ISIS PHARMACEUTICALS INC - 10-K Annual Report

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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, 2004

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.)
1896 Rutherford Road, 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. o

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 $286,390,779 as of June 30, 2004.*

The number of shares of voting common stock outstanding as of March 3, 2005 was 57,527,898.

DOCUMENTS INCORPORATED BY REFERENCE
(To the extent indicated herein)

Portions of the registrant's definitive Proxy Statement to be filed on or about April 11, 2005 with the Securities and Exchange Commission in connection with Registrant's annual meeting of stockholders to be held on May 26, 2005 are incorporated by reference into Part III of this Report. The Exhibit Index (Item No. 15) located on pages 66 to 70 incorporates several documents by reference as indicated therein.

*: Excludes 7,230,336 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, 2004. 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.

FORWARD-LOOKING STATEMENTS

This report on Form 10-K and the information incorporated herein by reference contain forward-looking statements regarding our business, the financial position of Isis Pharmaceuticals, Inc. 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, including those statements that are described as Isis' clinical goals. Such statements are subject to certain risks and uncertainties, particularly those inherent in the process of discovering, developing and commercializing drugs that are safe and effective for use as human therapeutics, in developing and commercializing technology and systems used to identify infectious agents, and in the endeavor of building a business around such products and services. Our forward-looking statements also involve assumptions that, if they never materialize or prove correct, could cause our results to differ materially from those expressed or implied by such forward looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report on Form 10-K, including those identified in the section of Item 1 entitled "Risk Factors." Although our forward-looking statements reflect the good faith judgment of our management, these statements are based only on facts and factors currently known by us. As a result, you are cautioned not to rely on these forward-looking statements.

TRADEMARKS

Affinitak™ is a trademark of Eli Lilly and Company.
Gemzar® is a registered trademark of Eli Lilly and Company.
Macugen® is a registered trademark of Eyetech Pharmaceuticals, Inc.
TAXOTERE® is a registered trademark of Aventis.
Vitravene® is a registered trademark of Novartis AG.

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 implicated in disease. Interference with RNA can keep the body from producing proteins that are involved in disease. We are the leader in exploiting RNA as a target for drugs, and have a strong proprietary position in RNA-based drug discovery technologies. With our primary technology, antisense, we create inhibitors, or oligonucleotides, designed to hybridize, with a high degree of specificity to their RNA target and modulate the production of specific proteins associated with disease. We also use our antisense technology internally and in collaborations with pharmaceutical companies to rapidly and efficiently identify and prioritize attractive gene targets for drug discovery. Within our Ibis division, we are expanding on our RNA expertise by creating a system that can rapidly and accurately identify a broad range of infectious organisms with a single test. Our ongoing development of this technology and a system related to this technology has been funded primarily by agencies within the United States government.

We successfully commercialized our first antisense drug, Vitravene. Vitravene demonstrates our ability to meet Food and Drug Administration, or FDA, and European regulatory requirements, and to commercially manufacture antisense drugs. We and our partners currently have 10 antisense products in preclinical and clinical development, the majority of which are in Phase I or Phase II human clinical trials. Our products in development address numerous therapeutic areas with major market potential, including inflammatory, metabolic and cardiovascular diseases, and cancer. We are expanding the therapeutic opportunities for antisense drugs by developing a variety of formulations to enhance patient convenience and compliance. In addition, our pipeline has matured to consist primarily of drugs based on our proprietary second-generation chemistry. Our second-generation antisense drugs offer a number of advantages over prior chemistries. Specifically, these drugs offer the potential for improved safety, increased potency and a longer half-life, which correlates with durability of therapeutic response and the potential for less frequent dosing. Physicians may be able to dose our second-generation drugs as infrequently as once every two weeks to once a month. We are also making progress on developing oral formulations of our second-generation antisense drugs. Our oral formulations may increase the commercial value of our antisense drugs.

Within our Ibis division we have invented technology that has the potential to revolutionize the identification of infectious diseases. This technology is called Triangulation Identification for Genetic Evaluation of Risks, or TIGER. We have applied the TIGER technology to develop a system to identify from a sample a broad range of infectious organisms, including organisms that are newly-emerging, genetically altered and unculturable. We have successfully demonstrated proof-of-principle of the TIGER system with the identification of a variety of bacteria and viruses in both environmental and human clinical samples. During 2004, we advanced the development of our TIGER system to include application development for epidemiological surveillance and biological products screening. These applications represent the first of many we plan to develop to enhance the TIGER system's commercial value and opportunity in the government, research, medical and diagnostic markets.

To date, we have earned $40.1 million in revenue from several government agencies, including up to $37.5 million for the development of TIGER and $2.6 million to discover small molecule drugs, under contracts valued at up to $66.3 million. These agencies include the Defense Advanced Research Projects Agency, or DARPA, the National Institute of Allergy and Infectious Diseases, or NIAID, part of the National Institutes of Health, or NIH, the Centers for Disease Control, or CDC, the Federal

Bureau of Investigation, or FBI, and the United States Army Medical Research Institute of Infectious Diseases, or USAMRIID.

We have a broad patent portfolio covering our products and technologies. We have rights to more than 1,500 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 products and those of our partners. Our intellectual property portfolio also enables us to expand our pipeline by granting to other companies limited access to antisense technology through licenses we grant them. Licensing partnerships may include traditionally structured antisense drug discovery and development collaborations with large pharmaceutical companies like Lilly and Amgen.

Antisense technology allows us to repeatedly produce more drug candidates than we can afford to develop on our own. As a result, we have extended our licensing partnerships to include our satellite company strategy in which we provide our expertise and intellectual property position in RNA-based therapeutics to industry partners that are interested in developing RNA-based therapeutics. Because these companies work closely together with us, with the common goals of advancing the technology and/or pipeline, we sometimes refer to these companies as satellite companies. These partnerships allow us to benefit from our partners' expertise and highly focused research efforts, while our partners benefit from our experience in RNA-based drug discovery and development and access to our intellectual property. In return for providing companies with access to our technology, we receive an ownership interest in the resulting products and/or in the companies. Through these relationships we are expanding the reach and potential of antisense therapeutics and participating in the success of multiple companies and products. 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 strategy through our partnerships with Alnylam Pharmaceuticals, Inc., or Alnylam; Antisense Therapeutics, Ltd., or ATL; Ercole Biotech Inc., or Ercole; OncoGenex Technologies, Inc., or OncoGenex; Santaris Pharma A/S, or Santaris; and Sarissa, Inc., or Sarissa.

In addition, we have an active intellectual property licensing program in which we license aspects of our intellectual property to companies like Hybridon, Inc., or Hybridon; Integrated DNA Technologies, Inc., or IDT; Roche Molecular Systems, or Roche: atugen A/S, or atugen; and Dharmacon, Inc., or Dharmacon. Through this program, we also license our non-antisense patents as we did with Eyetech Pharmaceuticals, Inc., or Eyetech. In December 2001, we licensed several chemistry patents to Eyetech for the development of Macugen, a drug for the treatment of wet age-related macular degeneration, or AMD, that Eyetech is co-developing and commercializing with Pfizer, Inc., or Pfizer. In 2004, we earned $4.0 million in milestone payments from Eyetech associated with their filing of a New Drug Application, or NDA, for Macugen with the FDA and Eyetech's receipt of marketing clearance for the drug. In January 2005, we sold a portion of our royalty rights in Macugen to Drug Royalty USA., Inc., or DRC, in exchange for aggregate payments of $24 million over the next three years. To date, we have generated nearly $70.0 million from our intellectual property licensing program that helps support our internal drug discovery and clinical development programs.

We incorporated in California in 1989, and in 1991 we reincorporated as a Delaware corporation. Our principal offices are in Carlsbad, California. In November 2003, we established Isis Pharmaceuticals Singapore Pte Ltd, our wholly-owned subsidiary in Singapore. As part of our strategic decision to reorganize and refocus our resources to advance our most promising second-generation drugs and to continue the development of antisense technology, we decided to close our research and development laboratory in Singapore during the first quarter of 2005.

Drug Discovery and Development

Antisense Drug Discovery

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, and 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 deoxyribonucleic acid, or DNA. 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 recipes 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, the 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 or antisense drugs, which resemble DNA and RNA and are the complement of mRNA. These potent antisense drugs 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 with a specific RNA and not with the RNAs of other 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 less toxic than traditional drugs, because we can design them to minimize the impact on unintended targets.

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. In contrast, 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. With the completion of the human genome sequencing project, we now know the sequence for all potential mRNA receptors in the human body.

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 advances in chemistries, which we call our second-generation antisense drugs. Second-generation drugs may have increased potency, stability, oral bioavailability and an improved side effect profile. We have also made significant progress in developing new formulations of antisense drugs, like oral, subcutaneous, intravitreal, aerosol, enema and topical cream that further expand the potential for antisense technology.

Further, 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. We have created inhibitors to thousands of genes, validated many targets and dissected numerous disease pathways.

Small Molecule Antibmicrobial Drug Discovery

Prior to the development of TIGER, our Ibis division focused on discovering novel small molecule antimicrobial drugs. DARPA principally funded this project until 2002, when USAMRIID elected to be the transition partner for a DARPA-sponsored research program to discover small molecule antimicrobial drugs for biological warfare defense. As part of the transition we entered into a three-year, $2.4 million contract with USAMRIID to advance this work. As of December 31, 2004, we had received $2.1 million from the United States government for this program. We expect to allocate limited resources to advance this technology once we complete our work under the USAMRIID contract in the first quarter of 2005. Our goal is to secure a partner for this program.

Ibis Division

TIGER is the product of core technology development and small molecule drug discovery research conducted within our Ibis division. In its early years, Ibis focused on discovering novel small molecule antimicrobial drugs. Ibis' central focus now is to develop and commercialize our TIGER technology.

The advancement of TIGER application development has brought us closer to realizing the commercial potential of this unique and proprietary technology. To continue this progress, we recently hired Michael Treble to head our Ibis division. Mr. Treble's knowledge and expertise in product development and in commercializing research instruments and diagnostic products will complement the expertise and innovation of David J. Ecker, Ph.D., the scientific leader of TIGER technology development.

date, we have earned $40.1 million in revenue under our government contracts and grants. Also, we have approval to invoice our government partners an additional $8.6 million under our existing contracts and grants. We may receive continued approval to invoice our government partners under these contracts based upon a variety of factors, including the accomplishment of program objectives and the exercise of additional contract options by the contracting agencies. In addition, these agencies may terminate these contracts and grants at their convenience at any time, even if we have fully performed our obligations. Consequently, we may never receive the full amount of the potential value of these awards. Our Ibis division has received contracts and grants from numerous government agencies valued at up to $63.2 million.

During 2004 and 2003, revenue generated from agencies of the United States Government totaled 28% and 20%, respectively, of our total revenue. Refer to Note 7, "Segment Information and Concentration of Business Risk, " starting on page F-30 of this report on Form 10-K for additional information about our Ibis division.

Approved Product and Products In Development

We successfully developed the first antisense drug to reach the market, Vitravene, for CMV retinitis, which is available through our partner, Novartis Opthalmics AG.

We have designed our drugs in development to treat a variety of health conditions, including inflammatory, metabolic, and cardiovascular diseases, and cancer, and we and our partners 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 and our partners' products under development, its target, disease indication and development status, as well as our commercial rights.

Isis Drugs in Development

Product(1)	Target	Potential Disease Indication(s)	Development Status(2)	Commercial Rights
Vitravene (I)	CMV	CMV Retinitis	Launched in the U.S. and Europe (3)	Isis/Novartis Ophthalmics AG(3)
Alicaforsen (ISIS 2302) (E)	ICAM-1	Ulcerative Colitis	Phase II	Isis
ISIS 113715 (P)*	PTP-1b	Diabetes	Phase II	Isis
ISIS 301012 (P)*	apoB-100	High Cholesterol	Phase I	Isis
ISIS 301012 (O)*	apoB-100	High Cholesterol	Preclinical	Isis
ISIS 345794 (P)*	STAT-3	Cancer	Preclinical	Isis

Partner Drugs in Development

Product(1)	Target	Potential Disease Indication(s)	Development Status(2)	Commercial Rights
ATL 1102 (ISIS 107248)(P)*	VLA-4	Multiple Sclerosis	Phase II	ATL
OGX-011 (ISIS 112989) (P)*	Clusterin	Cancer	Phase I/II	OncoGenex / Isis
ATL 1101 (T)*	IGF-1R	Psoriasis	Phase I	ATL
LY2181308 (P) *	Survivin	Cancer	Phase I	Lilly
LY2275796 (P) *	eIF-4E	Cancer	Preclinical	Lilly

*: Drugs based on proprietary second-generation chemistry
(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 or our partners have made a decision to initiate toxicology and pharmacokinetic studies in animals to support the initiation of human clinical studies.
(3): Novartis Ophthalmics AG has the exclusive worldwide rights to distribute Vitravene, which it distributes on a limited basis.

The following section provides more detailed descriptions of our approved product and those products in clinical development and the disease indications they target. We also have a significant research program. Our goal for 2005-2006 is to advance at least two new drug candidates from our cardiovascular, metabolic or inflammatory disease research programs into research development.

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. Among patients with AIDS, CMV retinitis is the primary cause of blindness. Currently approved drugs for CMV retinitis are ganciclovir, foscarnet, cidofovir and fomivirsen (Vitravene).

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. New anti-HIV drugs, particularly protease inhibitors and combination treatment regimens, have prolonged survival in HIV-infected individuals. This has resulted in a decline in mortality from AIDS, accompanied by a decline in the incidence of many opportunistic infections, including CMV retinitis. As a result, Novartis AG currently offers Vitravene on a limited basis.

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 and another adhesion molecule called CD49d, which is a subunit of Very Late Antigen-4, or VLA-4. Researchers believe that these proteins are involved in inflammatory diseases.

Alicaforsen (ISIS 2302—The most advanced compound in our inflammatory disease program selectively inhibits ICAM-1 gene expression. Over-expression of ICAM-1 occurs in a wide variety of inflammatory disorders, including inflammatory bowel disease. According to the Crohn's and Colitis Foundation of America, up to one million people have inflammatory bowel disease, with diagnoses

evenly split between Crohn's disease and ulcerative colitis, or UC. According to the European Federation of Crohn's and UC Associations, inflammatory bowel disease affects a similar number of people in Europe.

•: Ulcerative Colitis—UC is an inflammatory disease of the colon, a part of the large intestine. Inflammation and ulceration of the innermost lining of the colon characterize UC. Symptoms typically include diarrhea, rectal bleeding and abdominal pain. In December 2004, we released the results of three Phase II studies of alicaforsen enema to treat patients with UC in which alicaforsen enema produced significant and long-lasting disease improvement, as measured by changes in Disease Activity Index, or DAI, scores and other indicators of disease. In the Phase II studies alicaforsen enema outperformed both placebo and the enema standard of care. In particular, a substantial number of patients treated with alicaforsen enema experienced mucosal healing, as well as decreases in rectal bleeding and in stool frequency, manifestations of the disease that cause considerable discomfort, inconvenience and pain to patients. In all three trials, alicaforsen enema was well-tolerated and improved signs and symptoms of disease in ulcerative colitis patients. In addition, data from a 2003 clinical trial for an enema formulation of alicaforsen demonstrated an improvement in clinical disease symptoms of up to nine months in patients with pouchitis. Pouchitis is an ulcerative colitis-like inflammation of the surgically constructed internal pouch created in ulcerative colitis patients when their diseased colons are removed. We plan to find a strong commercial partner for alicaforsen enema, while planning a Phase III program for the drug.

Our goals for 2005 - 2006 for alicaforsen enema for ulcerative colitis are to:

•: meet with the FDA to discuss Phase III development plans for the drug; and
•: identify a marketing partner with late-stage development and commercial expertise, and work with that partner to develop and implement a successful Phase III development program.

•: Crohn's disease—Crohn's disease is a serious inflammatory disease that affects the entire digestive tract, unlike UC which affects only the colon. A patient with Crohn's disease suffers chronic and often severe episodes of diarrhea, abdominal pain, rectal bleeding and fever. In December 2004, we reported the results of our Phase III clinical trials of alicaforsen in patients with Crohn's disease. In these trials alicaforsen did not demonstrate statistically significant induction of clinical remission compared to placebo. As a result of these data, we will not invest further in the development of alicaforsen for Crohn's disease.

ATL 1102—ATL 1102, formerly called ISIS 107248, is a second-generation antisense inhibitor of CD49d, which is a subunit of Very Late Antigen-4, or VLA-4. Studies in animal models have demonstrated that inhibition of VLA-4 has a positive effect on a number of inflammatory diseases, including multiple sclerosis. In December 2001, we licensed ATL 1102 to ATL. Under our agreement with ATL, we completed the required preclinical studies for ATL 1102 and manufactured the drug for human clinical trials at ATL's expense. ATL is responsible for the clinical development and the commercialization of the drug. In June 2004, ATL announced the results of a Phase I clinical trial of ATL 1102, in which the drug was well-tolerated. In December 2004, ATL initiated a Phase IIa clinical trial of ATL 1102 in patients with multiple sclerosis. In March 2005, ATL announced that, although it and the trial investigators are confident that the current ATL 1102 Phase II trial is safe, in light of the recently announced safety issues associated with one other VLA-4 inhibitor that works through a different mechanism, ATL decided to halt the current trial and convene an advisory group to consider the potential development path for ATL 1102 which may include restarting a Phase II trial program in multiple sclerosis and exploring ATL 1102 as an inhaled asthma treatment. We plan to support ATL's development efforts to determine the potential of ATL 1102 as an effective treatment for multiple sclerosis and asthma.

ATL 1101—ATL 1101 is an antisense compound targeting Insulin-like Growth Factor-I Receptor, or IGF-1R. Researchers believe that IGF-1R plays a pivotal role in the regulation of cell growth in psoriasis. Their research has demonstrated that antisense molecules delivered by intra-dermal injection successfully inhibit production of IGF-1R and normalize the skin architecture in human psoriasis skin samples grafted onto mice. We plan to support ATL's program to explore the activity of ATL 1101 in patients with psoriasis, which includes completing the ongoing study ATL is conducting. According to the National Psoriasis Foundation, more than 4.5 million people in the United States have psoriasis, which is a non-contagious disorder of the skin. Abnormal growth or overproduction of skin cells characterizes psoriasis.

Metabolic Diseases

We are pursuing the discovery and development of antisense drugs for metabolic diseases such as diabetes and obesity. These chronic diseases affect millions of people and there continues to be a significant need for new therapies for these patients. We believe that our second-generation antisense drugs will have properties that will make them attractive therapies for metabolic diseases. According to the American Diabetes Association, diabetes affects more than 18 million people, with type 2 diabetes constituting about 90 percent of those cases.

ISIS 113715—ISIS 113715 is our second-generation antisense inhibitor of the PTP-1b gene for the treatment of type 2 diabetes. An antisense inhibitor of PTP-1b represents a new approach to the treatment of diabetes. For years, pharmaceutical companies interested in treating diabetes have actively pursued phosphatases, such as PTP-1b, as targets in their traditional small molecule drug discovery efforts. However, due to structural similarities among closely related phosphatases, it is often difficult to identify small molecule drugs with sufficient specificity to be safe. Antisense allows us to design very specific inhibitors to PTP-1b that do not inhibit other phosphatases.

In May 2003, we initiated a Phase I clinical trial to assess the safety and pharmacokinetic profile of several doses of ISIS 113715 by parenteral administration in 20 healthy volunteers. In September 2003, we reported the results from this Phase I study, in which ISIS 113715 increased insulin sensitivity in normal volunteers. Further, subjects treated with ISIS 113715 did not experience hypoglycemia or excessively low blood sugar, which is an adverse effect observed with many currently available treatments for type 2 diabetes. Based on the results of this Phase I study, we initiated a Phase II clinical trial to further evaluate the drug's ability to regulate blood sugar levels in patients with type 2 diabetes.

Our goals for 2005-2006 for our ISIS 113715 clinical development program for type 2 diabetes are to:

•: demonstrate safety of the drug as a single agent in patients with type 2 diabetes to support longer-term dosing;
•: define the optimal dose and schedule to support future clinical trials;
•: advance ISIS 113715 into additional clinical trials to evaluate longer-term dosing; and
•: explore the drug in patients who are taking oral anti-diabetic therapies.

Our development plans for 2005-2006 to meet these goals are to:

•: report the results from our ongoing Phase II single agent trial in patients with type 2 diabetes;
•: report the results following 12 weeks of dosing from a single agent trial in patients with type 2 diabetes; and
•: initiate dosing in patients with type 2 diabetes who are also taking oral anti-diabetic therapy.

Cardiovascular Diseases

We are pursuing the discovery and development of antisense drugs for cardiovascular diseases such as high cholesterol. According to the American Heart Association, cardiovascular disease is the leading cause of death in the United States. Researchers have shown a strong correlation between high cholesterol levels and subsequent cardiovascular diseases. Statistics from the American Heart Association show more than 100 million American adults have high cholesterol levels.

ISIS 301012—ISIS 301012 is a second-generation compound that targets apoB-100, a molecule that has been of great interest to the industry, yet has long been considered "undruggable" by traditional small molecule approaches. ApoB-100 is a protein that plays a pivotal role in the production of low-density lipoprotein, or LDL, the "bad" cholesterol. In preclinical studies, ISIS 301012 reduced total cholesterol, very low-density lipoproteins, or VLDL, LDL, and triglyceride levels, all of which are keys to managing heart disease. We initiated a Phase I study in late 2003 in volunteers with borderline elevated cholesterol. The goal of this initial study was to measure the safety and pharmacokinetic profile of ISIS 301012, and its ability to reduce several components of cholesterol. In 2004, we announced preliminary data from this trial, which demonstrated ISIS 301012 produced dose-dependent, rapid and prolonged reductions of its target, apoB-100, in LDL, in VLDL, and in total cholesterol levels in volunteers with borderline elevated cholesterol. We have also demonstrated that an oral formulation of ISIS 301012 reduces cholesterol in animals.

For 2005-2006, our goals for ISIS 301012 clinical development programs for lowering high cholesterol, both the subcutaneous injection and oral formulations, are to:

•: understand the optimal dose and schedule for the drug as a single agent;
•: prepare to initiate combination studies with atorvastatin, and other drugs;
•: define the oral bioavailability of ISIS 301012 and demonstrate reduction of its target, apoB-100, and cholesterol reduction in man;
•: advance ISIS 301012 into additional clinical trials to evaluate longer-term dosing; and
•: explore other indications, such as apheresis, that may offer shortened routes to commercialization.

Our development plans for 2005-2006 to meet these goals are to:

•: report final results from our ongoing Phase I single agent study in normal volunteers with borderline elevated cholesterol at an appropriate scientific meeting;
•: initiate a Phase II trial to evaluate dose and dose schedule in patients with high cholesterol;
•: initiate a pharmacokintetic study to evaluate the addition of ISIS 301012 to statin therapy;
•: initiate a Phase 2 study in patients with high cholesterol who are also taking statins; and
•: initiate a Phase I trial of the oral formulation of ISIS 301012 in volunteers with normal cholesterol levels.

Cancer

We, together with our partners, are pursuing the development of antisense drugs for the treatment of a variety of cancers. In clinical trials, we and our partners have observed evidence of activity of our anti-cancer 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.

OGX-011—OGX-011, formerly called ISIS 112989, is a second-generation antisense inhibitor of clusterin, which we are co-developing and commercializing with OncoGenex, a Canadian oncology-focused research and development company. We have designed OGX-011 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, breast, renal, bladder, non-small cell lung and ovarian. By inhibiting clusterin, clinicians may be able to enhance the effects of drug therapies in the treatment of these cancers.

In a Phase I trial evaluating OGX-011 in combination with hormone ablation therapy prior to surgical removal of the prostate, OGX-011 was well-tolerated, achieved excellent drug concentration in its target tissue, the prostate, and produced up to a 91 percent dose-dependent reduction of its target, clusterin. In preclinical animal studies, scientists from both OncoGenex and Isis, in collaboration with the Prostate Center at Vancouver General Hospital, demonstrated that OGX-011 improved the potency of traditional chemotherapies more than ten-fold in prostate cancer, without compromising safety. These studies also demonstrated that OGX-011, when combined with other cancer treatments in preclinical model systems, may 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. We plan to support OncoGenex's expansion of OGX-011 development into additional cancer therapeutic areas through the completion of this second Phase I trial evaluating OGX-011 in combination with TAXOTERE in solid tumors, and with the initiation of Phase II clinical trials in patients with lung, breast and prostate cancers in 2005.

LY2181308—We licensed our preclinical anti-cancer candidate, LY2181308, formerly ISIS 23722, to Lilly in 2002, as part of the expansion of our Lilly antisense drug discovery research collaboration into cancer for which we earned $1.1 million. Under the two-year agreement, we and Lilly collaborated to discover antisense drugs to inhibit specific gene targets associated with cancer. The cancer collaboration built on the broad, strategic alliance the companies forged in August 2001, to among other things, discover antisense drugs in the areas of inflammatory and metabolic diseases. The compound targets survivin, which plays a role in cancer cell death, or apoptosis. Survivin is one of the most highly overexpressed proteins in cancers. Our researchers and collaborators have shown that inhibiting expression of survivin by LY2181308 inhibits the growth of cancer cells. Since normal cells in the body do not express survivin, we expect that this drug will have fewer side effects than traditional chemotherapy.

In 2003, we earned a $1.5 million milestone from Lilly in the development of LY2181308. LY2181308 is the first compound from this partnership to advance to clinical trials. In November 2004, Lilly initiated Phase I clinical trials of LY218308 in cancer patients, for which we earned a second $1.5 million milestone.

LY2275796—LY2275796 is the second anti-cancer drug candidate we have licensed to Lilly and is currently in preclinical studies. During 2004, we earned a $750,000 license fee for this second-generation antisense drug which targets eukaryotic initiation factor-4E, or eIF-4E, a protein involved in tumor progression, angiogenesis and metastases, including breast, head and neck, prostate, lung, bladder, colon, thyroid and non-Hodgkin's lymphomas. Based on scientific literature, there is a strong indication that eIF-4E may act as a critical "switch" in cancer progression.

During 2005 - 2006, we plan to support Lilly's ongoing anti-cancer antisense research and development programs through the progression of the above Phase I trial of LY2181308 in patients with cancer and the continued preclinical development of LY2275796 for cancer. Further, we plan to support Lilly's oncology franchise by providing new antisense drug candidates for licensing consideration by Lilly.

ISIS 345794—ISIS 345794 is the latest compound to emerge from our cancer research program and is in preclinical development for cancer. Signal Transducer and Activator of Transcription 3, or STAT-3 is a protein that regulates cell division and growth and prevents cell death. In preclinical studies, we have demonstrated that antisense inhibition of STAT-3 significantly delayed tumor growth and increased the rate of cancer cell death in multiple cell and animal models of cancer. Based on these findings, we selected ISIS 345794 for clinical development.

Recently Discontinued Products

ISIS 104838 produced positive disease responses in patients with rheumatoid arthritis, according to results of two Phase II studies. While we are encouraged by the performance of this drug, in light of the strong competition in this market and the significant investment required to bring the first oral anti-TNF product to market, we elected to discontinue development of this drug. In addition, we have discontinued development of ISIS 14803, a first-generation drug for the treatment of hepatitis C.

In October 2004, we reported the results of a second Phase III clinical trial of Affinitak in combination with Gemzar and cisplatin in patients with non small cell lung cancer, or NSCLC. Findings from this trial, which was sponsored by Lilly, were similar to the results of the initial Isis-sponsored Phase III study of Affinitak for NSCLC, in which Affinitak failed to demonstrate improved survival sufficient enough to support an NDA filing. As a result of these trials, we will not invest further in the development of Affinitak.

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 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 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 drug discovery programs focused on various cardiovascular, metabolic and inflammatory disease targets, and cancer.

We are pursuing three early-stage antisense mechanisms, including RNA interference, or RNAi, micro-RNA, and alternative splicing, through research collaborations and partnerships like those we have with Ercole and Alnylam.

RNAi is an antisense mechanism that involves using a small interfering RNA, or siRNA, as a method to target an mRNA sequence. With siRNA, the cell recruits a protein group called RISC to prevent the production of a disease-causing protein. We have a strong intellectual property position in RNAi methodology and are pursuing opportunities to license these patents to companies specializing in RNA interference as a therapeutic method.

Micro-RNAs are an emerging class of drug targets and a new area for drug discovery. Micro-RNAs are small RNA molecules that appear to have critical functions in controlling the process of gene expression. Micro-RNAs can serve as drug targets or as drugs themselves. Researchers estimate that there are approximately 250-300 known micro-RNA molecules in humans.

Modulation of alternative splicing seeks to control the process by which a single gene can lead to several proteins. To be converted into proteins, genes must be initially copied into a pre-mRNA. Pre-mRNA often contains extra sequence information that must be removed prior to translation into the protein. This process is called splicing. Using antisense technology, we have been able to control how these stretches of RNA are spliced back together. This provides another way to control the production of a disease causing protein.

Prior to the development of TIGER, our Ibis division focused on discovering novel small molecule antibacterial drugs. We expect to allocate limited resources to advance this technology once we complete our work under the USAMRIID contract in the first quarter of 2005. Our goal is to secure a partner for this program.

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 and biotechnology companies, we can obtain funding, expand existing programs and gain additional expertise in developing and marketing products.

2004 and Recent Collaboration and Licensing 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 the three key areas of our business: antisense drug discovery and development, our Ibis division, and our intellectual property estate. The following is a list of our collaboration and licensing highlights for 2004 and early 2005.

•: We formed a strategic alliance with Alnylam to accelerate the development and commercialization of RNAi therapeutics. We earned a $5.0 million technology access fee and a $500,000 payment from our participation in Alnylam's partnering program;
•: We received a two-year contract providing up to $19.5 million from DARPA through a contract with SAIC to further the development of our TIGER system to identify infectious agents in biological warfare attacks;
•: We were granted three new government contracts valued at up to $10.0 million for the continued development of our TIGER technology;
•: We earned $4.0 million in milestone payments from Eyetech associated with their filing of an NDA for Macugen and receipt of marketing clearance for the drug, and sold a portion of our royalty rights in Macugen to DRC in exchange for aggregate payments of $24.0 million over the next three years;

•: We earned a $1.5 million Phase I clinical milestone from Lilly for LY2181308, an inhibitor of survivin;
•: We earned a $750,000 payment from Lilly for the license of LY2275796, a cancer drug that targets eIF-4E;
•: We extended our anti-cancer antisense drug discovery collaboration with Lilly. This oncology relationship builds on a broad, ongoing strategic alliance previously established by Isis and Lilly to discover antisense drugs in the areas of inflammatory and metabolic diseases;
•: We jointly developed a new high performance solid support for the manufacture of oligonucleotides with Nitto Denko Corporation of Osaka, Japan. Solid support is the base structure used in the synthesis of oligonucleotides, both antisense, including RNA and DNA-based and RNAi, and aptamer drugs and represents a substantial portion of the cost to manufacture these drugs. The new solid support has the potential to decrease manufacturing costs of oligonucleotide-based drugs, including antisense;
•: We acquired Elan Corporation plc's minority interest in Orasense and HepaSense, joint ventures arising out of prior collaborations between Isis and Elan, and eliminated all future royalties to Elan related to the oral delivery platform developed within the Orasense collaboration and to ISIS 14803;
•: We expanded our strong intellectual property position in RNA-based drug discovery by licensing core intellectual property regarding all therapeutic uses of miRNA from the Max Planck Society;
•: We licensed an anti-cancer antisense drug to Sarissa, Inc., in exchange for a $1.0 million represented by a debt instrument which will convert into Sarissa stock upon Sarissa's successful completion of a venture capital financing; and
•: We broadened our antisense drug development partnership with Oncogenex to allow for the development of two additional second-generation antisense anti-cancer drug candidates.

Eli Lilly and Company

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

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Lilly purchased $75.0 million of our common stock at $18 per share.

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We licensed to Lilly rights to Affinitak, which Lilly has decided to discontinue funding.

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We initiated with Lilly a four-year antisense drug discovery collaboration in the areas of metabolic and inflammatory diseases and a related gene functionalization and target validation collaboration to determine the function of up to 1,000 genes. Key achievements and developments under this collaboration include:

•: In 2002, Lilly and we expanded our antisense drug discovery collaboration to include oncology and the license of LY2181308, our antisense inhibitor of survivin for which we earned a $1.1 million license fee. Under the two-year agreement, we and Lilly collaborated to discover antisense drugs to inhibit specific gene targets associated with cancer. The expanded collaboration focused initially on several antisense preclinical compounds, including LY2181308, directed at cellular regulators of cancer cell death, or apoptosis.
•: In April 2003, we earned a $1.5 million milestone from Lilly in the development of LY2181308, the antisense inhibitor of survivin, as part of the research collaboration oncology expansion. LY2181308 is the first compound from the partnership selected by Lilly for clinical development. In November 2004, Lilly initiated Phase I clinical trials of

LY218308 in cancer patients, marking a significant milestone in the partnership and triggering a $1.5 million milestone payment from Lilly to us. Our collaboration with Lilly also may generate additional milestone payments aggregating up to $25.0 million based on LY2181308 achieving specified regulatory and commercial milestones.

•: In July 2003, we expanded the cancer research component of our antisense drug discovery collaboration with Lilly to include multiple antisense mechanisms, such as RNAi and alternative splicing, as well as third generation antisense chemistries. We are currently jointly developing follow-on drugs to LY2181308 that work through an RNAi mechanism and that use proprietary Isis chemistries.
•: In May 2004, Lilly and we announced the extension of our antisense drug discovery collaboration in cancer. During this extension, Isis and Lilly will continue to characterize and develop RNase H, siRNA, and splicing modulating inhibitors for the treatment of cancer using advanced generation chemistries. An important component of this extension will be the exploration of potential new anti-cancer drug targets using RNA-directed technologies.
•: In September 2004, Lilly licensed from us LY2275796. This second-generation antisense anti-cancer drug candidate targets eIF-4E. We earned a $750,000 payment from Lilly for the license. LY2275796 is the second compound from the partnership to be selected by Lilly for clinical development. Our collaboration with Lilly also may generate additional milestone payments aggregating up to $20.3 million based on LY2275796 achieving specified regulatory and commercial milestones.

•: Lilly committed to lend us, interest-free, up to $100.0 million over a four-year period to fund our obligations under the research collaboration. This loan comes due in August 2005. We can repay this loan at our option in either cash or our common stock, at a fixed conversion price of $40 per share.

To date, Lilly has paid or committed to pay us $292.9 million in funding through 2005, including the $100.0 million loan, the $75.0 million equity investment, the $25.0 million in Affinitak up-front license fees, reimbursement for Affinitak development costs and research collaboration license fees and milestones. Of this $292.9 million we had collected $287.9 million as of December 31, 2004. Assuming the success of multiple products from our collaboration with Lilly, we have the opportunity to earn additional future milestones and royalties from Lilly that could be substantial to us.

As part of our relationship with Lilly, in 2003, we upgraded and expanded our manufacturing facility, including the addition of a new state-of-the-art manufacturing suite. Lilly provided us with $21.2 million in funding to build the new suite. We can use this facility to manufacture drugs for ourselves and our partners.

Our relationship with Lilly has historically provided several revenue sources, including research funding related to their $100.0 million research loan to us, development milestones similar to the milestones for LY2181308 and LY2275796, and revenue related to Affinitak. During 2004, 2003 and 2002, we generated revenue from our relationship with Lilly totaling $15.7 million, $30.9 million and $45.4 million, respectively, which comprised 37%, 62%, and 57%, respectively, of our total revenue during those same periods. Our current collaboration with Lilly expires in August 2005. Consequently, we anticipate our revenue from Lilly will decrease in 2005.

Antisense Drug Discovery Collaborations

Singapore Economic Development Board

In November 2003, we received a grant of up to $8.0 million over three years from the Singapore Economic Development Board, or EDB, which was intended to fund, in part, the broadening of two of our RNA-based drug discovery and development programs: micro-RNA drug discovery and antisense drug discovery targeting the coronavirus associated with SARS. In connection with this grant, we established Isis Pharmaceuticals Singapore Pte Ltd, a wholly-owned subsidiary of Isis Pharmaceuticals, Inc. As part of our strategic decision to reorganize and refocus our resources to advance our most promising second-generation drugs and to continue the development of antisense technology, we decided to close our research and development laboratory in Singapore during the first quarter of 2005 and terminate our agreement with the EDB. To date, we have received $1.5 million in cash payments under our EDB grant and do not anticipate receiving any additional payments under the grant.

Industrial and Technology Research Institutes of Taiwan

In June 2003, we initiated a collaboration with ITRI to identify antisense candidates targeting the coronavirus associated with SARS. We conducted the research in exchange for an upfront payment of $1.0 million, milestone payments, and the potential for future funding. In December 2003, we achieved two milestones in our antisense drug discovery partnership with ITRI, for which we received a total of $1.0 million. The milestones related to the identification of second-generation antisense drugs that inhibit SARS virus replication and the successful completion of preclinical studies evaluating aerosol and parenteral delivery of antisense drugs as specified under the agreement. This collaboration has ended in accordance with its terms.

Amgen

In December 2001, we entered into a three-year collaboration with Amgen to discover new antisense drugs. In December 2004, this collaboration with Amgen ended in accordance with its terms.

Satellite Company Collaborations

Sarissa, Inc.

In February 2005, we licensed an anti-cancer antisense drug to Sarissa, Inc., a biotechnology company emerging from the University of Western Ontario. The drug is an antisense inhibitor of thymidylate synthase, or TS, a well-known drug target that protects cancer cells from the effects of several chemotherapy treatments. In preclinical studies, antisense inhibition of TS suppressed human tumor cell growth and overcame tumor cell resistance to marketed TS-targeted drugs.

Under the terms of the agreement, Sarissa paid us a $1.0 million upfront fee in exchange for the exclusive, worldwide license to the TS antisense drug. Sarissa paid the upfront fee with a debt instrument, which will convert into Sarissa stock upon Sarissa's successful completion of a venture capital financing. Sarissa will also pay us milestone payments totaling up to $5.5 million for key clinical and regulatory achievements and royalties on any product sales. Sarissa will be solely responsible for preclinical and clinical development of the drug.

Alnylam Pharmaceuticals, Inc.

In March 2004, we entered into a strategic alliance with Alnylam to develop and commercialize RNAi therapeutics. Under the terms of the agreement, we exclusively licensed to Alnylam our patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry for double-stranded RNAi therapeutics in exchange for a $5.0 million technology access fee, participation in fees for

Alnylam's partnering programs, as well as future milestone and royalty payments from Alnylam. For each of these drugs, the potential milestone payments total $3.4 million and are payable upon the occurrence of specified development and regulatory events. We retained rights to a limited number of RNAi therapeutic targets and all rights to single-stranded RNAi therapeutics. In addition, Alnylam and we will share the proceeds of any licenses Alnylam grants under its previously announced InterfeRx program that include sublicenses to our patents. We agreed to provide Alnylam with access to our resources for development and commercialization of RNAi therapeutics, including process development, bioanalytic methods, quality control and manufacturing. We also made a $10.0 million equity investment in Alnylam.

In turn, Alnylam nonexclusively licensed us its patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry to research, develop and commercialize single-stranded RNAi therapeutics and to research double-stranded RNAi compounds. We also received a license to develop and commercialize double-stranded RNAi drugs targeting a limited number of therapeutic targets on either an exclusive or co-exclusive basis depending on the target. If we develop or commercialize an RNAi-based drug using Alnylam's technology, we will pay Alnylam milestones and royalties. For each of these drugs, the potential milestone payments total $3.4 million and are payable upon the occurrence of specified development and regulatory events. As of December 31, 2004, we did not have an RNAi-based drug in clinical development. As part of the collaboration, each party granted the other party a nonexclusive cross license to its respective patent estate relating to antisense motifs and mechanisms and oligonucleotide chemistry for microRNA therapeutics.

Our Alnylam alliance provides us with an opportunity to realize substantial value from our pioneering work in antisense mechanisms and oligonucleotide chemistry and is an example of our strategy to participate in all areas of RNA-based drug discovery. For example, in the second quarter of 2004, we earned a $500,000 license fee from Alnylam related to Alnylam's alliance with Merck.

In September 2004, we recorded a non-cash loss on investment of $5.0 million related to the impairment of our equity investment in Alnylam. The loss on investment reflected a decrease in the market value of Alnylam's stock in 2004, which Isis believes was primarily a result of financial market conditions related to biotechnology companies.

In October 2004, we and Alnylam expanded our strong intellectual property positions in RNA-based drug discovery by licensing core intellectual property regarding all therapeutic uses of microRNA from the Max Planck Society.

During 2004, we generated revenue from our relationship with Alnylam totaling $5.5 million, or 13%, of our total revenue.

Ercole Biotech, Inc.

In May 2003, we and Ercole initiated a multi-year collaboration to discover antisense drugs that regulate alternative RNA splicing. As part of the collaboration, we cross-licensed our respective splicing-related intellectual property. We are combining our alternative splicing expertise with Ercole to discover antisense drugs that regulate alternative RNA splicing. As part of this collaboration, we granted Ercole a license to our Bcl-x molecule and certain of our chemistry patents. In addition, we took an equity ownership position in Ercole, with the initial funding in the form of convertible debt, which the companies anticipate will convert into securities that Ercole issues in its next venture capital financing. We also have the option to make an additional equity investment in Ercole. Pursuant to the terms of a Note and Warrant Purchase Agreement, during 2003 and early 2004, we made cash payments to Ercole of $500,000 and $250,000, respectively, in exchange for a convertible promissory note. We expensed the payments when made. The Note is secured by all of Ercole's assets, including intellectual property and licenses. The Note will convert into securities that Ercole issues in a qualified financing, as defined by the agreement.

Antisense Therapeutics Limited

In December 2001, we licensed ATL 1102, formerly ISIS 107248, to ATL, an Australian company publicly traded on the Australian Stock Exchange. We were responsible for completing the required preclinical studies for ATL 1102 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. In June 2004, ATL announced the results of a Phase I clinical trial of ATL 1102, in which ATL 1102 was well-tolerated. In December 2004, ATL initiated a Phase IIa clinical trial of ATL 1102 in patients with multiple sclerosis. In March 2005, ATL announced that, although it and the trial investigators are confident that the current ATL 1102 Phase II trial is safe, in light of the recently announced safety issues associated with one other VLA-4 inhibitor that works through a different mechanism, ATL decided to halt the current trial and convene an advisory group to consider the potential development path for ATL 1102, which may include restarting a Phase II trial program for multiple sclerosis and exploring ATL 1102 as an inhaled asthma treatment.

ATL is also developing ATL 1101, an antisense compound targeting IGF-1R for the treatment of psoriasis. ATL recently initiated a Phase I study in patients with psoriasis.

In addition, we are participating with ATL in a five-year antisense drug discovery and development collaboration. ATL pays us for access to our antisense expertise and for research and manufacturing services we may provide them during the collaboration. Additionally, ATL is obligated to pay us royalties on any antisense drugs discovered and developed within the partnership. We currently own approximately 11% of ATL's equity and hold options for additional shares. If all of ATL's outstanding options, including ours, were exercised, our ownership in ATL would be approximately 14%.

OncoGenex Technologies Inc.

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, formerly ISIS 112989, an anti-cancer antisense drug candidate. We share in the costs of developing OGX-011. In exchange, we share in any revenue generated by OncoGenex for OGX-011. 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 non-small cell lung, prostate, breast, renal, and ovarian cancers. In a Phase I trial evaluating OGX-011 in combination with hormone ablation therapy prior to surgical removal of the prostate, OGX-011 was well-tolerated, achieved excellent drug concentration in its target tissue, the prostate, and produced up to a 91 percent dose-dependent reduction of its target, clusterin. In April 2003, OncoGenex and we initiated a second Phase I/II trial to evaluate OGX-011 in combination with TAXOTERE in various solid tumors. OGX-011 was our first second-generation antisense anti-cancer drug in clinical trials. We plan to support OncoGenex's expansion of OGX-011 development into additional cancer therapeutic areas through the completion of this second Phase I trial evaluating OGX-011 in combination with TAXOTERE in solid tumors, and with the initiation of Phase II clinical trials in patients with lung, breast and prostate cancers.

In September 2003, we and OncoGenex expanded our antisense drug development partnership to include the development of the second-generation antisense anti-cancer drug candidate, OGX-225. OncoGenex has responsibility for the preclinical and clinical development of the drug. OncoGenex issued us OncoGenex securities as payment for an upfront fee. In addition, OncoGenex agreed to

provide to us milestone payments totaling up to $3.5 million for key clinical and regulatory achievements and to pay us royalties on product sales. As of December 31, 2004, OncoGenex had not triggered any of these milestone payments related to OGX-225.

In January 2005, we broadened our antisense drug development partnership with Oncogenex to allow for the development of two additional second-generation antisense anti-cancer drug candidates. Under the terms of the agreement, OncoGenex will be responsible for the preclinical and clinical development of the drug. OncoGenex agreed to pay us an upfront fee, milestone payments for key clinical and regulatory achievements, and royalties on future product sales.

As of December 31, 2004, our ownership interest in OncoGenex was less than 10%.

Santaris Pharma A/S (formerly Pantheco A/S)

In November 1998 and September 2000, we entered into license agreements with Santaris, formerly Pantheco. We amended the agreements in May 2003. Under the terms of the amended and restated license agreement, we licensed our novel antisense chemistry, Peptide Nucleic Acid, or PNA, to Santaris on a limited exclusive basis to develop products. The license restricts Santaris to a limited number of molecular targets that are subject to our approval. Santaris has agreed to pay us royalties on any products developed under the license.

As part of our original license agreements with Pantheco, we received shares of Pantheco common stock. In May 2003, Pantheco and Cureon A/S merged to form Santaris. Prior to the merger, we purchased additional shares of Pantheco for $55,000 as a result of antidilution provisions related to Pantheco's stock. After the merger and as of December 31, 2004, our ownership interest in Santaris was less than 10%.

Antisense Commercialization

Novartis Ophthalmics AG

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 $20.0 million in pre-commercial fees and milestones. As of December 31, 2001, we had received the full $20.0 million of these pre-commercial fees and milestones. In August 1998, the FDA approved Vitravene to treat CMV retinitis in AIDS patients. Novartis Opthalmics AG launched Vitravene in November 1998. Due to the low incidence of CMV retinitis among patients with AIDS, Novartis AG currently offers Vitravene on a limited basis.

Ibis Collaborations

To develop the TIGER technology and applications, our Ibis division has received contracts from a number of government agencies, including DARPA, the NIAID, part of the NIH, the CDC and the FBI. Each of these agencies represents a significant source of funding for our TIGER program. To date, we have earned $40.1 million in revenue under our government contracts and grants. Also, we have approval to invoice our government partners an additional $8.6 million under our existing contracts and grants. We may receive continued approval to invoice our government partners under these contracts based upon a variety of factors, including the accomplishment of program objectives and the exercise of additional contract options by the contracting agencies. In addition, these agencies may terminate these contracts and grants at their convenience at any time, even if we have fully performed our obligations. Consequently, we may never receive the full amount of the potential value of these awards. Our Ibis division has received contracts and grants from numerous government agencies valued at up to $63.2 million.

In 2004, we received three new government contracts valued at up to $10.0 million for the continued development of our TIGER system. A key highlight of these new contracts was funding from the NIAID to develop a TIGER application aimed at ensuring vaccine safety. Currently, there are few tests available that can specifically address safety issues unique to cell substrates used in vaccine manufacturing, such as the identification of unknown or novel microbes that have the potential to contaminate vaccine cell lines and substrates. Successful development of an application to simultaneously identify a broad array of infectious agents in vaccine cell substrates would create a new commercial prospect for our TIGER system.

We receive funding from DARPA through a subcontract with SAIC, on a multi-year project for the ongoing development of TIGER. This project combines our expertise in microbial genome sequence analysis and advanced mass spectrometry technology with SAIC's advanced signal processing capabilities. In March 2004, we entered into a two-year contract with SAIC that provides for up to $19.5 million in funding by DARPA. During 2004 and 2003, revenue from SAIC comprised 18% and 16%, respectively, of our total revenue.

In September 2003, we received a three-year grant for up to $6.0 million from the CDC to develop and apply our TIGER technology to the surveillance of human infectious disease in the United States. Using the grant from the CDC, we expect to develop and provide TIGER technology for CDC projects focused on emerging human infectious disease.

Intellectual Property Licensing Agreements

In-Licensing Arrangements

Hybridon, Inc.

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, Hybridon and we cancelled the remaining reciprocal financial obligations related to this agreement. The cancellation of the obligations resulted in a decrease to our carrying value for the license in the amount of $500,000.

Molecular Biosystems, Inc.

In March 2001, we amended a non-exclusive Patent License Agreement, which we entered into with Molecular Biosystems, Inc. in September 1992. The amendment provided us with a fully paid-up license to certain patents and patent applications in exchange for a one-time payment to Molecular Biosystems of $1.0 million. Molecular Biosystems has since been acquired by Alliance Pharmaceuticals, Inc.

Integrated DNA Technologies, Inc.

In March 1999, we further solidified our intellectual property leadership position in antisense technology by licensing certain antisense patents from IDT, a leading supplier of antisense inhibitors for research. The patents we licensed from IDT are useful in functional genomics and in making certain antisense drugs. In December 2001, we expanded this license agreement to allow us to exclusively sublicense this intellectual property for functional genomics purposes. Under the license, we have paid IDT $4.2 million through December 31, 2004 and expect to pay IDT an aggregate of $700,000 in 2005 for the license.

In addition, in December 2001 we established a long-term research-scale antisense inhibitor supply agreement with IDT. In this supply agreement IDT agreed to manufacture research-scale antisense inhibitors and research reagents to our specifications. We paid IDT $5.0 million toward our future purchase of antisense inhibitors. During the fourth quarter of 2004, we recorded a non-cash charge of $4.2 million to write off the unused portion as part of our restructuring activities.

Out-Licensing Arrangements; Royalty Factoring Agreements

Roche Molecular Systems

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.

Eyetech Pharmaceuticals, Inc.

In December 2001, we licensed to Eyetech, a publicly-held company, certain of our patents necessary for Eyetech to develop, make and commercialize Macugen, a non-antisense compound intended for use in the treatment of ophthalmic diseases. Eyetech paid us a $2.0 million 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 December 2002, Eyetech entered into an agreement with Pfizer to develop and commercialize Macugen.

During 2004, we earned from Eyetech $4.0 million in milestones associated with the filing of an NDA and FDA approval for Macugen for the treatment of wet age-related macular degeneration. Our license with Eyetech also may generate additional milestone payments aggregating up to $2.8 million based on achieving specified regulatory milestones with respect to the use of Macugen for each additional therapeutic indication.

Drug Royalty Corporation

In December 2004, we sold a portion of our royalty rights in Macugen to Drug Royalty USA, Inc., or DRC, in exchange for aggregate payments of $24 million over the next three years. Under the terms of the agreement, we and DRC will share the royalty rights on Macugen through 2009. After 2009, we retain all royalties for Macugen under our Eyetech agreement. Under the agreement, through 2009 DRC will receive royalties on the first $500 million of annual sales of Macugen. We and DRC will each

receive 50 percent of royalties on annual sales between $500 million and $1 billion. We retain 90 percent of all royalties on annual sales in excess of $1.0 billion and 100 percent of all royalties after 2009. We have retained all milestones payable to Isis by Eyetech under the license agreement.

As part of the sale, we agreed to pay DRC liquidated damages if any one of a defined set of defaults occurs. The amount of liquidated damages will be calculated such that DRC will receive a ten per cent per annum return, compounded quarterly on the total of all purchase price payments made by DRC to us through the default date minus the total of any royalties received by DRC through the default date. In addition, DRC may withhold any installment of the purchase price if immediately prior to such payment, we fail to meet a minimum liquidity requirement equal to the then outstanding balance on our loan with Silicon Valley Bank; plus the potential amount of liquidated damages, assuming that DRC has paid the impending purchase price installment; plus our cash burn over the most recent three months.

As collateral for our obligations under the sale agreement, we granted DRC a first priority security interest in the patents licensed by us to Eyetech under the license agreement and in the license agreement itself.

Dharmacon

In May 2004, we entered into a patent license agreement with Dharmacon, a wholly owned subsidiary of Fisher Scientific International, Inc. In order to sell chemically modified RNA for research purposes, Dharmacon licensed from us certain chemistry and method-of-use patents in return for an upfront licensing fee and royalties on reagent sales. Through this agreement, we are able to provide access to our technology to a wide array of academic labs, research institutes and companies practicing this technology while participating financially in Dharmacon's success.

Manufacturing

In the past, except for small quantities, it was generally expensive and difficult to produce chemically modified oligonucleotides, like the antisense drugs 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. For example, in November 2004, we and Nitto Denko Corporation announced that we have jointly developed a new high performance solid support for the manufacture of oligonucleotides. The new solid support has the potential to decrease manufacturing costs because it is less expensive than currently used solid supports and it has the potential to increase yield, thereby further reducing costs.

As part of our relationship with Lilly, in 2002 we upgraded and expanded our manufacturing facility, including the addition of a new state-of-the-art manufacturing suite. Lilly provided us with $21.2 million in funding to build the new suite. We can use this facility to manufacture drugs for ourselves and our partners.

We have contractual obligations to manufacture clinical trial materials and/or commercial supply for 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 and improvements in chemistry, 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 March 3, 2005, we owned or had exclusively licensed more than 1,500 issued patents worldwide. Patents issued to us, applied for by us or exclusively licensed to us cover the following types of inventions, processes and products:

•: Method claims for the use of RNA/DNA oligonucleotides and other antisense inhibitors, in gene functionalization and target validation, including chemistries, antisense inhibitor designs called "motifs", methods of use of antisense inhibitors and mechanisms of action by which antisense inhibitors inactivate an RNA target;
•: Composition of matter claims to core chemistries for chemically modifying oligonucleotides, which cover our rights to the building blocks of our compounds;
•: Composition of matter claims to antisense compounds targeted to particular RNA target sequences, which cover our drugs;
•: Use claims for using oligonucleotides targeted to particular disease targets, which cover our right to use oligonucleotide-based drugs to treat specific diseases or modulate expression of the target gene;
•: Method and composition of matter claims for the formulation and delivery of therapeutic oligonucleotides, which cover our pharmaceutical formulations of our drugs;
•: Method claims for the manufacture of oligonucleotides, which cover our new, improved and/or more cost effective ways to manufacture oligonucleotides;
•: Composition of matter claims to RNA structural elements, which cover our rights for discovery of small molecules that bind to these RNA structural elements;
•: Method claims for analyzing the interaction of small molecules with RNA, which cover our novel discovery methods using mass spectrometry to analyze the interaction of small molecules with RNA;
•: Method claims for optimizing the interaction of drug substances with their target molecules, which cover our mass spectrometry-based structural activity relationship discovery methods;
•: Method claims for identifying unknown bioagents utilizing mass-spectrometry-based analyses; and
•: Method claims for rapidly discovering antisense oligomeric compounds, which cover our rapid throughput method of discovering antisense oligonucleotides.

Government Regulation

Extensive regulation by United States and foreign governmental authorities governs 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.

We fund our Ibis division primarily through contracts or subcontracts with agencies of the United States Government. As a result, we must comply with various government regulations, including the Federal Acquisition Regulations, or FARs, and agency regulations supplemental to the FARs; the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with certain contract negotiations; and laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the export of certain products and technical data.

Competition

For many of their applications, our drugs will compete with existing therapies for market share. In addition, there are a number of companies 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 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 to compete among products approved for sale based on a variety of factors, including, among other things, product efficacy, safety, reliability, availability, price and patent position.

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

Employees

As of March 3, 2005 we employed approximately 303 individuals, of whom 141 held advanced degrees. These numbers exclude employees impacted by our January 2005 reduction in force, some of who were still employed by us as transition employees or under our salary continuation program. 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.