, Ibis transitioned its government-sponsored

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research program to discover novel broad-spectrum antibacterial drugs for biological warfare defense to USAMRIID. Ibis received a three-year contract from USAMRIID to advance its work in this area and expects to receive funding of up to $2.4 million under this contract.

        Ibis also has research relationships with several other government entities including the United States Navy, the Federal Bureau of Investigations and the Center for Disease Control and Prevention.

        In addition to the projects with government agencies, Ibis collaborated with Pfizer from June 2000 through June 2002 to discover and develop small molecule drugs against certain RNA targets. During this period, Ibis earned two research milestones totaling $4.0 million. This collaboration ended in June 2002 in accordance with its terms.

Product Approved and Products Under Development

        We have successfully developed the first antisense drug to reach the market, Vitravene, for CMV retinitis. Our commercialization partner, Novartis Ophthalmics AG, markets this drug.

        We have designed our drugs in development to treat a variety of health conditions, including inflammatory, viral, metabolic and dermatological diseases, and cancer, and we are studying them in intravenous, subcutaneous, topical cream, enema and oral formulations. Intravenous and subcutaneous formulations are commonly grouped together and referred to as parenteral forms of administration. The following table lists our approved product and each of our products under development, its target, disease indication and development status, as well as our commercial rights.


Products Approved and in Development

Product(1)
   Target
   Potential Disease Indication(s)
   Development Status(2)
   Commercial Rights
Vitravene (I)   Antiviral   CMV Retinitis   Commercially available in the U.S., Europe, Australia and Brazil.   Isis/Novartis Ophthalmics(3)
Affinitak (formerly LY900003 or ISIS 3521) (P)   PKC-alpha   Cancer—Non-Small Cell Lung Cancer, Others   Phase III   Lilly
Alicaforsen (ISIS 2302) (P)   ICAM-1   Crohn's Disease   Phase III   Isis
Alicaforsen (ISIS 2302) (E)   ICAM-1   Ulcerative Colitis, Pouchitis   Phase II   Isis
ISIS 14803 (P)   Antiviral   Hepatitis C   Phase II   Isis
ISIS 2503 (P)   H-ras   Cancer—Pancreatic, Others   Phase II   Isis
ISIS 104838 (P,O)*   TNF-alpha   Rheumatoid Arthritis   Phase II   Isis
ISIS 104838 (T)*   TNF-alpha   Psoriasis   Phase II   Isis
OGX-011 (P)*   Clusterin   Cancer—Prostate, Others   Phase I   Isis/OncoGenex
ISIS 23722 (P)*   Survivin   Cancer   Preclinical   Lilly
ISIS 113715 (P)*   PTP-1B   Diabetes   Preclinical   Isis
ISIS 13650 (I)*   C-raf kinase   Diabetic Retinopathy, Age-Related Macular Degeneration   Preclinical   Isis
ISIS 107248 (P)*   VLA-4   Multiple Sclerosis, Inflammatory Diseases   Preclinical   Antisense Therapeutics Limited
(1)
I = Intravitreal; P = Parenteral; T = Topical; O = Oral; E = Enema

(2)
A compound in the preclinical phase of development is one in which we have initiated toxicology and pharmacokinetic studies in animals to support the filing with the FDA of an Investigational New Drug, or IND.

(3)
Novartis Ophthalmics has the exclusive worldwide rights to distribute Vitravene.

*
Second-generation drugs

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        The following section provides more detailed descriptions of our approved product and those products under development and the disease indications they target. We also have a significant research program with the potential to yield additional development candidates in the future.

Cytomegalovirus, or CMV, Retinitis

        Individuals with suppressed immune systems, such as those with AIDS resulting from the HIV virus, are susceptible to opportunistic infections caused by CMV. In the AIDS population, CMV retinitis is the primary cause of blindness. The most recent statistics available from the Centers for Disease Control indicate there are more than 362,000 active AIDS cases in the United States. New anti-HIV drugs, particularly protease inhibitors and combination treatment regimens, have prolonged survival in HIV-infected individuals. Over the last several years, this has resulted in a decline in mortality from AIDS, accompanied by a decline in the incidence of many opportunistic infections including CMV retinitis. Currently approved drugs for CMV retinitis are ganciclovir, foscarnet, cidofovir and fomivirsen. Foscarnet and cidofovir are available in intravenous dosing forms only. Ganciclovir is available in intravenous and oral doses, as well as in an intraocular implant form.

        Vitravene, or fomivirsen—In August 1998, the FDA approved Vitravene to treat CMV retinitis in AIDS patients. Vitravene is an antisense compound that we discovered and developed. Novartis Ophthalmics AG, the eye health unit of life sciences leader, Novartis AG, and our worldwide distribution partner for this drug, launched Vitravene in November 1998. For a more detailed discussion of this collaboration, see "Collaborative Arrangements and Licensing Agreements—Novartis Ophthalmics." Vitravene is commercially available in the U.S., Europe, Australia and Brazil.

Cancer

        We are pursuing the development of antisense drugs for the treatment of a variety of cancers. In our clinical trials, we have observed evidence of activity of our drugs. In addition, patients tolerated our compounds well, with none of the serious side effects, such as bone marrow or immune system suppression, gastrointestinal distress or hair loss, associated with standard cancer chemotherapies.

        Affinitak—Affinitak, which we licensed to Lilly in August 2001, is our antisense compound in Phase III clinical development for non-small cell lung cancer. Affinitak inhibits the production of one particular isotype, the alpha isotype, of protein kinase C, or PKC. PKC alpha is a member of a family of proteins that are associated with both normal and abnormal cell growth. PKC alpha has been shown to be involved in cancer cell growth and maintenance. In preclinical studies, we have been able to specifically inhibit the production of the PKC-alpha isotype without inhibiting the production of other isotypes, thus allowing the inhibition of an isotype believed to be involved in abnormal cell growth without more broadly affecting all the different PKC isotypes.

        We recently announced the results of our Phase III clinical trial of Affinitak in combination with traditional cancer chemotherapy drugs to treat patients with non-small cell lung cancer. In this 616-patient trial, we observed no difference in a primary log-rank analysis of overall survival, the primary endpoint of the trial, of those patients who received Affinitak plus the chemotherapy regimen of carboplatin and paclitaxel compared to those patients who received the chemotherapy alone. The median survival for the Affinitak treated patients was ten months compared to 9.7 months for those patients treated with the chemotherapy alone.

        It is common in clinical trials to perform additional analyses of the data using other standard statistical methods or tests, and after conducting other analyses of the trial, we observed evidence of activity of Affinitak in this trial. For example, our statistical analysis plan allowed for a stratified log-rank analysis of survival of all 616 patients in the trial. The benefit of the stratified log-rank analysis is that it considers a number of predefined variables, including duration of treatment. We observed that survival of the Affinitak treated patients was greater than that of the patients who received the

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chemotherapy alone. This result was statistically significant. Another potentially important observation from the trial is that those patients who completed the prescribed course of therapy, 6 cycles, experienced a survival benefit compared to those patients who did not complete therapy. A survival analysis of the 256 patients who completed the prescribed 6 cycles of the chemotherapy showed a median survival of 17.3 months for Affinitak patitents compared to 14.4 months for patients who received the chemotherapy alone. This result suggests that the duration of treatment with Affinitak may contribute to improved survival. Additionally, in those patients who completed the prescribed course of therapy, results favored the Affinitak group across multiple secondary endpoints, including time to disease progression, time to treatment failure and duration of remission.

        The addition of Affinitak to carboplatin and paclitaxel was well tolerated. There were no increases in severe toxicities or toxicity related deaths in patients receiving Affinitak, compared to those receiving the chemotherapy alone. The most common side effects among patients in the study were fatigue and nausea. Patients in the study receiving Affinitak in combination with the chemotherapy had a higher rate of moderate thrombocytopenia, nausea and vomiting. Further, because Affinitak is given via continuous intravenous infusion, Affinitak treated patients had a higher incidence of catheter-related infections.

        All of the above results are based on our initial assessment of the data. We and Lilly are performing an in-depth analysis of the data and we expect to submit the complete findings of the trial for scientific presentation at an appropriate medical meeting later this year. Lilly plans to evaluate Affinitak's performance in Lilly's on-going Phase III trial, in which patients being treated with Affinitak in combination with gemcitabine and cisplatin. As we proceed with these evaluations, Lilly and we will make a decision about the further development of Affinitak.

        According to the American Cancer Society, lung cancer is the leading cause of cancer death for both men and women. In 2003, an estimated 171,000 new cases of lung cancer are expected to be diagnosed and approximately 157,000 Americans are expected to die due to the disease. More people die of lung cancer than of colon, breast and prostate cancers combined. Non-small cell lung cancer is the most prevalent form of lung cancer, accounting for approximately 80 percent of lung cancer diagnoses in the United States.

        ISIS 2503—Substantial evidence exists supporting a direct role for ras gene products in the development and maintenance of human cancer. Ras proteins are involved in passing information between cells. Ras, in both normal and mutated forms, is associated with abnormal cell growth and, as such, is associated with cancer. ISIS 2503, a potent selective inhibitor of Harvey ras, or H ras, has been shown to inhibit abnormal cell growth in cell culture and animal models.

        In Phase I studies, patients tolerated ISIS 2503 well and reported no serious side effects. We also observed evidence of activity. These results supported continued development of ISIS 2503 in Phase II trials for the treatment of pancreatic, breast and non-small cell lung cancer. We have recently completed a Phase II study of ISIS 2503 in pancreatic cancer. Final results of this Phase II study demonstrated that 57.5 percent of 48 patients who received ISIS 2503 plus gemcitabine survived six months or longer. Gemcitabine is the standard care for pancreatic cancer. Based on these results reported in December 2002, we are considering various strategies, including partnering, for the further development of this compound in pancreatic cancer.

        OGX-011—OGX-011 is a second-generation antisense inhibitor of clusterin, which we are co-developing and commercializing with OncoGenex Technologies Inc., a Canadian oncology-focused research and development company. OGX-011 is designed to inhibit the secretory protein clusterin, which acts as a cell-survival protein that is over-expressed in response to tumor killing strategies, like chemotherapy, hormone ablation and radiation therapy. Based on analysis of human tumor tissue, clusterin is over-expressed in several cancers, including prostate, renal, bladder, lung and ovarian.

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Inhibiting clusterin is intended to enhance the effects of drug therapies in the treatment of these cancers.

        In preclinical animal studies, scientists from both OncoGenex and Isis demonstrated OGX-011 improved the potency of traditional chemotherapies more than 10-fold in prostate cancer, without compromising safety. When combined with other cancer treatments in preclinical model systems, OGX-011 has been shown to significantly improve tumor reduction and delay disease progression in prostate, lung, bladder and renal cancer. These findings support the continued development of OGX-011 in combination with standard chemotherapy and other agents.

        OncoGenex initiated a Phase I program of OGX-011 in patients with prostate cancer in December 2002. This Phase I trial is evaluating OGX-011 in combination with hormone therapy prior to surgical removal of the prostate. A second Phase I study is scheduled to start in 2003 and will evaluate OGX-011 in combination with TAXOTERE® in various solid tumors. OGX-011 is our third anti-cancer drug in human clinical trials, and the first second generation antisense anti-cancer drug.

        ISIS 23722—We licensed our preclinical anti-cancer candidate, ISIS 23722, to Lilly in 2002, as part of the expansion of our Lilly research collaboration into cancer. The compound targets survivin, which plays a role in cancer cell death, or apoptosis. Survivin is one of the most abundantly expressed proteins in cancers. Our researchers and collaborators have shown that inhibiting expression of survivin by ISIS 23722 in cancer cells inhibits the growth of cancer cells and kills cancer cells. Since survivin is not expressed in normal cells in the body, we expect that this drug will have fewer side effects than traditional chemotherapy.

Inflammatory Diseases

        Our research and development efforts in the therapeutic area of inflammatory diseases focus on identifying and developing antisense inhibitors to proteins such as intercellular adhesion molecule 1, or ICAM-1, another adhesion molecule called CD49d, which is a subunit of VLA-4, and tumor necrosis factor-alpha, or TNF-alpha. Researchers believe that these proteins are involved in inflammatory diseases.

        Alicaforsen (ISIS 2302)—The most advanced compound in our cell adhesion program selectively inhibits ICAM-1 gene expression. ICAM-1 is a member of the intercellular adhesion molecule family. Over-expression of ICAM-1 occurs in a wide variety of inflammatory disorders, such as rheumatoid arthritis, asthma, psoriasis and inflammatory bowel diseases. Experts believe that ICAM-1 contributes to the pathology of these diseases and conditions. We are currently evaluating alicaforsen in two Phase III studies for the treatment of Crohn's disease. Additionally, we are conducting Phase II studies of alicaforsen enema formulation for the treatment of ulcerative colitis and pouchitis.

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        ISIS 104838—ISIS 104838 is a second-generation antisense inhibitor of TNF-alpha and the first product from our proprietary second-generation chemistry to enter the clinic. TNF-alpha, or tumor necrosis factor alpha, is a naturally occurring cytokine that is implicated in the development and progression of many inflammatory, infectious and autoimmune diseases, including rheumatoid arthritis and psoriasis. TNF-alpha is involved in bone and cartilage absorption, facilitates inflammation and inhibits bone formation. Most patients with rheumatoid arthritis have high levels of TNF-alpha.

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        ISIS 107248—ISIS 107248, or ATL 1102, is a second-generation antisense inhibitor of CD49d, which is a subunit of VLA-4. Inhibition of VLA-4 has been demonstrated to have a positive effect in animal models of a number of inflammatory diseases such as multiple sclerosis. In December 2001, we licensed ISIS 107248 to Antisense Therapeutics Limited, or ATL. Under our agreement with ATL, we were responsible for completing the required preclinical studies for ISIS 107248 and for manufacturing the bulk drug for human clinical trials at ATL's expense. ATL is responsible for the future clinical development and the commercialization of the drug. ATL expects to initiate a Phase I clinical trial of ISIS 107248 for the treatment of multiple sclerosis in the first half of 2003.

Hepatitis C, or HCV

        HCV represents a major public health challenge. This potentially deadly disease affects the liver and can eventually cause liver cirrhosis and death. It is estimated that almost four million people in the United States have been infected with HCV and 10,000 to 12,000 people in the United States are expected to die from his disease each year. Physician's attempt to eradicate this virus from chronically infected individuals by using Interferon-alpha therapy, either alone or in combination with the drug ribavirin. Patients with genotype 1 HCV have less than a 50% chance of having a sustained response with the current standard of care, pegylated interferon-alpha therapy and ribavirin. Type 1 genotype is the most common genotype in the United States. Better, safer and more effective treatments are urgently needed, as current therapies have limited efficacy and potentially serious side effects.

        ISIS 14803—Our antisense inhibitor of HCV, ISIS 14803, may represent a significant therapeutic advance in treating this serious viral epidemic. We designed ISIS 14803 to inhibit the replication of

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HCV. In November 2002, Isis presented data from two studies that showed ISIS 14803 is active in drug resistant, genotype 1 HCV patients, the most difficult-to-treat segment of the HCV patient population. In a 12 week Phase II study, the drug demonstrated promising antiviral activity by producing up to 3.8 log reductions in the level of virus in the blood, or viral titers, a 6,300-fold decrease in the viral loads of patients with this disease. This study is ongoing and we plan to report final results in 2003. In a four-week Phase I/II clinical trial, which we designed to evaluate both the safety and efficacy of ISIS 14803 in patients with HCV, ISIS 14803 demonstrated dose-dependent antiviral activity, decreasing the level of virus in the blood in patients with drug resistant chronic HCV. All patients in the clinical study had the most common and drug resistant form of HCV, genotype 1, and all but one patient had failed previous interferon-based therapy. Flu-like symptoms, headache and fatigue were the most common side effects observed in the trials. In 2003 we plan to evaluate ISIS 14803 in combination with currently used HCV treatments in an additional Phase II study.

        The development of ISIS 14803 had been the focus of our joint venture with Elan, HepaSense. In late 2002, Elan concluded its participation in the HepaSense collaboration, in conjunction with their continuing restructuring efforts. As a result, we have regained all rights to ISIS 14803, with a potential nominal royalty due to HepaSense.

Metabolic Diseases

        We are pursing the discovery and development of antisense drugs for metabolic diseases such as diabetes and obesity. These chronic diseases affect millions of people and represent significant areas of unmet medical need. We believe that our second-generation antisense drugs will have properties that will make them attractive therapies

        ISIS 113715—ISIS 113715 is our second-generation antisense inhibitor of the PTP-1B gene for Type 2 diabetes. According to the American Diabetes Association, diabetes affects nearly 17 million people and Type 2 diabetes constitutes 90 percent of those cases. An antisense inhibitor of PTP-1B represents a new approach to the treatment of diabetes. For years, pharmaceutical companies interested in diabetes research have actively pursued phosphatases, such as PTP-1B, as part of traditional small molecule drug discovery efforts. However, due to structural similarities among closely related enzymes, it is often difficult to identify small molecule drugs with the degree of specificity that the antisense approach can obtain.

        The preclinical studies of ISIS 113715 demonstrate compelling activity in multiple diabetic animal models and suggest activity as an insulin sensitizer without causing hypoglycemia and while reducing cholesterol and weight gain. In December 2002 we regained the full product rights to ISIS 113715 from Merck. We plan to initiate Phase I clinical trials of ISIS 113715 for the treatment of Type 2 diabetes this year.

        ISIS 13650—ISIS 13650 is an inhibitor of c-raf kinase for the treatment of diabetic retinopathy and age-related macular degeneration. Diabetic retinopathy is an ocular complication of diabetes. The incidence of these conditions continues to grow with the advancing age of the U.S. population. In preclinical studies, antisense inhibition of c-raf kinase is associated with a reduction of neovascularizatio, or growth of blood vessels, which can obstruct vision. ISIS 13650, a second-generation antisense product, is in preclinical development. We are exploring options for its further development.

Research Programs

        We combine our core technology programs in medicinal chemistry, RNA biochemistry, and molecular and cellular biology with molecular target-focused drug discovery efforts to design drug candidates. The goal of our target-based research programs is to identify antisense and small molecule drug candidates to treat diseases for which there are substantial markets and for which there is a need

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for better drugs. In addition, our research programs focus on identifying next-generation compounds to serve as backup compounds to our current products in development and to our development candidates. Our Ibis division is focused on discovering anti-infective drugs and creating mass spectrometry-based technology for infectious disease diagnostics.

        Our core technology programs can support multiple target-based antisense research programs without significantly increasing costs. Through these programs, we can efficiently explore numerous disease targets and identify lead compounds to advance into preclinical development. We are currently pursuing antisense and small molecule drug discovery programs focused on various anti-viral and anti-bacterial targets, inflammatory disease targets, and other key molecular targets that might play critical roles in cancer and metabolic diseases like diabetes and obesity.

Collaborative Arrangements and Licensing Agreements

        Our strategy is to use alliances with other companies and equity-based financing to increase our financial resources, reduce risk, and retain an appropriate level of ownership of products currently in development. Through alliances with major pharmaceutical companies, we can obtain funding, expand existing programs, learn of new technologies, and gain additional expertise in developing and marketing products.

2002 Business Development Highlights

        We are focused on establishing new partnerships and on advancing and building upon existing relationships. We currently have agreements with more than a dozen partners. These span all four areas of our business: antisense drug discovery and development, GeneTrove, Ibis and our intellectual property estate. The following is a list of our business development highlights for 2002:

Eli Lilly and Company

        In August 2001, we entered into a broad strategic relationship with Lilly that has four key components:

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        Lilly has committed more than $200 million in funding to us over a four-year period, which consists of the $75 million equity investment Lilly made in us, the $25 million Lilly paid to us in an upfront license fee for Affinitak, the amount Lilly has committed to pay us for the remaining development and registration costs for Affinitak and the $100 million Lilly has committed to loan us. Assuming success of Affinitak and the success of multiple products from the collaboration, the cumulative contingent funds over the life of the development process have the potential to exceed these committed funds.

        In September 2002, we further expanded our relationship with Lilly by agreeing to manufacture Affinitak during the product launch period for Lilly. Through this agreement we upgraded and expanded our manufacturing facility. We added a new state-of-the-art manufacturing suite dedicated to Affinitak. Lilly provided us with funding in the form of a loan of up to $21 million, to build the Affinitak suite. We will repay the loan from Affinitak success milestones due from Lilly, if we achieve such milestones, or other product-related cash flows. The movable equipment purchased for the manufacturing suite secures this loan. In February 2003, we completed construction of the facility, which is located on our Carlsbad campus in an existing building.

Antisense Drug Discovery Collaborations

        In December 2001, we entered into a three-year collaboration with Amgen to discover new antisense drugs. Amgen has the right to develop and commercialize antisense drugs resulting from the collaboration. If drugs from the collaboration are successful, we will receive milestone payments upon key clinical and commercial achievements, as well as royalties on sales of any products resulting from the collaboration. In August 2002 and February 2003, we earned progress-related research milestones under this drug discovery collaboration.

        In April 2002, we extended for a second time a research collaboration, with Merck to discover small molecule drug candidates to treat patients infected with HCV. Our chemists are working together with Merck scientists to design, synthesize and evaluate novel compounds that Merck may screen in its proprietary enzymatic assays for identifying Hepatitis C virus replication inhibitors. Merck has the right to commercialize any drugs arising from the collaboration, and we retain the right to use technology developed in the collaboration in our antisense program. The collaboration provides us with annual research support, research and clinical development milestone payments, and royalties upon commercialization of drugs that arise from the collaboration. In October 2001 and April 2002, we earned milestone payments for progress in the collaboration. We began the original three year drug discovery collaboration with Merck in June 1998 and announced the first one year extension in May 2001. We expect the collaboration will end in May 2003 in accordance with its terms.

Antisense Drug Development Collaborations

        An important aspect of our business model is to selectively extend our expertise and intellectual property position in antisense technology to industry partners that are interested in developing antisense therapeutics. In return for providing companies with access to our technology, we receive an ownership interest in the resulting products and/or in the companies. This provides us with the opportunity to create a much broader antisense pipeline than we could afford to develop on our own while minimizing our financial obligations. We have implemented this integral component of our

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strategy through our partnerships with major pharmaceutical companies and with Antisense Therapeutics Limited, OncoGenex and Pantheco. Our partnerships with OncoGenex, ATL and Pantheco represent our ability to broaden the reach of antisense technology in emerging companies globally. We believe we will have more of these opportunities that, when combined with our own antisense drug pipeline, will allow us to participate in the establishment of a new sector of the pharmaceutical industry based on antisense technology.

        ISIS 107248 has been demonstrated to have positive effects in animal models for the treatment of certain inflammatory diseases such as multiple sclerosis. In December 2001, we licensed ISIS 107248 to Antisense Therapeutics Limited, an Australian company publicly traded on the Australian Stock Exchange. We were responsible for completing the required preclinical studies for ISIS 107248 and for manufacturing the drug for human clinical trials at ATL's expense. ATL agreed to undertake the future clinical development and commercialization of the drug. ATL expects to initiate a Phase I clinical trial of ISIS 107248 for the treatment of multiple sclerosis in the first half of 2003. In addition, we are participating with ATL in a five-year antisense drug discovery and development collaboration. ATL will pay us for access to our antisense expertise and for research and manufacturing services we provide them during the collaboration. Additionally, ATL is obligated to pay us royalties on any antisense drugs discovered and developed within the partnership. In December 2001, ATL successfully completed its initial public offering in Australia. In December 2002, ATL successfully completed a subsequent share placement in which we participated as an investor. We currently own approximately 15% of ATL's equity and hold options for additional shares. If all ATL's options were exercised, including ours, our ownership would remain at approximately 15%.

        In November 2001, we established a drug development collaboration with OncoGenex Technologies Inc., a Canadian oncology-focused research and development company, to co-develop and commercialize OGX-011, an anti-cancer antisense drug candidate. OGX-011 combines OncoGenex's proprietary antisense position in inhibitors to the target, clusterin, with our proprietary second-generation antisense chemistry. We conducted preclinical toxicology and pharmacokinetic studies of OGX-011 during 2002. We also manufactured OGX-011 for preclinical and Phase I/II studies. OncoGenex has responsibility to perform Phase I clinical trials to assess the safety of OGX-011 in combination with hormone ablation therapy in men with localized prostate cancer and to perform Phase I/II clinical trials in combination with standard chemotherapy in patients with solid tumors known to express clusterin including lung, prostate, renal, bladder and ovarian cancers. In December 2002, OncoGenex and we announced the initiation of a Phase I clinical trial of OGX-011 in patients with prostate cancer. OncoGenex plans to start a second Phase I trial in 2003.

        As part of a licensing agreement for our novel antisense chemistry Peptide Nucleic Acid, PNA, completed in November 1998, we received common shares in Pantheco. In September 2000, we entered into a second license for PNA with Pantheco, whereby we received additional common shares upon the completion of Pantheco's October 2000 financing. As a result of Pantheco's October 2000 financing, our total ownership in Pantheco was 22% and valued at approximately $1.1 million. In 2001, Pantheco issued additional shares and Isis' holdings in Pantheco declined to 15.5% and we currently hold 15.5% of Pantheco's outstanding shares.

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        In May 2001, we licensed to Merck our preclinical antisense drug candidate, ISIS 113715. In December 2002, we reacquired full product rights to ISIS 113715. ISIS 113715 is currently in preclinical development for adult onset, or Type 2, diabetes. We expect to initiate Phase I trials of ISIS 113715 in 2003.

        In January 2000, we formed a joint venture with Elan, called HepaSense, to develop our antisense drug, ISIS 14803, to treat patients chronically infected with the Hepatitis C virus or HCV. As part of the original joint venture, both Elan and we licensed significant technology to HepaSense. Through the HepaSense joint venture we were able to advance the development of ISIS 14803, including:

        In November 2002, Elan concluded its participation in the HepaSense collaboration in conjunction with its continuing restructuring efforts. As a result, we have regained all rights to ISIS 14803, with a potential nominal royalty due to HepaSense. HepaSense will distribute the royalty to Elan and us on a pro rata basis based on each parties' equity ownership in HepaSense. This favorable outcome allows us to pursue the clinical development of ISIS 14803.

        Under the terms of the HepaSense joint venture, we provided 80.1% of the funding necessary to operate the joint venture while Elan provided 19.9%. In connection with this funding arangement, Elan made available to us a $12.0 million line of credit evidenced by a convertible promissory note, $7.2 million of which we used to provide funding to HepaSense. In July 2002, we prepaid the $7.9 million in outstanding principal and accrued interest on the HepaSense convertible promissory note held by Elan. As of December 31, 2002, the HepaSense convertible promissory note was fully paid and we cannot borrow any additional funds against it.

        As part of the joint venture, Elan purchased $7.5 million of our common stock at a premium to its market price and we issued Elan warrants, which have a five year life and expire in January 2005. Elan also purchased our Series B preferred stock, which is convertible in the future into either our stock or stock in HepaSense. In April 2002, we achieved a development milestone in the HepaSense collaboration, triggering a $3.8 million equity purchase by Elan of our common stock at a premium to its market price. As part of the milestone investment, Elan also received warrants to purchase shares of our common stock, which have a five year life and expire in April 2007.

        In April 1999, we formed a joint venture, called Orasense, with Elan to develop a platform technology for the oral delivery of antisense drugs. As part of the agreement, we licensed to Orasense the oral rights to ISIS 104838, our antisense inhibitor for TNF-alpha. Through the Orasense joint venture, we were able to share some of our development expenses for ISIS 104838 with Elan and were able to significantly advance our oral delivery technology. For example, Orasense completed a Phase I clinical trial of ISIS 104838 of oral solid formulations to evaluate the absorption, distribution, metabolism and elimination of ISIS 104838 in oral dosage forms. The results from this study demonstrated that antisense drugs can be administered orally and support further clinical development of oral antisense drugs.

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        In 2002, Elan and we agreed to extend the Orasense collaboration. Effective December 31, 2002 Elan concluded its participation in the Orasense collaboration in conjunction with its continuing restructuring efforts. As a result, we have regained all rights to ISIS 104838, with a potential royalty due to Orasense. Orasense will distribute the royalty to Elan based on Elan's equity ownership in Orasense. This favorable outcome allows us to pursue further clinical development of ISIS 104838 and oral antisense drugs.

        Under the terms of the Orasense joint venture, we provided 80.1% of the funding necessary to operate the joint venture while Elan provided 19.9%. In connection with this funding arangement, Elan made available to us an $18.4 million line of credit evidenced by a convertible promissory note, $15.5 million of which we used to provide funding to Orasense. In July 2002, we prepaid $11.8 million in outstanding principal and accrued interest on the Orasense convertible promissory note held by Elan. Approximately $5.1 million in principal remains outstanding under the Orasense convertible promissory note as of December 31, 2002. We cannot borrow any additional principal under the Orasense convertible promissory note. However, interest will continue to accrue on the outstanding amounts. The maturity date for the Orasense convertible promissory note is April 19, 2005.

        As part of the joint venture, Elan made a $27 million equity investment in us, consisting of the purchase of $15 million of our common stock purchased at a premium to its market price and the purchase of $12 million of our Series A preferred stock. Elan also received warrants which have a five year life and expire in April 2004. In August 2002, the holder of our Series A preferred stock exercised its option to convert the Series A shares and related cumulative dividends on the Series A preferred stock into Isis common stock. The transaction converted all the outstanding shares of our Series A preferred stock into shares of our common stock.

Antisense Commercialization

        In 1997, we entered into an agreement with Novartis Ophthalmics AG, formerly CIBA Vision Corporation, granting them exclusive worldwide distribution rights for Vitravene, an antisense compound that we discovered and developed. The terms of the agreement provided for us to receive $20 million in pre-commercial fees and milestones. As of December 31, 2001, we had received the full $20 million of these pre-commercial fees and milestones. In August 1998, the FDA approved Vitravene to treat CMV retinitis in AIDS patients. Vitravene is commerically available in the U.S., Europe, Australia and Brazil. Novartis Ophthalmics AG, the eye health unit of life sciences leader, Novartis AG, and our worldwide distribution partner for this drug, launched Vitravene in November 1998. While Novartis Ophthalmics AG markets and sells Vitravene worldwide, we manufacture and sell Vitravene to Novartis Ophthalmics AG at a price that allows us to share the commercial value of the product with them.

        Our GeneTrove division has partnerships with major pharmaceutical and biotechnology companies in which we provide one or more of the following services:

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        Our partners in 2002 included:


        We recently extended GeneTrove's collaboration with Celera to end in June 2003. GeneTrove's collaborations with Abbott and Aventis concluded in 2002 under the terms of their agreements.

        Our Ibis Therapeutics division has entered into numerous contracts and grants with various government agencies to complete research and development work for defense against biological warfare attacks and threat scenarios. The contracts and grants include a multi-year contract, with expected funding up to $9.8 million, with the Defense Advanced Research Projects Agency, or DARPA, a three-year contract, with expected funding up to $2.4 million, with the U.S. Army Medical Research Institute of Infectious Diseases, or USAMRIID, and a one-year grant from the Federal Bureau of Investigation, or FBI.

        In addition to the projects with government agencies, our Ibis Therapeutics division entered into a collaboration with Pfizer in June 2000 for the discovery and development of small molecule drugs against certain RNA targets. This collaboration ended in June 2002 in accordance with its terms.

Intellectual Property Licensing Agreements

        In December 2001, we established a long-term research-scale antisense inhibitor supply agreement with Integrated DNA Technologies, Inc., or IDT. IDT is a leading supplier of antisense inhibitors used in research. Additionally, we further solidified our intellectual property leadership position in antisense technology by broadening our license to certain antisense patents from IDT.

        In this long-term supply agreement, IDT agreed to manufacture research-scale antisense inhibitors and research reagents to our specifications. The agreement enables us to meet increasing demand for functional genomics services that our GeneTrove division provides to us for our in-house drug discovery efforts and to major pharmaceutical and biotechnology customers. We paid IDT $5 million toward our future purchase of antisense inhibitors. As of December 31, 2002, the balance of our prepayment is $4.5 million.

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        Consistent with our goal of broad control of intellectual property associated with antisense technology, we have expanded our existing licensing agreement with IDT on certain patents that are useful in functional genomics and in making certain antisense drugs. The expanded license allows us to exclusively sublicense this intellectual property for functional genomics purposes. The agreement also eliminates prior milestone payment obligations and significantly reduces royalty rates associated with commercialized second-generation antisense drugs. We have paid IDT $3.9 million to date and will pay IDT $1.1 million over the next three years for the license.

        In May 2001, we entered into an agreement with Hybridon under which we acquired an exclusive license to all of Hybridon's antisense chemistry and delivery patents and technology. Hybridon retained the right to practice its licensed antisense patent technologies and to sublicense it to collaborators under certain circumstances. In addition, Hybridon received a non-exclusive license to our suite of RNase H patents. In exchange for the license to Hybridon's antisense patents, we paid $15.0 million in cash and agreed to pay Hybridon $19.5 million in our common stock before May 2003. In return for access to our patents, Hybridon agreed to pay us $6.0 million in Hybridon common stock before May 2004. In September 2001 and October 2001, we issued to Hybridon 357,143 shares of our common stock valued at $5.0 million and 500,000 shares of our common stock valued at $10.0 million, respectively. In May 2002, Hybridon issued to us 1,005,499 shares of its common stock valued at $1.3 million and paid us $700,000 in cash. In August 2002, we and Hybridon cancelled the remaining reciprocal financial obligations related to this agreement. Specifically, Hybridon owed us an additional $4 million worth of Hybridon common stock, payable immediately. We owed Hybridon $4.5 million in cash or stock, due in May 2003. The cancellation of the obligations resulted in a decrease to our carrying value for the license in the amount of $500,000.

        In March 2001, we amended a non-exclusive Patent License Agreement, which we entered into with Molecular Biosystems, Inc. in September 1992. The amendment provides us with a fully paid-up license to certain patents and patent applications in exchange for a one-time payment to Molecular Biosystems of $1 million.

        In December 2001, we licensed to Eyetech Pharmaceuticals, Inc., a privately held company, certain of our patents necessary for Eyetech to develop, make and commercialize Macugen, formerly EYE001, a non-antisense compound intended for use in the treatment of ophthalmic diseases. Macugen is currently in Phase II/III clinical trials sponsored by Eyetech. Eyetech paid us an upfront fee and agreed to pay us milestone and royalty payments in exchange for non-exclusive, worldwide rights to the intellectual property licensed from us.

        In October 2000, we licensed some of our novel chemistry patents to Roche, a business unit of Roche Diagnostics, for use in the production of Roche's diagnostic products. The royalty-bearing license grants Roche non-exclusive worldwide access to some of our proprietary chemistries, in exchange for initial and ongoing payments from Roche to us.

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Manufacturing

        In the past, except for small quantities, it was generally expensive and difficult to produce chemically modified oligonucleotides, like those we use in our research and development programs. As a result, we have dedicated significant resources to develop ways to improve manufacturing capacity. Since we can use variants of the same nucleotide building blocks and the same type of equipment to produce our oligonucleotide compounds, we found that the same techniques we used to efficiently manufacture one oligonucleotide drug could help improve the manufacturing processes for many other oligonucleotide drugs. By developing several proprietary chemical processes to scale up our manufacturing capabilities, we have greatly reduced the cost of producing oligonucleotide compounds. For example, we have significantly reduced the cost of raw materials through improved yield efficiency, while at the same time increasing our capacity to make the compounds. Through both our internal research and development programs and collaborations with outside vendors we may achieve even greater efficiency and further cost reductions.

        In September 2002, we further expanded our relationship with Lilly by agreeing to manufacture Affinitak during the product launch period for Lilly. Through this agreement we expanded our manufacturing facility. We upgraded our existing manufacturing suite that is dedicated to the production of products for us and our non-Lilly partners. In addition, we added a second state-of-the-art manufacturing suite dedicated to Affinitak. Lilly provided us with funding in the form of a loan of up to $21 million, to build the Affinitak suite. We will repay the loan from Affinitak success milestones due from Lilly, if we achieve such milestones, or other product-related cash flows. The movable equipment purchased for the manufacturing suite secures this loan. In February 2003, we completed construction of the facility, which is located on our Carlsbad campus in an existing building.

        In addition, we have contractual obligations to manufacture clinical trial materials and/or commercial supply for Amgen, ATL, Lilly, Novartis and OncoGenex. We believe we have sufficient manufacturing capacity to meet our current and future obligations under existing agreements with our partners for commercial, research and clinical needs as well as meet our current internal research and clinical needs. We believe that we have, or will be able to develop or acquire, sufficient supply capacity to meet our anticipated needs. We also believe that with reasonably anticipated benefits from increases in scale, we will be able to manufacture antisense compounds at commercially competitive prices.

Patents and Proprietary Rights

        Our success will depend, in part, on our ability to obtain patent protection for our products in the United States and other countries. We file applications, as appropriate, for patents covering our products and processes. As of February 28, 2003, we own or have exclusively licensed nearly 1,200 issued patents worldwide. Patents issued to us, applied for by us or exclusively licensed by us cover the following types of inventions, processes and products:

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        On July 9, 2001, we commenced an action against Sequitur, Inc. in the United States District Court for the Southern District of California, No. 01 CV 1223 BTM (JFS), for infringement of U.S. Patent No. 6,001,653. We settled this action and two subsequent actions we commenced against Sequitur on terms favorable to us. On September 13, 2002 the court dismissed with prejudice all three actions.

Government Regulation

        Extensive regulation by United States and foreign governmental authorities govern our manufacture and potential sale of therapeutics. In particular, pharmaceutical products are subject to rigorous preclinical and clinical testing and other approval requirements by the FDA in the United States under the Federal Food, Drug and Cosmetic Act and by comparable agencies in most foreign countries. Various federal, state and foreign statutes also govern or influence the manufacture, safety, labeling, storage, record keeping and marketing of such products. State, local, and other authorities also regulate pharmaceutical manufacturing facilities.

        In conjunction with obtaining approval of Vitravene, we successfully passed the manufacturing pre-approval inspection by the FDA and European regulatory authorities. Approval of each new drug will require a rigorous manufacturing pre-approval inspection by regulatory authorities.

        In addition to regulations enforced by the FDA, we are also subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state and local regulations.

Competition

        For many of their applications, antisense-based drugs as well as Ibis small molecules will compete with existing therapies for market share. In addition, a number of companies are pursuing the development of oligonucleotide-based technology and the development of pharmaceuticals utilizing this technology. These companies include specialized pharmaceutical firms and large pharmaceutical companies acting either independently or together with biopharmaceutical companies.

        Vitravene and our other products under development address numerous markets. The diseases targeted by our drugs for which we may receive regulatory approval will determine our competition. For certain of our products, an important factor in competition may be the timing of market

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introduction of competitive products. Accordingly, the relative speed with which we can develop products, complete the clinical trials and approval processes and supply commercial quantities of the products to the market is an important competitive factor. We expect that competition among products approved for sale will be based, among other things, on product efficacy, safety, reliability, availability, price and patent position.

        The market for Vitravene, our antisense drug for CMV retinitis, has been affected by a number of factors. The introduction of new anti-HIV drugs, that were introduced prior to Vitravene's approval, have prolonged survival in HIV-infected individuals. This resulted in a decline in mortality from AIDS, accompanied by a decline in the incidence of many opportunistic infections including CMV retinitis.

        We currently have two drugs in Phase III trials. We licensed Affinitak, our antisense drug for non-small cell lung cancer, to Lilly in August 2001. Under our agreement with Lilly, Lilly is responsible for the commercialization of Affinitak. If future studies support commercialization, we expect that physicians would use Affinitak in combination with current standard chemotherapy regimens for non-small cell lung cancer. As such, we expect that it will be complementary to existing drugs for the treatment of non-small cell lung cancer rather than directly competitive. Our second drug in Phase III trials is alicaforsen, which we are studying in patients with Crohn's disease. Alicaforsen will likely compete with Johnson & Johnson's drug, Remicade, which is approved for the treatment of Crohn's disease and rheumatoid arthritis.

Employees

        As of February 28, 2003 we employed 523 individuals, of whom 159 hold advanced degrees. A significant number of our management and professional employees have had prior experience with pharmaceutical, biotechnology or medical product companies. Collective bargaining agreements do not cover any of our employees, and management considers relations with its employees to be good.

Executive Officers

        The following set forth certain information regarding our executive officers as of February 28, 2003:

Name
   Age
   Position
Stanley T. Crooke, M.D., Ph.D.   57   Chairman of the Board, President and Chief Executive Officer
B. Lynne Parshall, Esq.   47   Director, Executive Vice President, Chief Financial Officer and Secretary
C. Frank Bennett, Ph.D.   46   Vice President, Antisense Research
Richard K. Brown, Ph.D.   50   Isis Vice President and President, GeneTrove
Douglas L. Cole, Ph.D.   55   Vice President, Development Chemistry and Pharmaceutics
David J. Ecker, Ph.D.   48   Isis Vice President and President, Ibis Therapeutics
Arthur A. Levin, Ph.D.   49   Vice President, Development
Patricia Lowenstam   56   Vice President, Human Resources and Operations
Karen Lundstedt   38   Vice President, Corporate Communications
John McNeil   38   Vice President, Informatics
Aron Stein, Ph.D.   44   Vice President, Regulatory Affairs and Quality Assurance

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STANLEY T. CROOKE, M.D., PH.D.
 Chairman of the Board, President and Chief Executive Officer

        Dr. Crooke was a founder of Isis and has been its Chief Executive Officer and a director since January 1989. He served as our President from January 1989 to May 1994, and was elected Chairman of the Board in February 1991. SmithKline Beckman Corporation, a pharmaceutical company, employed Dr. Crooke from 1980 until January of 1989, where his titles included President of Research and Development of SmithKline and French Laboratories. He serves as a director of Antisense Therapeutics Ltd., a biopharmaceutical company, Axon Instruments, Inc., a developer and manufacturer of novel high-technology devices and software for drug discovery, and EPIX Medical, Inc., a developer of magnetic resonance imaging contrast agents. Dr. Crooke is also an adjunct professor of pharmacology at the University of California, San Diego, and San Diego State University.

B. LYNNE PARSHALL, ESQ.
 Director, Executive Vice President, Chief Financial Officer, and Secretary

        Ms. Parshall has served as a director of Isis since September 2000. She has served as our Executive Vice President since December 1995, our Chief Financial Officer since June 1994, and our Secretary since November 1991. From February 1993 to December 1995, she was a Senior Vice President of Isis, and from November 1991 to February 1993, she was a Vice President of Isis. Prior to joining Isis, Ms. Parshall practiced law at Cooley Godward LLP, counsel to Isis, where she was a partner from 1986 to 1991. Ms. Parshall is on the Board of Visitors at Stanford University Law School. Ms. Parshall is also a member of the Licensing Executives Society and a member of the American, California and San Diego bar associations.

C. FRANK BENNETT, PH.D.
 Vice Presid