10-Q

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark One)

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

For the quarterly period ended September 30, 2006

OR

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

For the transition period from                      to                     .

Commission file number 0-15190

OSI Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

Delaware	13-3159796
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
41 Pinelawn Road, Melville, New York	11747
(Address of principal executive offices)	(Zip Code)

631-962-2000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

At November 6, 2006, the registrant had outstanding 57,263,858 shares of common stock, $.01 par value.

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONTENTS

	Page No.
PART I. FINANCIAL INFORMATION		1
Item 1. Financial Statements		1
Consolidated Balance Sheets - - September 30, 2006 (Unaudited) and December 31, 2005		1
Consolidated Statements of Operations (Unaudited) - - Three Months Ended September 30, 2006 and September 30, 2005		2
Consolidated Statements of Operations (Unaudited) - - Nine Months Ended September 30, 2006 and September 30, 2005		3
Consolidated Statements of Cash Flows (Unaudited) - -Nine Months Ended September 30, 2006 and September 30, 2005		4
Notes to Consolidated Financial Statements (Unaudited)		5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3. Quantitative and Qualitative Disclosures About Market Risks		37
Item 4. Controls and Procedures		37
PART II. OTHER INFORMATION		39
Item 1. Legal Proceedings		39
Item 1A. Risk Factors		39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		42
Item 3. Defaults Upon Senior Securities		42
Item 4. Submission of Matters to a Vote of Security Holders		42
Item 5. Other Information		42
Item 6. Exhibits		42
SIGNATURES		44
INDEX TO EXHIBITS		45
EX-10.1: 1999 INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION
EX-32.2: CERTIFICATION

i

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands except per share data)

	September 30,			December 31,
	2006			2005
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	60,231		$	164,084
Investment securities		140,457			5,061
Restricted investment securities		9,479			10,461
Accounts receivables – net		89,558			152,482
Inventory – net		63,224			75,715
Interest receivable		563			78
Prepaid expenses and other current assets		8,580			10,618
Total current assets		372,092			418,499
Property, equipment and leasehold improvements – net		58,303			61,947
Debt issuance costs – net		5,376			6,667
Goodwill		39,248			359,035
Other intangible assets – net		192,583			207,194
Other assets		9,324			5,240
	$	676,926		$	1,058,582
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	66,768		$	80,467
Collaboration profit share payable		10,932			49,869
Unearned revenue – current		13,050			10,737
Other liabilities		38			1,255
Total current liabilities		90,788			142,328
Other liabilities:
Rent obligations and deferred rent expenses		5,536			6,337
Unearned revenue – long-term		67,722			39,051
Convertible senior subordinated notes		265,000			265,000
Contingent value rights		—			22,047
Accrued postretirement benefit cost		6,404			5,353
Total liabilities		435,450			480,116
Stockholders’ equity:
Preferred stock, $.01 par value; 5,000 shares authorized; no shares issued at September 30, 2006 and December 31, 2005, respectively		—			—
Common stock, $.01 par value; 200,000 shares authorized, 58,958 and 58,728 shares issued at September 30, 2006 and December 31, 2005, respectively		590			587
Additional paid-in capital		1,605,631			1,592,155
Deferred compensation		—			(7,341	)
Accumulated deficit		(1,330,510	)		(971,469	)
Accumulated other comprehensive income		2,986			1,755
		278,697			615,687
Less: treasury stock, at cost; 1,943 shares at September 30, 2006 and December 31, 2005		(37,221	)		(37,221	)
Total stockholders’ equity		241,476			578,466
Commitments and contingencies
	$	676,926		$	1,058,582

See accompanying notes to consolidated financial statements.

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands except per share data)

	Three Months Ended September 30,
	2006			2005
Revenues:
Net revenue from unconsolidated joint business	$	39,833		$	21,464
Product sales		9,078			(51	)
Royalties on product sales		14,647			1,453
Sales commissions		1,639			7,610
License, milestone and other revenues		2,575			3,512
Collaborative agreement revenues		6,221			—
		73,993			33,988
Expenses:
Cost of goods sold		6,660			1,464
Collaborative profit share		3,007			—
Research and development		43,080			28,698
Selling, general and administrative		36,599			21,363
Goodwill impairment		870			—
Amortization of intangibles		4,979			3,831
		95,195			55,356
Loss from operations		(21,202	)		(21,368	)
Other income (expense):
Investment income — net		2,503			2,393
Interest expense		(1,906	)		(1,219	)
Other (expense) income — net		(652	)		157
Net loss	$	(21,257	)	$	(20,037	)
Basic and diluted net loss per common share:
Net loss	$	(0.37	)	$	(0.39	)
Weighted average shares of common stock outstanding		56,974			51,439

See accompanying notes to consolidated financial statements.

2

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands except per share data)

	Nine Months Ended September 30,
	2006			2005
Revenues:
Net revenue from unconsolidated joint business	$	114,699		$	54,892
Product sales		96,972			525
Royalties on product sales		33,671			1,952
Sales commissions		11,058			21,578
License, milestone and other revenues		16,716			8,737
Collaborative agreement revenues		19,294			—
		292,410			87,684
Expenses:
Cost of goods sold		45,883			3,636
Collaborative profit share		39,190			—
Research and development		133,065			86,007
Acquired in-process R&D		—			3,542
Selling, general and administrative		117,934			65,765
Goodwill Impairment		320,261			—
Amortization of intangibles		14,930			11,435
		671,263			170,385
Loss from operations		(378,853	)		(82,701	)
Other income (expense):
Investment income — net		5,902			10,563
Interest expense		(5,672	)		(3,657	)
Other (expense) income — net		(2,464	)		(1,283	)
Net loss before extraordinary gain		(381,087	)		(77,078	)
Extraordinary gain		22,046			—
Net loss	$	(359,041	)	$	(77,078	)
Basic and diluted net loss per common share:
Loss before extraordinary item	$	(6.70	)	$	(1.50	)
Extraordinary gain		0.39			—
Net loss	$	(6.31	)	$	(1.50	)
Weighted average shares of common stock outstanding		56,918			51,284

See accompanying notes to consolidated financial statements.

3

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)

	Nine Months Ended
	September 30,
	2006			2005
Cash flows from operating activities:
Net loss	$	(359,041	)	$	(77,078	)
Adjustments to reconcile net loss to net cash used in operating activities:
Extraordinary gain from reversal of contingent consideration		(22,046	)		—
Gain on sale of investment		—			114
Gain on sale and disposals of equipment		5			753
Depreciation and amortization		26,359			19,851
Acquired in-process R&D		—			3,542
Non-cash compensation charges		12,827			1,288
Other non-cash charges-net		1,049			—
Impact of inventory step-up related to inventory sold		18,621			—
Goodwill Impairment		320,261			—
Changes in assets and liabilities:
Receivables		62,813			(24,572	)
Inventory		(8,204	)		(14,868	)
Prepaid expenses and other current assets		2,175			(104	)
Other assets		(4,029	)		123
Accounts payable and accrued expenses		(47,996	)		(7,242	)
Unearned revenue		30,985			15,915
Accrued postretirement benefit cost		1,051			862
Net cash provided by (used in) operating activities		34,830			(81,416	)
Cash flows from investing activities:
Payments for acquisitions		—			(1,794	)
Purchases of investments (restricted and unrestricted)		(169,791	)		(357,351	)
Maturities and sales of investments (restricted and unrestricted)		35,545			285,039
Net additions to property, equipment and leasehold improvements		(8,713	)		(21,512	)
Proceeds from sale of assets		786			—
Additions to compound library assets		(16	)		(377	)
Investments in privately-owned companies		—			(344	)
Net cash used in investing activities		(142,189	)		(96,339	)
Cash flows from financing activities:
Payment of expense relating to public offering		—			(116	)
Proceeds from the exercise of stock options, stock warrants, employee purchase plan and other		3,705			10,503
Other		(102	)		—
Payments on capital leases obligation		(603	)		(3	)
Net cash provided by financing activities		3,000			10,384
Net decrease in cash and cash equivalents		(104,359	)		(167,371	)
Effect of exchange rate changes on cash and cash equivalents		506			670
Cash and cash equivalents at beginning of period		164,084			329,556
Cash and cash equivalents at end of period	$	60,231		$	162,855
Cash paid for interest	$	6,025		$	4,875
Non-cash activities:
Issuance of common stock to employees	$	—		$	614
Issuance of common stock to directors	$	—		$	527
Issuance of common stock in connection with acquisitions	$	—		$	4,158
Purchase accounting adjustments	$	3,505		$	—
Acceleration of options	$	—		$	816

See accompanying notes to consolidated financial statements.

4

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(Unaudited)

     In this Quarterly Report on Form 10-Q, “OSI,” “our company,” “we,” “us,” and “our” refer to OSI Pharmaceuticals, Inc. and subsidiaries. We own or have rights to use various copyrights, trademarks and trade names used in our business, including the following: Tarceva^® (erlotinib), Macugen^® (pegaptanib sodium injection) and Novantrone^® (mitoxantrone for injection concentrate). This Form 10-Q also includes trademarks, service marks and trade names of other companies.

(1) Basis of Presentation

     In the opinion of management, the accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2005.

Use of Estimates

     We have made a number of estimates and assumptions related to the reported amounts in our financial statements and accompanying notes to prepare these consolidated financial statements in conformity with U.S. generally accepted accounting principles. Key estimates and assumptions include those that are used in determining such items as the provision for obsolete and excess inventories, the recoverability of long-lived assets and goodwill, the provisions for sales discounts and returns, amortizable lives of our fixed assets and amounts recorded for contingencies. Actual results could differ from those estimates and assumptions.

     The Company has reviewed the recoverability of its investment in certain intangible assets related to Macugen and the valuation of its Macugen inventory using certain assumptions which include an improvement in the current sales trend. If improvement is not seen in the sales trend for Macugen in the future, we may be required to record future impairment charges related to our eye disease assets, including Macugen inventory and our intangible asset related to Macugen.

(2) Revenue Recognition

Net revenue from unconsolidated joint business

     Net revenue from unconsolidated joint business is related to our co-promotion and manufacturing agreements with Genentech, Inc., our U.S. partner for Tarceva. It consists of our share of the pretax co-promotion profit generated from our co-promotion arrangement with Genentech for Tarceva, the partial reimbursement from Genentech of our sales and marketing costs related to Tarceva, and the reimbursement from Genentech of our manufacturing costs related to Tarceva. Under the co-promotion arrangement, all U.S. sales of Tarceva and associated costs and expenses, except for a portion of our sales related costs, are recognized by Genentech. For the three months ended September 30, 2006 and 2005, Genentech recorded $100 million and $73 million, respectively, in net sales of Tarceva in the United States and its territories. For the

5

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

nine months ended September 30, 2006 and 2005 Genentech recorded $296 million and $191 million, respectively, in net sales of Tarceva in the United States and its territories. We record our 50% share of the co-promotion pretax profit on a quarterly basis, as set forth in our agreement with Genentech. Pretax co-promotion profit under the co-promotion arrangement is derived by calculating U.S. net sales of Tarceva to third party customers and deducting costs of sales, distribution, and selling and marketing expenses incurred by Genentech and us. The costs incurred during the respective periods represent estimated costs of both parties and are subject to further adjustment based on each party’s final review. Based on past experience, we do not believe that these adjustments, if any, will be significant to our consolidated financial statements. The partial reimbursement of our sales and marketing costs related to Tarceva is recognized as revenue as the related costs are incurred. We defer the recognition of the reimbursement of our manufacturing costs related to Tarceva until the time Genentech ships and the product is received by the third party customers at which time our risk of inventory loss no longer exists. The unearned revenue related to shipments by our third party manufacturers of Tarceva to Genentech that have not been shipped to third party customers was $6.2 million and $7.0 million as of September 30, 2006 and December 31, 2005, respectively, and is included in unearned revenue-current in the accompanying consolidated balance sheet.

     Net revenues from unconsolidated joint business consist of the following (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
Co-promotion profit and reimbursement of sales force and marketing related costs	$	36,708	$	18,851	$	106,060	$	47,894
Reimbursement of manufacturing costs		3,125		2,613		8,639		6,998
Net revenue from unconsolidated joint business	$	39,833	$	21,464	$	114,699	$	54,892

Product Sales

     Product sales primarily consist of sales of Macugen in the United States and its territories. For the three and nine months ended September 30, 2006, Macugen net sales totaled $8.8 million and $96.1 million, respectively. We acquired Eyetech Pharmaceuticals, Inc. in the fourth quarter of 2005 and therefore only product sales for the first nine months of 2006 are included in the accompanying consolidated statement of operations. Net Macugen sales represent gross product revenue less distribution service fees and estimates for returns and allowances. Macugen is sold primarily to distributors who, in turn, sell to physicians, a limited number of specialty pharmacy providers and federal government buying groups. We do not recognize revenue from product sales until there is persuasive evidence of an arrangement, delivery has occurred, the price is fixed and determinable, the buyer is obligated to pay us, the obligation to pay is not contingent on resale of the product, the buyer has economic substance apart from us, we have no obligation to bring about sale of the product, the amount of returns can be reasonably estimated and collectibility is reasonably assured.

     Under an agreement dated February 2003 with Pfizer Inc., we share selling and marketing responsibility with Pfizer for Macugen in the United States. We record all of the revenue from the sale of Macugen. We have determined that we are qualified as a principal

6

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

under the criteria set forth in Emerging Issues Task Force, or EITF, Issue 99-19, “Reporting Gross Revenue as a Principal vs. Net as an Agent,” based on our responsibilities under our contracts with Pfizer, which include manufacture of product for sale in the United States, distribution, ownership of product inventory and credit risk from customers.

     We record allowances for distribution fees, product returns and governmental rebates for products sold in the United States at the time of sale, and report revenue net of such allowances. We must make significant judgments and estimates in determining these allowances. If actual results differ from our estimates, we will be required to make adjustments to these allowances in the future.

Royalties on Product Sales

     We estimate royalty revenue and royalty receivables in the periods these royalties are earned, in advance of collection. Our estimate of royalty revenue and receivables is based upon communication with our collaborative partners. Differences between actual revenues and estimated royalty revenue, if any, are adjusted for in the period which they become known, typically the following quarter. Historically, such adjustments have not been material to our consolidated financial condition or results of operations.

Sales Commissions

     Sales commissions represent commissions earned on the sales of the drug, Novantrone, in the United States for oncology indications pursuant to a co-promotion agreement dated March 11, 2003 with Ares Trading S.A., an affiliate of Serono, S.A. Serono markets Novantrone in multiple sclerosis indications and records all U.S. sales for all indications including oncology indications. Sales commissions from Novantrone on net oncology sales are recognized in the period the sales occur based on the estimated split between oncology sales and multiple sclerosis sales, as determined by an external third party. The split between oncology and multiple sclerosis sales is then subject to further adjustment in the subsequent quarter based upon the parties’ final review. Historically, such adjustments have not been material to our consolidated financial condition or results of operations.

Licenses, Milestones and Other Revenues

     Our revenue recognition policies for all nonrefundable upfront license fees and milestone arrangements are in accordance with the guidance provided in the Securities and Exchange Commission, or SEC, Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by SEC Staff Accounting Bulletin No. 104, “Revenue Recognition.” In addition, in fiscal 2004, we adopted the provisions of EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables” for multiple element revenue arrangements entered into or materially amended after September 30, 2003 with respect to recognition of upfront and milestone payments received under collaborative research agreements. Milestones which have been received from Genentech are being recognized over the term of our Manufacturing and Supply Agreement with Genentech, under which the last items of performance to be delivered to Genentech are set forth, on a straight-line basis, which approximates the expected level of performance under the Manufacturing and Supply Agreement. The milestone payments received

7

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

from Roche are recognized over the expected term of the research and development collaboration. At September 30, 2006, we had unearned revenue of $40.6 million relating to Genentech and Roche payments, of which $3.3 million was classified as short-term.

     We recognized $9.4 million of milestone revenue in the nine months ended September 30, 2006, in connection with license agreements previously granted under our patent portfolio covering the use of dipeptidyl peptidase IV, or DP-IV, inhibitors for the treatment of type 2 diabetes and related indications. These payments are included in license and milestone revenues in the accompanying consolidated statement of operations for the nine months ended September 30, 2006. We recognize revenue from license agreements where we have no future obligations under the license agreements and the collection of payments is reasonably assured.

     During the second quarter of 2006, we received a $35 million milestone payment from Pfizer in connection with the launch of Macugen in select European countries. The milestone payment is being recognized over the term of our Collaboration and License Agreements, under which the last items of performance to be delivered to Pfizer are set forth, on a straight-line basis, which approximates the expected level of performance under the agreements. At September 30, 2006, we had unearned revenue of $33.6 million relating to Pfizer payments, of which $3.3 million was classified as short-term.

     Concurrent with the launch of Macugen in Europe, we paid a $5 million milestone payment under a licensing agreement whereby we obtained certain technical rights and know-how related to Macugen. We have deferred the payment and are amortizing it on a straight-line basis over the expected benefit period, which equals the term of the licensing agreement and the term of the Pfizer agreements. The amortization expense is recognized in the accompanying consolidated statement of operations in cost of goods sold. At September 30, 2006, we had a deferred asset of $4.8 million relating to these payments.

Collaborative Program Revenues

     Collaborative program revenues represent a funding arrangement for research and development with Pfizer for the development of Macugen and are recognized when earned in accordance with the terms of our agreement with Pfizer and related research and development activities undertaken.

     Based on the terms of our collaboration agreement with Pfizer, revenues derived from reimbursement of costs associated with the development of Macugen are recorded in compliance with EITF Issue 99-19 and EITF Issue 01-14, “Income Statement Characterization of Reimbursements Received For ‘Out-of-Pocket’ Expenses Incurred.” According to the criteria established by these EITF Issues, in transactions where we act as a principal with discretion to choose suppliers, bear credit risk and perform part of the services required in the transaction, we have met the criteria to record revenue for the gross amount of the reimbursements.

(3) Accounting for Stock-Based Compensation

     We have established several equity compensation plans for our employees, officers, directors and consultants, including our Amended and Restated Stock Incentive Plan and our

8

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

Stock Incentive Plan for New Hires. The plans are administered by the Compensation Committee of the Board of Directors, which may grant either non-qualified or incentive stock options as well as stock awards, depending upon the plan. The Committee determines the exercise price and vesting schedule at the time the option is granted. Options vest over various periods and expire no later than 10 years from date of grant. Historically, we have satisfied the exercise of options by issuing new shares. The total authorized shares under these plans are 11,559,500, of which 1,456,486 shares were available for future grant as of September 30, 2006.

     We have two employee stock purchase plans under which eligible employees may contribute up to 10% of their base earnings toward the quarterly purchase of our common stock. The employee’s purchase price is derived from a formula based on the fair market value of the common stock at a 15% discount. As of September 30, 2006, we had 511,509 shares of common stock available for future grant in connection with these plans.

     We sponsor a stock purchase plan for our UK-based employees. Under the terms of the plan, eligible employees may contribute between £5 and £250 of their base earnings, in 36 monthly installments towards the purchase of our common stock. As of September 30, 2006, we had 112,369 shares of our common stock available for future grant in connection with this plan.

     Effective January 1, 2006, we adopted the provisions of Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 123(R), “Share-Based Payments,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No. 123(R), stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). We adopted SFAS No. 123(R) using the modified prospective method and, as a result, periods prior to January 1, 2006 have not been restated.

     We recognized stock-based compensation for awards issued under our equity compensation plans, restricted stock and options assumed in the acquisition of Eyetech and employee stock purchase plans in the following line items in the consolidated statement of operations for the three and nine months ended September 30, 2006 (in thousands):

	Stock–based		Compensation
	compensation as a		expense related
	result of the		to restricted stock		Total stock-based
	adoption		and restricted		compensation
	of SFAS 123(R)		options		expense
Three months ended September 30, 2006
Cost of sales	$	54	$	35	$	89
Research and development expenses		773		433		1,206
Selling, general and administrative expenses		2,276		970		3,246
Stock-based compensation expense	$	3,103	$	1,438	$	4,541
Nine months ended September 30, 2006
Cost of sales	$	201	$	297	$	498
Research and development expenses		2,365		1,319		3,684
Selling, general and administrative expenses		8,318		3,608		11,926
Stock-based compensation expense	$	10,884	$	5,224	$	16,108

9

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

     As of December 31, 2005, we had recognized deferred compensation related to restricted stock and options assumed in connection with the acquisition of Eyetech. In connection with the adoption of SFAS No. 123(R) on January 1, 2006, we eliminated the caption deferred compensation by reducing accrued expenses by $3.9 million and additional paid in capital by $3.4 million. This compensation expense will continue to be recognized over the remaining vesting period of such restricted stock and options.

     Total net stock-based compensation expense is attributable to the granting of, and the remaining requisite service periods of, stock options and restricted stock. Compensation expense attributable to net stock-based compensation for the three and nine months ended September 30, 2006 was $4.5 million and $16.1 million, respectively, or $.08 per share and $.28 per share, respectively, for both basic and diluted earnings per share. At September 30, 2006, the total remaining unrecognized compensation cost related to unvested stock-based payment awards was $30.1 million. This cost is expected to be recognized over a weighted average period of approximately 3 years.

     During the three and nine months ended September 30, 2005, we recorded compensation expense for stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees.” Since the exercise price for such options was equal to the fair market value of our stock at the date of grant, the stock options had no intrinsic value upon grant and, therefore, no expense associated with stock options was recorded in the consolidated statements of operations.

     Had the compensation cost of our equity compensation plans for the three and nine months ended September 30, 2005 been determined in accordance with SFAS No. 123(R), our pro forma net loss and net loss per share would have been (in thousands except per share amounts):

	Three Months			Nine Months
	Ended			Ended
	September 30,			September 30,
	2005			2005
Net loss	$	(20,037	)	$	(77,078	)
Add: stock-based compensation included in net loss		193			2,667
Compensation cost determined under fair value method		(6,625	)		(19,855	)
Pro forma net loss	$	(26,469	)	$	(94,266	)
Basic and diluted net loss per common share:
Net loss – as reported	$	(0.39	)	$	(1.50	)
Net loss – pro forma	$	(0.51	)	$	(1.84	)

     Under the modified prospective method, SFAS No. 123(R) applies to new awards and to awards outstanding on the effective date that are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service had not been rendered as of December 31, 2005 is being recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under SFAS No. 123(R). We amortize the fair value of all awards on a straight-line basis over the total requisite service period.

10

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

     We estimate the fair value of stock options using the Black-Scholes option-pricing model. We believe that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair value of our stock options granted during the three and nine months ended September 30, 2006. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.

     The per share weighted average fair value of stock options granted during the three and nine months ended September 30, 2006 was $16.42 and $14.80, respectively, compared to $19.13 and $22.22 for the three and nine months ended September 30, 2005, respectively. In addition to the exercise and grant date prices of the awards, certain weighted average assumptions that were used to estimate the fair value of stock option grants in the respective periods are listed in the table below:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Expected dividend yield		0	%		0	%		0	%		0	%
Expected volatility		53.39	%		48.06	%		56.81	%		56.86	%
Risk-free interest rate		4.77	%		3.94	%		4.50	%		3.92	%
Expected term (years)		4.57			4.25			4.33			4.06

     A summary of our stock option programs as of September 30, 2006 and changes during the quarter ended is presented below:

					Aggregate Intrinsic		Weighted Average
	No. Shares		Weighted Average		Value (1)		Contractual Life
	(in thousands)		Exercise Price		(in millions)		Remaining in Years
Outstanding at December 31, 2005		6,921	$	35.26
Granted at fair value		445	$	29.40
Exercised at fair value		91	$	14.93
Expired		77	$	45.67
Forfeited		233	$	28.37
Outstanding at June 30, 2006		6,965	$	35.01
Granted at fair value		17	$	33.48
Exercised at fair value		102	$	16.21
Expired		61	$	46.94
Forfeited		123	$	23.13
Outstanding at September 30, 2006		6,696	$	35.41	$	48.3		6.22
Exercisable at September 30, 2006		4,401	$	39.34	$	23.9		6.08

(1) The intrinsic value of a stock option is the amount by which the current market value of the underlying stock exceeds the exercise price of the option.

     The total intrinsic value of stock options exercised during the three and nine months ended September 30, 2006 was $2.0 million and $3.4 million, respectively, compared with

11

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

$1.5 million and $13.7 million for the three and nine months ended September 30, 2005, respectively.

     Options granted prior to June 1, 2005 have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of 10 years and a vesting period of three years. Options granted subsequent to May 31, 2005 have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of seven years and a vesting period of four years. For the three and nine months ended September 30, 2006, the historical forfeiture rate was 16.9% for non-executive employees and no forfeitures for executive employees was assumed for purposes of recognizing compensation expense based upon adjusted historical experience.

     We estimate expected volatility based upon a combination of historical, implied and adjusted historical stock prices. The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. We assumed an expected dividend yield of zero since we have not historically paid dividends and do not expect to pay dividends in the foreseeable future. Commencing in the second quarter of fiscal 2005, the fair value of the options was estimated at the date of grant using a Black-Scholes option pricing model with the expected option term determined using a Monte Carlo simulation model that incorporates historical employee exercise behavior and post-vesting employee termination rates.

     On November 30, 2005, the Compensation Committee of our Board of Directors approved the forward vesting of all unvested out-of-the-money stock options with an exercise price greater than $30.00 per share for all of our employees, other than executive officers. Options to purchase approximately 1.6 million shares of common stock were accelerated. Options held by executive officers and non-employee directors were not accelerated. The accelerated options, which were considered fully vested as of November 30, 2005, had grant prices ranging from $30.09 to $82.40 per share and a weighted average grant price of $45.44 per share. The primary purpose of the accelerated vesting was to enable us to reduce the future compensation expense associated with our out-of-the-money stock options upon adoption of SFAS No. 123(R) in fiscal 2006.

Restricted Stock

     We issued 191,250 shares of restricted common stock during the nine months ended September 30, 2006. These restricted shares vest annually over a two or four year period depending on the award, and are subject to certain additional terms and conditions. We also assumed 339,439 shares of Eyetech restricted stock in connection with the acquisition of Eyetech. Pursuant to the terms of the acquisition agreement, each restricted share converted into the right to receive 0.12275 shares of our common stock and $15.00 cash payment upon vesting. As a result, on November 14, 2005, we reserved for issuance 41,666 shares of our common stock and $5.1 million in cash in connection with these restricted shares. As of September 30, 2006, 8,451 shares of our common stock and $1.0 million in cash remained subject to these restricted shares, representing $1.2 million of unrecognized compensation expense.

12

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

     The following is a summary of the status of the Company’s restricted shares (excluding shares assumed in the Eyetech acquisition) as of September 30, 2006 and activity for the nine months then ended:

			Weighted Average
	No. Shares		Grant Date Fair
	(in thousands)		Value
Balance at December 31, 2005		16	$	37.88
Granted at fair value		191	$	30.79
Vested at fair value		3	$	37.06
Forfeited		8	$	31.37
Balance at September 30, 2006		196	$	31.25

(4) Restricted Assets

     In September 2003, in connection with the issuance of $150.0 million in 3.25% convertible senior subordinated notes due 2023, or the 2023 Notes, we pledged $14.2 million of U.S. government securities, or restricted investment securities, with maturities at various dates through August 2006. Upon maturity of the restricted investment securities, the proceeds are used to pay the first six scheduled interest payments on the 2023 Notes when due. We consider our restricted investment securities to be held-to-maturity securities, as defined by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” These securities are reported at their amortized cost, which includes the direct costs to acquire the securities plus the amortization of any discount or premium, and accrued interest earned on the securities. The balance of restricted investment securities decreases as scheduled interest payments are made.

     Certain of our facility leases have outstanding letters of credit issued by commercial banks which serve as security for our performance under the leases. Included in restricted investment securities as of September 30, 2006 were $9.5 million of investments to secure these letters of credit.

(5) Inventory

     Tarceva is stated at the lower of cost or market, with cost being determined using the weighted average method. Included in inventory are raw materials and work-in-process for Tarceva that may be used in the production of pre-clinical and clinical product, which will be expensed to research and development cost when consumed for these uses. Prior to receipt of U.S. Food and Drug Administration, or FDA, approval of Tarceva for commercial sale on November 18, 2004, we had expensed all costs associated with the production of Tarceva to research and development expense in our consolidated statements of operations. Effective November 18, 2004, we began to capitalize the costs of manufacturing Tarceva as inventory, including the costs to label, package and ship previously manufactured bulk inventory which costs had already been expensed as research and development. Inventory is comprised of three components: raw materials, which are purchased directly by us, work-in-process, which is

13

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

primarily active pharmaceutical ingredient, or API, where title has transferred from our contract manufacturer to us, and finished goods, which are packaged product ready for commercial sale.

     At December 31, 2005, the cost reflected in a portion of the finished goods inventory for Tarceva consisted solely of the cost incurred to package and label work-in-process inventory that had been previously expensed. As of September 30, 2006, we had sold all the inventory that was partially produced and expensed prior to November 18, 2004.

     As part of the acquisition of Eyetech, acquired finished goods and work-in-process was valued at fair value. Included in the finished goods and work-in-progress inventory at September 30, 2006 is $11.7 million and $15.6 million, respectively, of step-up in value assigned to Eyetech inventory as part of the acquisition. At December 31, 2005, the amount of the step-up in value assigned to finished goods and work-in-process inventory was $15.3 million and $33.1 million, respectively. The carrying value of raw materials acquired on the date of acquisition and Macugen inventory purchased and manufactured subsequent to the acquisition are stated at the lower of cost or market and are determined by weighted average method.

     Inventory, net of the reserve for excess inventory, at September 30, 2006 and December 31, 2005, consisted of the following (in thousands):

	September 30,		December 31,
	2006		2005
Raw materials	$	6,793	$	5,905
Work in process		30,860		44,961
Finished goods on hand, net		19,905		19,533
Inventory subject to return		5,666		5,316
Total inventory	$	63,224	$	75,715

     Inventory subject to return primarily represents the amount of Tarceva shipped to Genentech which has not been recognized as revenue.

(6) Comprehensive Income (Loss)

     Comprehensive income (loss) for the three and nine months ended September 30, 2006 and 2005 was as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Net loss	$	(21,257	)	$	(20,037	)	$	(359,041	)	$	(77,078	)
Other comprehensive income (loss):
Foreign currency translation adjustments		290			(201	)		1,289			(2,126	)
Unrealized holding gains (losses) arising during period		112			(332	)		(58	)		(1,100	)
Less: Reclassification adjustment for gains realized in net loss		—			2,189			—			2,127
		402			1,656			1,231			(1,099	)
Total comprehensive income (loss)	$	(20,855	)	$	(18,381	)	$	(357,810	)	$	(78,177	)

14

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

     The components of accumulated other comprehensive income were as follows (in thousands):

	September 30,			December 31,
	2006			2005
Cumulative foreign currency translation adjustment	$	3,117		$	1,828
Unrealized loss on available-for-sale securities		(131	)		(73	)
Accumulated other comprehensive income	$	2,986		$	1,755

(7) Net Loss per Common Share

     Basic and diluted net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the respective period. Common share equivalents (convertible senior subordinated notes and stock options) are not included since their effect would be anti-dilutive. The contingent shares pursuant to the contingent value rights are not included since the contingency condition has not been satisfied.

     Such common share equivalents and contingent shares for the three and nine months ended September 30, 2006 and 2005 amounted to (in thousands):

	Three Months				Nine Months
	Ended				Ended
	September 30,				September 30,
	2006		2005		2006		2005
Common share equivalent		7,959		3,732		7,651		4,164
Contingent shares		1,585		1,585		1,585		1,585

(8) Intangible Assets

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

	September 30, 2006							December 31, 2005
	Carrying		Accumulated			Net Book		Carrying		Accumulated			Net Book
	Amount		Amortization			Value		Amount		Amortization			Value
Novantrone	$	46,009	$	(42,745	)	$	3,264	$	46,009	$	(41,657	)	$	4,352
Macugen technology		201,400		(15,840	)		185,560		201,400		(2,263	)		199,137
Acquired patent estate		726		(165	)		561		668		(65	)		603
Acquired licenses issued to other companies		3,758		(560	)		3,198		3,458		(356	)		3,102
Total	$	251,893	$	(59,310	)	$	192,583	$	251,535	$	(44,341	)	$	207,194

     In connection with the acquisition of Eyetech on November 14, 2005, we recognized $201.4 million of intangible assets with determinable lives consisting of core and developed technology related to Macugen. These intangibles are being amortized on a straight-line basis over 11 years, the underlying life of the last to expire patent. Total amortization expense for the

15

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

three and nine months ended September 30, 2006 was $5.0 million and $14.9 million, respectively, compared to $3.8 million and $11.4 million for the three and nine months ended September 30, 2005, respectively. Amortization expense is estimated to be $5.0 million for the remaining three months of 2006 and $19.9 million for the years 2007 through 2008 and $18.5 million for the years 2009 and 2010.

(9) Consolidation of Facilities

(a) Corporate headquarters

     During the first quarter of 2006, we relocated our corporate headquarters to our current facility in Melville, New York. As a result, in accordance with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities,” or SFAS No. 146, during the first quarter of 2006, we recognized a liability of $2.7 million and net expense of $2.3 million for the exit cost associated with the termination of the lease for the old facility. During the second quarter of 2006, we recognized an additional expense of $240,000 in connection with final lease settlement. The total recognized net expense of $2.6 million is comprised of the net lease obligations of $3.0 million, offset by previously accrued rent expense of $369,000. The activity for the three and nine months ended September 30, 2006 was as follows (in thousands):

	Three Months			Nine Months
	Ended			Ended
	September 30,			September 30,
	2006			2006
Opening liability	$	2,179		$	2,734
Accrual for rental payments		—			240
Accretion expense		45			103
Cash paid for rent and other		(173	)		(1,026	)
Ending liability	$	2,051		$	2,051

(b) Eyetech

     In connection with the acquisition of Eyetech on November 14, 2005, we implemented a plan to consolidate certain facilities and reduce the workforce. Included in the liabilities assumed in the acquisition, we recognized $6.2 million for the termination benefits and relocation cost of employees and $5.4 million for the present value of future lease commitments. The present value of the lease payments was determined based upon the date we plan to exit the facility and the remaining lease expiration, offset by estimated sublease income. Rental payments for the facilities prior to closure will be included in operating expense. For the three and nine months ended September 30, 2006, we recognized an additional $1.1 million and $5.4 million, respectively, of retention bonus costs. Of these costs, $367,000 was included in research and development costs and $739,000 was included in selling and administrative expenses for the three months ended September 30, 2006. For nine months ended September 30, 2006, $3.5 million was included in research and development costs and $1.9 million was included in selling

16

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

and administrative expenses. The activity for the three and nine months ended September 30, 2006 was as follows (in thousands):

	Three Months			Nine Months
	Ended			Ended
	September 30, 2006			September 30, 2006
Opening liability	$	8,603		$	10,262
Accrual for severance, relocation and retention bonus		1,033			5,280
Accretion expense		26			26
Cash paid for severance		(2,322	)		(6,906	)
Cash paid for rent		(542	)		(1,864	)
Reversals		(2,800	)		(2,800	)
Ending liability	$	3,998		$	3,998

(c) Oxford, England

     During the fourth quarter of fiscal 2004, we consolidated all of our U.K.-based oncology research and development activities into our New York locations. The consolidation resulted in a reduction in our U.K.-based oncology workforce by approximately 82 employees. During the year ended December 31, 2005, we recorded a charge of $4.4 million, in selling general and administrative expenses, for estimated facility lease return costs and the remaining rental obligation net of estimated sublease rental income in accordance with SFAS No. 146.

     The activity for the three and nine months ended September 30, 2006 and 2005 was as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Opening liability	$	4,090		$	3,686		$	4,210		$	4,302
Provision for rental adjustments		—			—			(403	)		761
Provision for facility refurbishment		—			—			—			1,019
Cash paid for severance		—			—			—			(1,286	)
Cash paid for facility reimbursement		—			—			—			(350	)
Cash paid for rent		(147	)		(269	)		(147	)		(829	)
Other		53			(26	)		336			(226	)
Ending liability	$	3,996		$	3,391		$	3,996		$	3,391

(d) Horsham, Pennsylvania

     During the second quarter of fiscal 2004, we committed to and approved an exit plan for our Horsham, Pennsylvania facility, which we acquired in connection with our acquisition of Cell Pathways, Inc. in June 2003. We have recognized the rent obligations for the remainder of the lease (through June 2008), offset by the sublease rental income. These exit costs are comprised of the net lease obligations of $2.1 million, offset by previously accrued rent expense of $338,000. In May 2004, we entered into a sublease agreement for the Horsham facility. We charge the rental payments less the sublease rental income received against the accrued liability.

17

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

The activity for the three and nine months ended September 30, 2006 and 2005 was as follows (in thousands):

	Three Months						Nine Months
	Ended						Ended
	September 30,						September 30,
	2006			2005			2006			2005
Opening liability	$	928		$	1,420		$	1,160		$	1,678
Cash paid for rent less sublease income received		(116	)		(121	)		(348	)		(379	)
Ending liability	$	812		$	1,299		$	812		$	1,299

(10) Employee Post-Retirement Plan

     We have a plan which provides post-retirement medical and life insurance benefits to eligible employees, board members and qualified dependents. Eligibility is determined based on age and service requirements. These benefits are subject to deductibles, co-payments and other limitations.

     Under SFAS No. 106, “Employer’s Accounting for Post-Retirement Benefits Other Than Pensions,” the cost of post-retirement medical and life insurance benefits is accrued over the active service periods of employees to the date they attain full eligibility for such benefits.

     Net post-retirement benefit cost for the three and nine months ended September 30, 2006 and 2005 included the following components (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
Service costs for benefits earned during the period	$	264	$	210	$	791	$	629
Interest costs on accumulated post-retirement benefits obligation		102		88		307		264
Amortization of initial benefits attributed to past services		1		1		4		4
Amortization of loss		17		16		50		48
Net post-retirement benefit cost	$	384	$	315	$	1,152	$	945

(11) Litigation

     On or about December 16, 2004, several purported shareholder class action lawsuits were filed in the United States District Court for the Eastern District of New York against us, certain of our current and former executive officers, and the members of our Board of Directors. The lawsuits were brought on behalf of those who purchased or otherwise acquired our common stock during certain periods in 2004, which periods differed in the various complaints. The Court has now appointed a lead plaintiff, and on February 17, 2006, the lead plaintiff filed a consolidated amended class action complaint seeking to represent a class of all persons who purchased or otherwise acquired our common stock during the period from April 26, 2004 through November 22, 2004. The consolidated complaint alleges that defendants made material

18

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

misstatements and omissions concerning the survival benefit associated with our product, Tarceva and the size of the potential market of Tarceva upon FDA approval of the drug. It alleges violations of Sections 11 and 15 of the Securities Act of 1933, as amended, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. The consolidated complaint seeks unspecified compensatory damages and other relief. On April 7, 2006, we filed a motion to dismiss the consolidated amended complaint. Briefing on this motion was completed on June 21, 2006. We have requested an oral argument on our motion and are awaiting a decision from the court. Based on the early stage of this litigation, the ultimate outcome cannot be determined and accordingly, no provision has been recorded in the consolidated financial statements.

(12) Acquisition of Eyetech and Goodwill Impairment

     On November 14, 2005, we completed our acquisition of Eyetech, pursuant to the terms of an Agreement and Plan of Merger dated August 21, 2005. The acquisition was structured as a merger of a wholly-owned subsidiary of OSI with and into Eyetech, and Eyetech was renamed (OSI) Eyetech, Inc.

     The acquisition was accounted for under the purchase method of accounting. The purchase price was allocated to the acquired assets and assumed liabilities based on the preliminary fair values as of the date of the acquisition. In connection with the merger, we committed to and approved an exit plan for consolidation of certain Eyetech facilities. As a result of the exit plan, we initially recognized a liability of $5.4 million for rent obligations based upon the present value of the remaining lease payments, after exiting the facilities, offset by the potential sublease rental income. In addition, we recognized $6.2 million of liabilities associated with personnel reductions and relocation costs. As of December 31, 2005, the final determination for the disposition of equipment and other costs was not finalized. During the third quarter of 2006, we finalized our valuation of Eyetech related assets and liabilities and recognized adjustments to decrease the fair value of the acquired Eyetech assets by $3.4 million and decrease the assumed Eyetech liabilities by $2.5 million, resulting in a $0.9 million adjustment to increase the value assigned to Eyetech goodwill. As discussed below, we determined the Eyetech goodwill was impaired in the second quarter of 2006 and recognized an impairment charge of $319.4 million, reflecting the entire amount of the carrying value of the Eyetech goodwill at June 30, 2006. Accordingly, the $0.9 million adjustment discussed above, has been recognized in the statement of operations as an adjustment to the second quarter impairment charge.

     The final purchase price allocation is as follows (in thousands):

Cash and investments	$	271,934
Accounts receivable		92,165
Inventory		62,587
Fixed assets		12,518
Prepaid expenses and other assets		7,955
Amortizable intangibles		201,400
Goodwill		320,261
In-process research and development (R&D)		60,900
Total assets and in-process R&D acquired		1,029,720
Less liabilities assumed		120,327
Purchase price	$	909,393

19

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

     In accordance with SFAS no. 142, goodwill and other indefinite-lived intangibles must be tested for impairment annually or in interim periods if events indicate there is a possible impairment. As a result of competitive developments relating to Macugen and the age-related macular degeneration, or wet AMD, marketplace, including competition from two Genentech products – Lucentis™ (ranibizumab injection) and the widespread off-label use of Avastin^® (bevacizumab) — we were required to assess the value of the $320.3 million of goodwill recorded in connection with the acquisition of Eyetech Pharmaceuticals, Inc. In our assessment, we considered the declining Macugen revenues and the decision to suspend or curtail research activities in the eye disease area, which further limits the potential for future revenues from new products. Based on this initial assessment, we recorded an estimated impairment charge of $319.4 million for the quarter ended June 30, 2006, reflecting the full value of the Eyetech goodwill as of June 30, 2006. We determined the amount of the charge based on present value techniques using discounted cash flows in accordance SFAS No. 142. During the third quarter of 2006 we finalized the Eyetech purchase valuation, as discussed above, which resulted in a $0.9 million adjustment to the value assigned to goodwill. In addition, we completed our impairment assessment and determined the $320.3 million value assigned to goodwill was impaired and therefore recorded an adjustment to our second quarter impairment charge of an additional $0.9 million.

(13) Convertible Debt

     On October 20, 2006, we announced that our 2.0% Convertible Senior Notes due 2025, or the 2025 notes, were convertible at the option of the holders and will remain convertible through December 29, 2006, the last trading day of the current fiscal quarter, as provided for in the indenture governing the 2025 notes.

     The 2025 notes became convertible as our common stock closed at or above $35.32 per share for twenty trading days within the thirty trading day period ending on September 29, 2006. As a result, during the conversion period commencing October 1, 2006 and continuing through and including December 29, 2006, holders of the 2025 notes can elect to convert the 2025 notes into shares of common stock, subject to the terms of the indenture. The 2025 notes are convertible at the conversion rate of 33.9847 shares per $1,000 principal amount of each 2025 note or an effective conversion price of $29.43 per share. There is currently outstanding $115 million principal amount of the 2025 notes.

(14) Subsequent Events

     On November 6, 2006, we announced that we intend to exit our eye disease business which consists principally of Macugen, our marketed product for the treatment of wet AMD. Macugen net sales totaled $8.8 million and $96.1 million for the three and nine months ended September 30, 2006, respectively. Over the next several months, we will conduct a thorough and orderly process to explore strategic options for this business, including licensing, partnering or selling Macugen and our research assets in the eye disease area with the goal of identifying a strategic partner or partners who will be better and more appropriately able to maximize the long term value of our eye disease portfolio. Our expectation is that it will take between six and nine months to complete this process and exit the business.

20

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

Overview

     We are a mid-cap biotechnology company committed to building a scientifically strong and financially successful top tier biopharmaceutical organization that discovers, develops and commercializes innovative molecular targeted therapies addressing major unmet medical needs in oncology, diabetes and obesity. Our primary focus is the oncology area where our business is anchored by our flagship product, Tarceva, a small molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR. In November 2004, Tarceva was approved by the U.S. Food and Drug Administration, or FDA, for the treatment of non-small cell lung cancer, or NSCLC, in patients who had failed at least one prior chemotherapy regimen, and subsequently, in November 2005, for the treatment of patients with locally advanced and metastatic pancreatic cancer in combination with the chemotherapy agent, gemcitabine. Tarceva was also approved for sale in the European Union, or EU, for the treatment of NSCLC in September 2005. In 2005, Tarceva achieved global sales of approximately $309 million and U.S. sales of approximately $275 million. For the nine months ended September 30, 2006, Tarceva global sales were approximately $460 million of which U.S. sales accounted for $296 million. We co-promote Tarceva in the United States with Genentech, Inc. and receive royalties on sales from our international partner, Roche.

     We also have research and early development programs in diabetes and obesity which are conducted through Prosidion Limited, our U.K. subsidiary. Our near term focus in the diabetes and obesity area is to progress our research projects through proof-of-concept (Phase IIa) studies followed by outlicensing or partnering these programs for upfront fees, milestones and royalties. We are presently developing PSN010, a glucokinase activator for diabetes, which is in Phase I clinical trials, and we recently advanced PSN602 a serotonin 1A agonist and monoamine reuptake inhibitor, or S1RUP, candidate into late stage preclinical development. PSN602 is the first anti-obesity molecule discovered by us to enter development. We also generate revenues from our patent estate relating to the use of DP-IV inhibitors for the treatment of type II diabetes and related indications. Six pharmaceutical companies have taken non-exclusive licenses to these patents, which provide us with upfront payments, as well as potential milestones and royalties.

     As discussed below in “Subsequent Events,” we announced on November 6, 2006 that we intend to exit our eye disease business, which consists principally of Macugen, our marketed product for the treatment of neovascular age-related macular degeneration, or wet AMD.

Quarterly Update

     We made a number of strategic decisions regarding our clinical candidates for the treatment of diabetes in the third quarter of 2006. Given the strong competitive environment within the DP-IV inhibitor area, including the recent approval of Merck & Co., Inc.’s Januvia™ (sitagliptin phosphate) by the FDA, we elected to suspend further clinical development of our DP-IV inhibitor, PSN9301, and are currently evaluating partnering options for this compound.

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We also suspended further development of PSN357, an oral, small molecule inhibitor of glycogen phosphorylase, after review of preliminary Phase II data.

     On September 21, 2006, we announced that we had begun a Phase III clinical trial of Tarceva as a targeted adjuvant therapy in patients who have undergone surgery for NSCLC with EGFR-positive tumors.

     On July 28, 2006, we announced that Roche had received a negative opinion from the European Committee for Medicinal Products for human Use, or CHMP, regarding the approval of Tarceva in combination with chemotherapy as first-line therapy for locally advanced, inoperable or metastatic pancreatic cancer. Roche has requested a re-examination of the CHMP decision.

Subsequent Events

     On November 6, 2006, we announced that we intend to exit our eye disease business which consists principally of Macugen, our marketed product for the treatment of wet AMD, as well as research assets in the eye disease area. Macugen net sales totaled $8.8 million and $96.1 million for the three and nine months ended September 30, 2006, respectively. We made the decision to exit because we believe that a key strategic goal of the acquisition of the eye disease business in November 2005 – the generation of significant cash flow from the eye disease business in the 2006 through 2008 fiscal years – will not be realized. Given the resulting financial constraints on our overall research and development budget, we do not believe that we could optimally develop the research and development assets in our eye disease business in the face of competing priorities in the oncology and diabetes areas. Over the next several months, we will conduct a thorough and orderly process to explore strategic options for this business, including licensing, partnering or selling Macugen and our research assets in the eye disease area with the goal of identifying a strategic partner or partners who will be better and more appropriately able to maximize the long term value of our eye disease portfolio. Our expectation is that it will take between six and nine months to complete this process and exit the business.

     On October 20, 2006, we announced that our 2025 notes were convertible at the option of the holders and will remain convertible through December 29, 2006, the last trading day of the current fiscal quarter, as provided for in the indenture governing the 2025 notes.

     On October 17, 2006, Merck announced the FDA approval of Januvia, a DP-IV inhibitor for the treatment of type 2 diabetes. Merck’s non-exclusive license of our DP-IV patent estate entitles us to receive a milestone payment as a result of this FDA approval, as well as royalties on future sales of Januvia.

Critical Accounting Policies

     We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ significantly from our estimates and the estimated amounts could differ significantly under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations

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and which require our most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Eyetech Purchase Accounting

     The purchase price related to the merger with Eyetech was allocated to tangible and identifiable intangible assets acquired and liabilities assumed based on the estimated fair market values as of the acquisition date. A third party valuation firm was engaged to assist in determining the fair values of in-process research and development, identifiable intangible assets, and certain property, plant and equipment, and in determining the useful lives of such tangible and identifiable intangible assets acquired. Such a valuation requires significant estimates and assumptions including but not limited to: determining the timing and expected costs to complete the in-process projects, determining the product life and term of estimated future cash flows, and developing appropriate costs, expenses, depreciation and amortization assumptions, tax rates, discount rates and probability rates by project. We believe the fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions. These assumptions are based on the best available information that we had at the time. Additionally, certain estimates for the purchase price allocation, including liabilities associated with restructuring activities, may change as subsequent information becomes available. As discussed in footnote 12, we have finalized our assessment of the Eyetech goodwill in the third quarter of 2006 and recorded an upward adjustment of $0.9 million to the estimated second quarter impairment charge of $320.3 million.

Revenue Recognition

Net revenues from unconsolidated joint business

     Net revenues from unconsolidated joint business are related to our co-promotion and manufacturing agreements with Genentech for Tarceva. They consist of our share of the pretax co-promotion profit generated from our co-promotion arrangement with Genentech for Tarceva, the partial reimbursement from Genentech of our sales and marketing costs related to Tarceva and the reimbursement from Genentech of our manufacturing costs related to Tarceva. Under the co-promotion arrangement, all U.S. sales of Tarceva and associated costs and expenses, except for a portion of our sales related costs, are recognized by Genentech. We record our 50% share of the co-promotion pretax profit on a quarterly basis, as set forth in our agreement with Genentech. Pretax co-promotion profit under the co-promotion arrangement is derived by calculating U.S. net sales of Tarceva to third-party customers and deducting costs of sales, distribution and selling and marketing expenses incurred by Genentech and us. The costs incurred during the respective periods represent estimated costs of both parties and are subject to further adjustment based on each party’s final review. Based on past experience, we do not believe that these adjustments, if any, will be significant to our consolidated financial statements. The partial reimbursement of sales and marketing costs related to Tarceva is recognized as revenue as the related costs are incurred. We defer the recognition of the reimbursement of our manufacturing costs related to Tarceva until the time Genentech ships the product to third-party customers at which time our risk of inventory loss no longer exists.

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License fees and milestones

     Our revenue recognition policies for all nonrefundable upfront license fees and milestone arrangements are in accordance with the guidance provided in the Securities and Exchange Commission, or SEC, Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by SEC Staff Accounting Bulletin No. 104, “Revenue Recognition.” In addition, we follow the provisions of EITF 00-21, “Revenue Arrangements with Multiple Deliverables” for multiple element revenue arrangements entered into or materially amended after September 30, 2003. Milestones received from Genentech after June 2004 and the remaining unearned upfront fee are being recognized over the term of our Manufacturing and Supply Agreement with Genentech, under which the last items of performance to be delivered to Genentech are set forth, on a straight-line basis, which approximates the expected level of performance under the Manufacturing and Supply Agreement. Milestone payments received from Roche are recorded as unearned revenue and recognized over the expected term of the research collaboration on a straight-line basis, which approximates the expected level of performance under the development plan. Milestone payments received from Pfizer are recorded as unearned revenue and recognized over the expected term of the collaboration and licensing agreements on a straight-line basis, which approximates the expected level of performance under the development plan.

Product Sales

     Product sales consist primarily of sales of Macugen. Macugen is sold primarily to distributors who, in turn, sell to physicians, a limited number of specialty pharmacy providers and federal government buying groups. We recognize revenue from product sales when there is persuasive evidence of an arrangement, delivery has occurred, the price is fixed and determinable, the buyer is obligated to pay us, the obligation to pay is not contingent on resale of the product, the buyer has economic substance apart from us, we have no obligation to bring about sale of the product, the amount of returns can be reasonably estimated and collectibility is reasonably assured.

     Under an agreement with Pfizer dated February 2003, we share sales and marketing responsibility for sales of Macugen in the United States. We report product revenue on a gross basis for these sales. We have determined that we are qualified as a principal under the criteria set forth in EITF 99-19, based on our responsibilities under our contracts with Pfizer, which include manufacture of product for sale in the United States, distribution, ownership of product inventory and credit risk from customers.

Collaborative revenue

     Collaborative program revenues represent funding arrangements for Macugen research and development with Pfizer and are recognized when earned in accordance with the terms of the agreements and related research and development activities undertaken.

     Based on the terms of our collaboration agreement with Pfizer, revenues derived from reimbursement of costs associated with the development of Macugen are recorded in compliance with EITF 99-19 and EITF 01-14. According to the criteria established by these EITF Issues, we have met the criteria to record revenue for the gross amount of the reimbursements.

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Sales commissions

     Sales commissions from Novantrone on net oncology sales are recognized in the period the sales occur based on the estimated split between oncology sales and multiple sclerosis sales, as determined on a quarterly basis by an external third party. The split between oncology and multiple sclerosis sales is subject to further adjustment based on the parties’ final review in the subsequent quarter. Based on past experience, we do not believe these adjustments, if any, will be significant to the consolidated financial statements.

Inventory

     The valuation of inventory requires us to make certain assumptions and judgments to estimate net realizable value. Inventories are reviewed and adjusted for obsolescence and aging based upon estimates of future demand, technology developments and market conditions. We determine the cost of raw materials, work in process and finished goods inventories using the weighted average method. Inventory costs include material, labor and manufacturing overhead. Inventories are valued at the lower of cost or market (realizable value) in accordance with Accounting Research Bulletin No. 43, or ARB 43. ARB 43 requires that inventory be valued at its market value where there is evidence that the utility of goods will be less than cost and that such write-down should occur in the current period. Accordingly, at the end of each period we evaluate our inventory and adjust to net realizable value the carrying value and excess quantities. Our analysis of the carrying value of inventory relies upon known market trends and expectations for future sales. If actual results differ significantly from our expectations, it could lead to the write down of inventory as a result of lot expiration and or obsolescence.

     Included in inventory are raw materials and work-in-process for Tarceva and Macugen that may be used in the production of pre-clinical and clinical product, which will be expensed to research and development cost when consumed for these uses. Tarceva is stated at the lower of cost or market, with cost being determined using the weighted average method. Prior to receipt of FDA approval of Tarceva for commercial sale on November 18, 2004, we had expensed all costs associated with the production of Tarceva to research and development expense in our consolidated statements of operations. Effective November 18, 2004, we began to capitalize the costs of manufacturing Tarceva as inventory, including the costs to label, package and ship previously manufactured bulk inventory which costs had already been expensed as research and development. As of September 30, 2006, we had sold all of the inventory that was partially produced and expensed prior to November 18, 2004.

     In November 2005, we recorded a $55.0 million step-up in value of finished goods and work-in-process inventory for the inventory we acquired from Eyetech. The step-up in fair value was determined based on the estimated selling price of the inventory less costs of disposal and a reasonable selling profit to both complete and sell the product. As of September 30, 2006, $27.3 million of initial increase in fair value of the inventory was included in inventory and will be included in cost of goods when the acquired inventory is sold in the future.

     The carrying value of Macugen raw material acquired on the date of the acquisition and Macugen inventory purchased and manufactured subsequent to the acquisition is stated at the lower of cost or market and is determined by the weighted average method.

Accruals for Contract Research Organization and Clinical Site Costs

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     We make estimates of costs incurred to date but not yet invoiced in relation to external contract research organizations, or CROs, and clinical site costs. We analyze the progress of clinical trials, including levels of patient enrollment, invoices received and contracted costs when evaluating the adequacy of the accrued liabilities. Significant judgments and estimates must be made and used in determining the accrued balance in any accounting period.

Goodwill and Other Long-Lived Assets

     We account for goodwill and other intangible assets in accordance with Statements of Financial Accounting Standards, or SFAS, No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations. It specifies the criteria which intangible assets acquired in a business combination must meet in order to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets determined to have indefinite lives no longer be amortized but instead be tested for impairment at least annually and whenever events or circumstances occur that indicate impairment might have occurred. We completed our annual impairment review of goodwill at December 31, 2005, and determined that no impairment charge was required. As discussed in footnote 12, we recorded an estimated impairment charge of $319.4 million to the Eyetech goodwill in the second quarter of 2006. We finalized our assessment of the Eyetech goodwill, as of September 30, 2006, and as a result, recorded an additional charge of $0.9 million.

     Our identifiable intangible assets are subject to amortization. SFAS No. 142 requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires, among other things, that long-lived assets be measured at the lower of carrying amount or fair value, less cost to sell, whether reported in continuing operations or in discontinued operations. We review our intangibles with determinable lives and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.

     Our judgments regarding the existence of impairment indicators are based on historical and projected future operating results, changes in the manner of our use of the acquired assets or our overall business strategy, and market and economic trends. Our most significant intangible asset is the acquired core and developed technology related to Macugen.

     In addition to our assessment of the Eyetech goodwill in the second and third quarter of 2006, we assessed the value attributable to the Macugen rights recorded as intangible assets at the time of the acquisition and determined that it was not impaired as of June 30, 2006 and September 30, 2006, based on our estimate of undiscounted cash flows from the expected future sales of Macugen. If improvement is not seen in the sales trend for Macugen, it could lead to a reduction in our expectations for future sales and cash flows and therefore, a potential impairment of the Macugen rights.

     In the future, events could cause us to conclude that impairment indicators exist and that certain other intangibles with determinable lives and other long-lived assets are impaired which may result in an adverse impact on our financial condition and results of operations.

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Stock-Based Compensation

     As discussed further in Part 1, Item 1, “Notes to Consolidated Financial Statements” – Note (4) “Accounting for Stock-Based Compensation,” we adopted SFAS No. 123(R) on January 1, 2006 using the modified prospective method. Through December 31, 2005, we accounted for our stock option and employee stock purchase plans under the intrinsic value method of Accounting Principles Board, or APB, Opinion No. 25, and as a result no compensation costs had been recognized in our historical consolidated statements of operations.

     We have used and expect to continue to use the Black-Scholes option-pricing model to compute the estimated fair value of stock options. The Black-Scholes option pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. We estimated expected volatility based upon a combination of historical, implied and adjusted historical stock prices. The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. We assumed an expected dividend yield of zero since the Company has not historically paid dividends and does not expect to pay dividends in the foreseeable future. Commencing in the second quarter of fiscal 2005, the fair value of the options was estimated at the date of grant using a Black-Scholes option pricing model with the expected option term determined using a Monte Carlo simulation model that incorporates historical employee exercise behavior and post-vesting employee termination rates.

     The assumptions used in computing the fair value of stock-based awards reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. As a result, if other assumptions or estimates had been used, the stock-based compensation expense that was recorded for the three and nine months ended September 30, 2006 could have been materially different. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted in the future.

Revenues

	Three Months Ended								Nine Months Ended
	September 30,								September 30,
	2006		2005			$ Change			2006		2005		$ Change
Net revenue from unconsolidated joint business	$	39,833	$	21,464		$	18,369		$	114,699	$	54,892	$	59,807
Product sales		9,078		(51	)		9,129			96,972		525		96,447
Royalties on product sales		14,647		1,453			13,194			33,671		1,952		31,719
Sales commissions		1,639		7,610			(5,971	)		11,058		21,578		(10,520	)
License and milestone revenues and other revenues		2,575		3,512			(937	)		16,716		8,737		7,979
Collaborative agreement revenues		6,221		—			6,221			19,294		—		19,294
Total revenues	$	73,993	$	33,988		$	40,005		$	292,410	$	87,684	$	204,726

Net Revenue from Unconsolidated Joint Business

     Net revenue from unconsolidated joint business is related to our co-promotion and manufacturing agreements with Genentech for Tarceva. For the three and nine months ended September 30, 2006, Genentech recorded net sales of Tarceva in the United States and its territories of $100 million and $296 million, respectively. The $100 million of Tarceva net sales for the three months ended September 30, 2006 represents a $27 million increase over the same period last year. For the three months ended September 30, 2006, net sales of Tarceva declined

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$3 million from $103 million for the three months ended June 30, 2006. We believe that the decrease on a sequential quarter-by-quarter basis may have been primarily due to seasonality in the first part of the third quarter of 2006.

     For the nine months ended September 30, 2006, net sales increased $105 million from $191 million for the nine months ended September 30, 2005. The increase was primarily due to the approval and launch of Tarceva for the pancreatic indication in November 2005, an increase in market share penetration in the NSCLC indications, and Tarceva price increases taken in 2005. Our share of these net sales is reduced by the costs incurred for cost of goods sold and for the sales and marketing of the product. We continue to believe that Tarceva will exhibit steady growth in the United States and strong growth outside of the United States. For the three and nine months ended September 30, 2006, we reported net revenue from our unconsolidated joint business for Tarceva of $39.8 million and $114.7 million, respectively, compared with $21.5 million and $54.9 million for the three and nine months ended September 30, 2005, respectively. The increase in net revenue from unconsolidated joint business was primarily due to higher net sales related to the approval and launch of Tarceva for the pancreatic cancer indication in November 2005, an increase in market share penetration in the NSCLC indications and Tarceva price increases taken in 2005.

Product Sales

     Product sales primarily consist of gross product revenue for Macugen less distribution service fees and estimates for allowances and returns. For the three and nine months ended September 30, 2006, Macugen net sales totaled $8.8 million and $96.1 million, respectively. At September 30, 2006, we estimated that our wholesale distribution network had approximately a two to four week supply of Macugen on hand based on current product demand.

     Macugen sales declined from $36.7 million in the second quarter of 2006 to $8.8 million in the third quarter of 2006, a decrease of $27.9 million. We believe the decline was primarily due to the launch Lucentis in July 2006 and the continued off-label use of Avastin for the treatment of wet AMD.

Royalties on Product Sales

     We receive royalties on the sales of Tarceva and Macugen outside of the United States and its territories. In September 2005, our partner Roche received approval from the European Commission for the sale of Tarceva in the EU for the treatment of patients with locally advanced or metastatic NSCLC. Roche has also received approval for reimbursement in a number of EU countries and is pursuing approval in other major markets in the EU. Tarceva sales are expected to increase outside the United States as additional reimbursement is secured. For the three and nine months ended September 30, 2006, Roche recorded $70 million and $164 million, respectively, in net sales of Tarceva outside of the United States and its territories, and we recorded $14.2 million and $33.2 million, respectively, in royalty revenues from these sales. Macugen royalties on rest of world sales were not material for the three and nine months ended September 30, 2006. Macugen was approved for marketing and sale in the EU in January 2006 and was launched in select EU countries by our partner, Pfizer, beginning in May 2006.

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Sales Commissions

     Sales commissions represent commissions earned on the sales of Novantrone in the United States for oncology indications. Sales commissions for the three and nine months ended September 30, 2006 were $1.6 million and $11.1 million, respectively, compared with $7.6 million and $21.6 million for the three and nine months ended September 30, 2005, respectively. Sales commissions declined significantly in the three months ended September 30, 2006, and are expected to continue to decline during the remainder of 2006, due to the patent expiration of Novantrone in April 2006. The decline in sales commissions results from a loss of market exclusivity for Novantrone, resulting in the launch of generic competitors in April 2006.

License, Milestone and Other Revenues

     We recognized $2.6 million and $16.7 million of license, milestone and other related revenues during the three and nine months ended September 30, 2006, respectively. The nine months ended September 30, 2006 includes $9.4 million of license and milestone payments under the worldwide non-exclusive license agreements entered into by Prosidion under our DP-IV patent portfolio covering the use of DP-IV inhibitors for treatment of type 2 diabetes and related indications. Also included in license and milestone revenues is the recognition of the ratable portion of upfront fees from Genentech and milestone payments received from Genentech and Roche to date in connection with various regulatory acceptances and approvals for Tarceva in the United States, Europe and Japan and a milestone payment from Pfizer as a result of the launch of Macugen in Europe. These payments were initially deferred and are being recognized as revenue in accordance with EITF 00-21. The ratable portion of the upfront fee and milestone payments recognized as revenue for the three and nine months ended September 30, 2006 were $1.6 million and $3.8 million, respectively, compared to $419,000 and $949,000 for the three and nine months ended September 30, 2005, respectively. The unrecognized deferred revenue related to these upfront fees and milestone payments received was $74.3 million and $42.0 million as of September 30, 2006 and December 31, 2005, respectively.

     Upon regulatory approvals and filings subsequent to September 30, 2006, additional milestone payments will be due from Genentech, Roche and Pfizer. Future milestone payments will be due from Roche upon the successful approval of Tarceva in a second oncology indication in the EU. Additional milestone payments will be due from Genentech and Roche upon approval of adjuvant indications in the United States and Europe. Additional milestone payments will be due from Roche upon the approval of Tarceva in Japan. Milestone payments will be due from Pfizer upon future approvals of Macugen for additional indications beyond the treatment of wet AMD. The ultimate receipt of these additional milestone payments is contingent upon the applicable regulatory approvals and other future events. In addition, we may receive future milestone payments from the licensees of our DP-IV patents.

Collaborative Program Revenues

     Collaborative program revenues primarily represent reimbursement of a portion of research and development costs for Macugen under our collaboration agreement with Pfizer.

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Expenses

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006		2005		$ Change		2006		2005		$ Change
Cost of goods sold	$	6,660	$	1,464	$	5,196	$	45,883	$	3,636	$	42,247
Collaborative profit share		3,007		—		3,007		39,190		—		39,190
Research and development		43,080		28,698		14,382		133,065		86,007		47,058
Acquired in-process research and development		—		—		—		—		3,542		(3,542	)
Selling, general and administrative		36,599		21,363		15,236		117,934		65,765		52,169
Goodwill impairment		870		—		870		320,261		—		320,261
Amortization of intangibles		4,979		3,831		1,148		14,930		11,435		3,495
Total expenses	$	95,195	$	55,356	$	39,839	$	671,263	$	170,385	$	500,878

Cost of Goods Sold

     Total cost of goods sold for the three and nine months ended September 30, 2006 were $6.7 million and $45.9 million, respectively, compared with $1.4 million and $3.6 million for the three and nine months ended September 30, 2005, respectively. For the three and nine months ended September 30, 2006, cost of goods sold primarily consisted of $5.5 million and $40.6 million, respectively related to Macugen and $1.2 million and $5.0 million, respectively, related to Tarceva.

     In November 2005, in connection with the acquisition of Eyetech, we recorded the acquired Macugen inventory at its estimated fair value in accordance with SFAS No. 141, “Business Combinations.” Included in cost of goods sold in the three and nine months ended September 30, 2006 was approximately $1.4 million and $18.6 million, respectively, of the step-up in fair market value from the purchase accounting adjustments. We expect that approximately $27.3 million of unamortized fair market value purchase accounting adjustments related to Macugen will be included in future cost of goods sold. The increase to fair market value is being recognized as cost of goods sold when the acquired inventory is sold. Included in cost of goods sold for Macugen are royalty expenses under agreements with three pharmaceutical companies and are determined based on net sales.

     Prior to receipt of approval of Tarceva for commercial sale on November 18, 2004, we had expensed all costs associated with the production of Tarceva to research and development. Effective November 18, 2004, we began to capitalize the costs of manufacturing Tarceva as inventory, including the costs to label, package and ship previously manufactured bulk inventory whose costs had already been expensed as research and development. As of September 30, 2006, we had sold all of the inventory partially produced and expensed prior to November 18, 2004. Cost of goods sold for the three and nine months ended September 30, 2006 would have been $299,000 and $1.4 million higher, respectively, if the Tarceva inventory sold had reflected the full absorption manufacturing costs. The increased costs presented in this manner are more reflective of our cost of goods sold going forward.

Collaborative Profit Share

     Collaboration profit share represents Pfizer’s share of net product sales of Macugen less cost of goods sold within the United States. We share with Pfizer on a 50/50 basis the gross profits of the Macugen sales in the United States. Under our agreements with Pfizer, we will share profits and losses from the commercialization of Macugen in the United States until the

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later of 15 years after commercial launch in the United States or the expiration of the U.S. patent rights for Macugen.

Research and Development

     We consider the active management and development of our clinical pipeline crucial to the long-term process of getting a clinical candidate approved by the regulatory authorities and brought to market. We manage our overall research, development and in-licensing efforts in a manner designed to generate a constant flow of clinical candidates into development to offset both the advancement of products to the market and the anticipated attrition rate of drug candidates that fail in clinical trials or are terminated for business reasons. The duration of each phase of clinical development and the probabilities of success for approval of drug candidates entering clinical development will be impacted by a variety of factors, including the quality of the molecule, the validity of the target and disease indication, early clinical data, investment in the program, competition and commercial viability. Because we manage our pipeline in a dynamic manner, it is difficult to predict the anticipated proportion of our research and development investments assigned to any one program prior to the Phase III stage of development, or to the future cash inflows from these programs. For the three and nine months ended September 30, 2006, we invested a total of $13.7 million and $42.3 million, respectively, in research and $29.3 million and $90.7 million, respectively, in pre-clinical and clinical development. For the three and nine months ended September 30, 2005, we invested a total of $12.2 million and $35.1 million, respectively, in research and $16.5 million and $50.9 million, respectively, in pre-clinical and clinical development. We consider this level of investment suitable for a company with our pipeline of clinical and pre-clinical candidates.

     Research and development expenses increased $14.4 million and $47.1 million for the three and nine months ended September 30, 2006, respectively, compared to the same periods last year. For the three months ended September 30, 2006, the increase was primarily due to $13.1 million of Eyetech research and development expenses related to Eyetech research programs, $2.1 million of diabetes related programs, $1.8 million of Tarceva related programs, $1.2 million of equity based compensation expense, and $367,000 of severance costs related to Eyetech. Partially offsetting these increases was a decline in research and development expenses for non-Tarceva related oncology programs. For the nine months ended September 30, 2006, the increase was primarily due to $42.3 million of research and development expenses related to Eyetech research programs, $5.4 million increase in Tarceva related programs, $3.5 million of severance costs related to Eyetech, and $3.7 million of equity based compensation expense. Partially offsetting these increases was a decline in research and development expenses for diabetes and non-Tarceva related oncology programs.

     We manage the ongoing development program for Tarceva with our partners, Genentech and Roche, through a global development committee under a Tripartite Agreement among the parties. Together with our partners, we have implemented a broad-based global development strategy for Tarceva that implements simultaneous clinical programs currently designed to expand the number of approved indications of Tarceva and evaluate the use of Tarceva in new and/or novel combinations. Our global development plan has included major Phase III clinical trials in lung, pancreatic, ovarian and colorectal cancer in the past, and currently includes additional major Phase III clinical trials in lung cancer in the maintenance and adjuvant settings. Since 2001, the alliance partners have committed an aggregate of approximately $650 million to the global development plan which is shared by the three parties. As of September 30, 2006, we

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had invested in excess of $168 million in the development of Tarceva, representing our share of the costs incurred in the tripartite global development plan and additional investments outside of the plan.

     We manage the ongoing development program for Macugen with Pfizer through a collaboration entered into in December 2002 whereby the parties jointly develop Macugen for the prevention and treatment of ophthalmic diseases. For the nine months ended September 30, 2006, we had invested $47.5 million in total eye disease research and development, of which $19.3 million had been reimbursed by Pfizer. Following the second quarter of 2006, in response to declining Macugen revenue and competitive developments in the wet AMD marketplace, including the wide spread off-label use of Avastin and the launch of Lucentis, we chose to suspend or curtail certain research activities in the eye disease area.

Selling, General and Administrative

     Selling, general and administrative expenses increased by $15.2 million and $52.2 million for the three and nine months ended September 30, 2006, respectively, compared to the same periods last year. For the three months ended September 30, 2006, the increase was primarily attributable to $10.1 million of Eyetech related expenses, which were principally commercial expenses, recognition of $3.2 million of equity based compensation expense, $3.6 million of corporate related expenses and $739,000 for severance costs related to Eyetech. Partially offsetting these increases was a decline in maintenance fees for Novantrone. For the nine months ended September 30, 2006, the increase was primarily attributable to $32.5 million of Eyetech related expenses, recognition of $11.9 million of equity based compensation expense, $5.1 million of corporate related expenses, $2.6 million for estimated facility lease return cost related to relocation of our corporate headquarters, and $1.9 million for severance costs related to Eyetech. Partially offsetting these increases were charges recorded in the nine months ended September 30, 2005 relating to consolidation of our UK-based oncology operations in 2005 which included a facility charge of $1.8 million and an $803,000 charge relating to the cashout of Prosidion options.

Acquired In-Process Research and Development

     In connection with the acquisition of the minority interest of Prosidion in 2005, we recorded an in-process research and development charge of $3.5 million representing the estimated fair value of the acquired in-process technology related to the acquired Prosidion interest, that had not yet reached technological feasibility and had no alternative future use.

Goodwill Impairment

     During the second quarter of 2006, we performed a preliminary assessment of the value of the goodwill related to our acquisition of Eyetech and recorded an estimated $319.4 million impairment charge related to the Eyetech reporting unit. During the third quarter of 2006, we finalized the purchase accounting estimates and our assessment of goodwill and recognized an additional charge of $0.9 million (see footnote 12).

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Amortization of Intangibles

     Amortization expense for the three and nine months ended September 30, 2006 were $5.0 million and $14.9 million, respectively. For the three and nine months ended September 30, 2006, amortization expense included $4.5 million and $13.6 million, respectively, of expense related to Macugen, and the related technology platform and patent estate of $201.4 million acquired in the Eyetech acquisition. The core technology is being amortized over the estimated useful life of 11 years which correlates with the last patent expiration. The increase in amortization expenses relating to Macugen was offset by a decrease in amortization expense for Novantrone of $3.4 million and $10.2 million for the three and nine months ended September 30, 2005, respectively, due to a change in the estimated useful life as of January 1, 2006.

Other Income and Expense

	Three Months Ended September 30,									Nine Months Ended September 30,
	2006			2005			$ Change			2006			2005			$ Change
Investment income – net	$	2,503		$	2,393		$	110		$	5,902		$	10,563		$	(4,661	)
Interest expense		(1,906	)		(1,219	)		(687	)		(5,672	)		(3,657	)		(2,015	)
Other income (expense) – net		(652	)		157			(809	)		(2,464	)		(1,283	)		(1,181	)
Total other income (expense)	$	(55	)	$	1,331		$	(1,386	)	$	(2,234	)	$	5,623		$	(7,857	)

     Investment income for the three months ended September 30, 2006 increased slightly compared to the same period last year due to two offsetting factors. Lower investment balances in 2006 resulted in lower investment income but this decrease was offset by the recognition of $2 million of unrealized losses in the three months ended September 30, 2005.

     The decrease in investment income for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 is primarily due to a decrease in our funds available for investment. This decrease is partially offset by $2.0 million of unrealized losses we recognized in the nine months ended September 30, 2005 relating to available-for-sale securities for which the impairment was deemed other then temporary.

     The increase in interest expense for the three and nine months ended September 30, 2006 compared to the same periods last year was primarily due to interest expense on our 2025 notes, which were issued in December 2005. Other income expense-net for the periods included the amortization of debt issuance costs and other miscellaneous income and expense items.

Extraordinary Gain

     In connection with the 2003 acquisition of Cell Pathways, Inc., we recognized contingent consideration of $22.0 million in the form of five-year contingent value rights through which each share of Cell Pathways’ common stock will be eligible for an additional 0.04 share of our common stock in the event of a filing of a new drug application by June 12, 2008 for either of the two clinical candidates acquired from Cell Pathways, OSI-461 or Aptosyn. We had ceased our development efforts of these two clinical candidates and have been seeking, and continue to seek, parties interested in licensing the candidates. We have concluded that, in our judgment, the milestone will not be met based upon the current progress of our outlicensing efforts and the technical hurdles for filing a new drug application by June 2008 and therefore, we have reversed

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the $22.0 million liability and recorded an extraordinary gain for the three months ended June 30, 2006 and the nine months ended September 30, 2006.

Liquidity and Capital Resources

     At September 30, 2006, cash and investments, including restricted securities, totaled $210.2 million compared to $179.6 million at December 31, 2005. The increase of $30.6 million was primarily due to net milestone receipts of $39.0 million, and cash from the exercise of employee stock options offset by $8.7 million of capital expenditures.

     We are currently transitioning from a research and development stage company, fully dependent on the capital markets for liquidity and capital resources, to a fully integrated and profitable biopharmaceutical company. When this transition is complete, we anticipate funding the majority, if not all, of our liquidity and capital needs from the generation of cash flow from operations, with the potential exception of strategic acquisitions of products and/or businesses.

     We estimate that during the next 12 to 15 months, assuming we are able to execute on our internal plans, our cash flow will become positive and we expect that we will be able to fund our R&D investments and our capital requirements from the internal generation of cash flow and from partnering activities. However, there continues to be a risk that we will not be able to execute on our internal plans. Tarceva, while expected to achieve significant revenues on a worldwide basis and therefore generate significant levels of cash flow for us, is in the early stages of gaining acceptance in markets outside of the United States including the EU, and faces emerging competition in the United States over the long term. If we are unsuccessful in executing on our strategy for Tarceva and our plans to partner certain assets in our R&D portfolio, our ability to generate positive cash flow will be impacted adversely.

Commitments and Contingencies

     Our major outstanding contractual obligations relate to our senior subordinated convertible notes and our facility leases. The following table summarizes our significant contractual obligations at September 30, 2006 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

	Remainder of										2011 &
	2006		2007		2008		2009		2010		Thereafter		Total
Contractual Obligations:
Senior convertible debt(a)	$	1,150	$	7,175	$	7,175	$	7,175	$	7,175	$	362,875	$	392,725
Operating leases		2,331		10,470		9,878		9,408		9,079		78,414		119,580
Purchase obligations(b)		12,833		36,137		34,120		17,882		11,271		24,500		136,743
Obligations related to exit activities(c)		2,150		1,434		548		2,455		—		802		7,389
Total contractual obligations	$	18,464	$	55,216	$	51,721	$	36,920	$	27,525	$	466,591	$	656,437

(a)	Includes interest payments at a rate of 3.25% per annum relating to the 2023 Notes and at a rate of 2% per annum relating to the 2025 Notes. The holders of the 2023 Notes have the right to require us to purchase, for cash, all of the 2023 Notes, or a portion thereof, in September 2008, and the holders of the 2025 Notes have the right to require us to purchase, for cash, all of the 2025 Notes, or a portion thereof, in December 2010.
(b)	Purchase obligations include inventory commitments, commercial and research commitments and other significant purchase commitments.
(c)	Includes payments for termination benefits and facility refurbishments.

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Other significant commitments and contingencies include the following:

• We are committed to share with Genentech and Roche approximately $650 million combined amount of certain global development costs for Tarceva, which represents an increase of approximately $350 million over the originally committed $300 million in 2001. These costs will be shared by the parties pursuant to the terms of our agreement with our partners. As of September 30, 2006, our future share of the commitment is approximately $80 million. We are also committed to share certain commercialization costs relating to Tarceva with Genentech. Under the terms of our agreement, there are no contractually determined amounts for future commercial and development costs.

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

• We have outstanding letters of credit of $9.0 million which primarily serve as security for performance under various lease obligations.

• We have a retirement plan, which provides post-retirement medical and life insurance benefits to eligible employees, board members and qualified dependents. Eligibility is determined based on age and years of service. We accrued postretirement benefit costs of $6.4 million at September 30, 2006.

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

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

• In connection with the acquisition of Eyetech in November 2005, we assumed various contracts related to the in-licensing, development, manufacture and marketing of Macugen. These license agreements represent rights and obligations of our subsidiary, (OSI) Eyetech, Inc. Under the terms of the license agreements, we will be required to make additional milestone payments, and we are also required to pay royalties on net sales.

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Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of FAS 157 are effective for the fiscal year beginning after November 15, 2007. The Company is currently evaluating the impact of the provisions of FAS 157.

     In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” or FAS 158. FAS 158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. The provisions of FAS 158 are effective for the Company for its fiscal year ending December 31, 2006. The Company is currently evaluating the impact of the provisions of FAS 158.

     In June 2006, FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the effect that this Interpretation will have on our consolidated financial statements.

     In February 2006, the FASB issued SFAS No. 155, which is an amendment of FASB SFAS Nos. 133 and 140. This Statement (a) permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (b) clarifies which interest-only strip and principal-only strip are not subject to the requirements of SFAS No. 133, (c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and (e) amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement is effective for financial statements for fiscal years beginning after September 15, 2006. Earlier adoption of this Statement is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued any financial statements for that fiscal year. We are currently evaluating the effect that this statement will have on our consolidated financial statements.

Forward Looking Statements

     A number of the matters and subject areas discussed in this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this report that are not historical or current facts deal with potential future circumstances and developments. The discussion of these matters and subject areas is qualified by the inherent risks and uncertainties surrounding future expectations generally, and these discussions may materially differ from our actual future experience involving any one or more of these matters

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and subject areas. These forward-looking statements are also subject generally to the other risks and uncertainties that are described below. These forward looking statements are also subject generally to the other risks and uncertainties that are described in Part 1, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, as modified by Part II, Item 1A of our Quarterly Report for the quarter ended June 30, 2006, and Part II, Item 1A of this Quarterly Report.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

     Our cash flow and earnings are subject to fluctuations due to changes in interest rates in our investment portfolio of debt securities, the fair value of equity instruments held and foreign currency exchange rates. We maintain an investment portfolio of various issuers, types and maturities. These securities are generally classified as available-for-sale as defined by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) included in stockholders’ equity.

     At September 30, 2006, we maintained a portion of our cash and cash equivalents in financial instruments with original maturities of three months or less. We also maintained an investment portfolio principally comprised of government and government agency obligations and corporate obligations that are subject to interest rate risk and will decline in value if interest rates increase. A hypothetical 10% change in interest rates during the periods would have resulted in a $250,000 and $590,000 change in our net loss for the three and nine months ended September 30, 2006, respectively.

     Our limited investments in certain biotechnology companies are carried on the equity method or cost method of accounting using the guidance of applicable accounting literature. Other-than-temporary losses are recorded against earnings in the same period the loss was deemed to have occurred.

     Our long-term debt totaled $265 million at September 30, 2006 and was comprised of our 2023 Notes which bear interest at a fixed rate of 3.25% and our 2025 Notes which bear interest at a fixed rate of 2.00%. Underlying market risk exists related to an increase in our stock price or an increase in interest rates which may make the conversion of the 2023 Notes or 2025 Notes to common stock beneficial to the holders of such notes. Conversion of the 2023 Notes or 2025 Notes would have a dilutive effect on any future earnings and book value per common share.

Item 4. Controls and Procedures

     Attached to this Quarterly Report on Form 10-Q as Exhibit 31.1 and 31.2, there are two certifications, or the Section 302 Certifications, one by each of our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO. This Item 4 contains information concerning the evaluation of our disclosure controls and procedures and internal control over financial reporting that is referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

     Evaluation of Our Disclosure Controls and Procedures. The Securities and Exchange Commission requires that as of the end of the period covered by this Quarterly Report on Form

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10-Q, the CEO and the CFO evaluate the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e)) under the Securities Exchange Act of 1934, as amended, and report on the effectiveness of the design and operation of our disclosure controls and procedures. Accordingly, under the supervision and with the participation of our management, including our CEO and CFO, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q.

     CEO/CFO Conclusions about the Effectiveness of the Disclosure Controls and Procedures. Based upon their evaluation of the disclosure controls and procedures, our CEO and CFO have concluded that our disclosure controls and procedures are at the reasonable assurance level to ensure that material information relating to OSI and our consolidated subsidiaries is made known to management, including the CEO and CFO, on a timely basis and during the period in which this Quarterly Report on Form 10-Q was being prepared.

     Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f)) under the Exchange Act identified in connection with the evaluation of such internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     On or about December 16, 2004, several purported shareholder class action lawsuits were filed in the United States District Court for the Eastern District of New York against us, certain of our current and former executive officers, and the members of our Board of Directors. The lawsuits were brought on behalf of those who purchased or otherwise acquired our common stock during certain periods in 2004, which periods differed in the various complaints. The Court has now appointed a lead plaintiff, and on February 17, 2006, the lead plaintiff filed a consolidated amended class action complaint seeking to represent a class of all persons who purchased or otherwise acquired our common stock during the period from April 26, 2004 through November 22, 2004. The consolidated complaint alleges that defendants made material misstatements and omissions concerning the survival benefit associated with our product, Tarceva, and the size of the potential market of Tarceva upon FDA approval of the drug. It alleges violations of Sections 11 and 15 of the Securities Act of 1933, as amended, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated there under. The consolidated complaint seeks unspecified compensatory damages and other relief. On April 7, 2006, we filed a motion to dismiss the consolidated amended complaint. We have requested an oral argument on our motion and are awaiting a decision from the court. Briefing on this motion was completed on June 21, 2006.

Item 1A. Risk Factors

     There have been no material changes to the Risk Factors included in Part 1, Item 1A of our Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 2005, except for the Risk Factors included in Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 and as set forth below.

Risks Related to Our Business

We depend heavily on our principal marketed product, Tarceva, to generate revenues in order to fund our operations.

     We currently derive, and are expected to continue to derive substantially all of our revenues from our principal marketed product, Tarceva, which provided 73% of our total revenues for the quarter ended September 30, 2006. We also currently derive, or have the potential to derive in the future, revenues from the milestone and royalty obligations under our license agreements for our DP-IV patent portfolio, and from upfront, milestone and royalty obligations under any future licenses.

     Our ability to maintain or increase our revenues and overall market share for Tarceva will depend on, and may be limited by, a number of factors, including the following:

• We must continue to expand the market share and revenues for Tarceva in the treatment of second-line and third-line NSCLC and for first-line pancreatic cancer;

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• Physicians may be reluctant to switch from existing treatment methods, including traditional chemotherapy agents, to Tarceva;

• The market for oncology products is very competitive, and there are marketed products and products which are currently in Phase III development that are or could be competitive with Tarceva;

• We must be successful in our clinical trials in additional indications and in receiving approval from the FDA and our foreign counterparts to market and sell Tarceva in such additional indications; and

• Third-party payors, including private health coverage insurers and health maintenance organizations, must continue to provide adequate coverage or reimbursement for Tarceva.

If our competitors succeed in developing products and technologies that are more effective than our own, or if scientific developments change our understanding of the potential scope and utility of our products, then our products and technologies may be rendered less competitive.

     We face significant competition from industry participants that are pursuing products and technologies that are similar to those we are pursuing and who are developing pharmaceutical products that are competitive with our products and potential products. Some of our industry competitors have greater capital resources, larger overall research and development staffs and facilities, and a longer history in drug discovery and development, obtaining regulatory approval and pharmaceutical product manufacturing and marketing than we do. With these additional resources, our competitors may be able to respond to the rapid and significant technological changes in the biotechnology and pharmaceutical industries faster than we can. Our future success will depend in large part on our ability to maintain a competitive position with respect to these technologies. Rapid technological development, as well as new scientific developments, may result in our compounds, products or processes becoming obsolete before we can recover any of the expenses incurred to develop them.

     The market for new oncology products is very competitive, with many products currently in Phase III development. Most major pharmaceutical companies and many biotechnology companies, including our collaborators for Tarceva, Genentech and Roche, currently devote a portion or all of their operations to the research and development of new oncology drugs or additional indications for oncology drugs which are already marketed. Tarceva currently competes, and may compete in the future, with existing chemotherapy options such as Alimta, and a number of other cancer treatments, including Avastin, Erbitux^® (cetuximab), Xeloda^® (capecitabine) and Vectibix™ (panitumumab). If ongoing Phase III clinical trials for Erbitux have exceptional activity, we would expect that Erbitux would pose a serious competitive threat to Tarceva in the treatment of NSCLC and pancreatic cancer as early as 2007.

     Macugen competes against two FDA approved therapies for the treatment of wet AMD: Lucentis, a non-selective VEGF-A inhibitor, and Visudyne, a photodynamic therapy used in combination with thermal laser treatment. Macugen faces its most significant competition from Lucentis, as well as from the off-label use of Avastin, the full-length antibody from which Lucentis is derived. Phase III trial results for Lucentis, reflected in its package insert, suggest

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that non-selective anti-VEGF-A agents have better efficacy than Macugen, resulting in significant vision improvement in about one-third of patients in the study. These trial results were recently published in the New England Journal of Medicine.

     Lucentis may also benefit from the results from the PIER study, a trial to evaluate a quarterly dosing frequency of Lucentis following an initial treatment of three monthly injections, which demonstrated that Lucentis could maintain vision with this regimen, although less effectively than its current monthly dosing regimen for one year. In addition, there are a number of proposed clinical trials which would study whether it is possible to reduce the dosing frequency of non-selective anti-VEGF-A agents by combining them with Visudyne therapy. If physicians choose a less frequent regimen than monthly dosing for Lucentis, it could eliminate the advantage Macugen enjoys over Lucentis in dosing frequency, as Macugen currently requires administration every six weeks.

     The package insert for Lucentis includes language which highlights a theoretical risk of serious thromboembolic adverse events secondary to intravitreal anti-VEGF-A treatments. While we believe that Macugen, as a selective VEGF-A 165 antagonist, has an advantage of reduced risk for such serious systemic events, physicians may determine that the potential long-term risks associated with Lucentis, or the off-label use of Avastin, are acceptable when compared with its benefits. Such a determination would undermine our strategy to capitalize on Macugen’s established safety profile and to position Macugen as a preferred treatment in the chronic management of wet AMD, and would negatively impact our revenues from Macugen.

     As a result of several small, recently-published retrospective studies, and the support of the American Academy of Ophthalmology, certain Medicare carriers have begun to reimburse the use of Avastin for the treatment of wet AMD. Avastin reimbursement has adversely affected our revenues for Macugen, and may continue to have an adverse affect on these revenues, particularly if such reimbursement becomes more widespread.

     Future commercial success for Macugen will depend on our ability to expand the indications for which we can market Macugen, such as proliferative diabetic retinopathy. Off-label use of Avastin, Lucentis or steroids, or a number of clinical trial candidates, may limit the market potential for Macugen in these indications.

We may be required to record a significant charge to our earnings if certain of our assets become impaired.

     Under generally accepted accounting principles, we evaluate our long-lived assets, such as property, goodwill and amortizable intangible assets, and certain short-lived assets, such as inventory, for impairment, when events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that may cause us to conclude that these assets are not recoverable include a decline in our stock price or market capitalization or a reduction in our expectations for future revenues and cash flows. Our estimated future cash flows are based on assumptions that are consistent with our annual planning process and include estimates for revenue and operating margins and future economic and market conditions. We base our fair value estimates on assumptions we believe to be reasonable at the time, but actual results may differ materially from these estimates.

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     In the second quarter of 2006, we recorded a $319 million impairment charge related to the goodwill from our acquisition of Eyetech, which we then adjusted to $320 million in the third quarter of 2006. If improvement is not seen in the sales trend for Macugen, we may be required to record future impairment charges related to our eye disease assets, including our intangible assets related to Macugen and the Macugen inventory.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     Not applicable.

Item 3. Defaults Upon Senior Securities

     Not applicable.

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

     Not applicable.

Item 5. Other Information

     In accordance with SFAS No. 142, goodwill and other indefinite-lived intangible assets must be tested annually for impairment or in interim periods if events indicate there is a possible impairment. As a result of recent competitive developments relating to Macugen and the market for wet AMD treatments, we were required to assess the value of the $320.3 million of goodwill recorded in connection with the acquisition of Eyetech in November 2005. These developments included the widespread off-label use of Avastin to treat wet AMD, and the launch of Lucentis, a competitive product to Macugen, in late July 2006. In performing this assessment, we considered the declining Macugen revenues, as well as our decision to suspend or curtail research activities in the eye disease area, which further limits the potential for future revenues from new eye disease products arising from Eyetech research capabilities. Based on our initial assessment , we determined on August 6, 2006 that we needed to record an estimated impairment charge of $319.4 million for the quarter ended June 30, 2006, reflecting the full value of the Eyetech goodwill as of June 30, 2006. During the third quarter of 2006, we finalized the purchase accounting estimates and our assessment of goodwill and recognized an upward adjustment of $0.9 million to the second quarter impairment charge. We determined the amount of the charge based on present value techniques using discounted cash flows and are in the process of finalizing our assessment of the Eyetech goodwill in accordance SFAS No. 142.

Item 6. Exhibits

3.1	Certificate of Incorporation, as amended, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal year ended September 30, 2001 (file no. 000-15190), and incorporated herein by reference.
3.2	Amended and Restated Bylaws, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 8-K filed on September 15, 2006 incorporated herein by reference.

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10.1*	OSI Pharmaceuticals, Inc. 1999 Incentive and Non-Qualified Stock Option Plan (incorporating Amendments No. 1 and 2, adopted July 19, 2001 and September 19, 2006, respectively). (Filed herewith)
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a). (Filed herewith)
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a). (Filed herewith)
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. § 1350. (Filed herewith)
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. § 1350. (Filed herewith)

* Indicates a management contract or compensatory plan, contract or arrangement in which a director or executive officer participates.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	OSI PHARMACEUTICALS, INC.
	(Registrant)
Date: November 9, 2006	/s/ Colin Goddard, Ph.D.
	Colin Goddard, Ph.D.
	Chief Executive Officer
Date: November 9, 2006	/s/ Michael G. Atieh
	Michael G. Atieh
	Executive Vice President and
	Chief Financial Officer
	(Principal Financial Officer)

44

INDEX TO EXHIBITS

Exhibit

3.1	Certificate of Incorporation, as amended, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 10-K for the fiscal year ended September 30, 2001 (file no. 000-15190), and incorporated herein by reference.
3.2	Amended and Restated Bylaws, filed by OSI Pharmaceuticals, Inc. as an exhibit to the Form 8-K filed on September 15, 2006 incorporated herein by reference.
10.1*	OSI Pharmaceuticals, Inc. 1999 Incentive and Non-Qualified Stock Option Plan (incorporating Amendments No. 1 and 2, adopted July 19, 2001 and September 19, 2006, respectively). (Filed herewith)
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a). (Filed herewith)
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a). (Filed herewith)
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. § 1350. (Filed herewith)
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. § 1350. (Filed herewith)

* Indicates a management contract or compensatory plan, contract or arrangement in which a director or executive officer participates.

45

EX-10.1

Exhibit 10.1

OSI PHARMACEUTICALS, INC.
1999 INCENTIVE AND NON-QUALIFIED
STOCK OPTION PLAN
(Incorporating Amendments No. 1 and 2,
adopted July 19, 2001 and September 19, 2006, respectively)

1. Purpose

     The purpose of this 1999 Incentive and Non-Qualified Stock Option Plan (the “Plan”) is to encourage and enable selected management, other employees, directors (whether or not employees), and consultants of OSI Pharmaceuticals, Inc. (the “Company”) or a parent or subsidiary of the Company to acquire a proprietary interest in the Company through the ownership of common stock, par value $.01 per share (the “Common Stock”), of the Company. Such ownership will provide such employees, directors, and consultants with a more direct stake in the future welfare of the Company, and encourage them to remain with the Company or a parent or subsidiary of the Company. It is also expected that the Plan will encourage qualified persons to seek and accept employment with, or become associated with, the Company or a parent or subsidiary of the Company. Pursuant to the Plan, the Company may grant (i) “incentive stock options,” within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”) and (ii) stock options that do not qualify as incentive stock options (“non-qualified stock options”). No option granted under the Plan shall be treated as an incentive stock option unless the stock option agreement which evidences the grant refers to such option as an incentive stock option and such option satisfies the requirements of Section 422 of the Code.

     As used herein, the term “parent” or “subsidiary” shall mean any present or future corporation which is or would be a “parent corporation” or “subsidiary corporation” of the Company as the term is defined in Section 424 of the Code (determined as if the Company were the employer corporation).

2. Administration of the Plan

     The Plan shall be administered by a committee (the “Committee”) as appointed from time to time by the Board of Directors of the Company, which may be the Compensation Committee of the Board of Directors. Except as otherwise specifically provided herein, no person, other than members of the Committee, shall have any discretion as to decisions regarding the Plan. The Company may engage a third party to administer routine matters under the Plan, such as establishing and maintaining accounts for Plan participants and facilitating transactions by participants pursuant to the Plan.

     In administering the Plan, the Committee may adopt rules and regulations for carrying out the Plan. The interpretations and decisions made by the Committee with regard to any question arising under the Plan shall be final and conclusive on all persons participating or eligible to participate in the Plan. Subject to the provisions of the Plan, the Committee shall determine the terms of all options granted pursuant to the Plan, including, but not limited to, the persons to whom, and the time or times at which, grants shall be

made, the number of shares to be covered by each option, the duration of options, the exercisability of options, whether options shall be treated as incentive stock options, and the option price.

3. Shares of Stock Subject to the Plan

     Except as provided in paragraphs 6(h), 6(i) and 7 hereof, the number of shares that may be issued or transferred pursuant to the exercise of options granted under the Plan shall not exceed 2,000,000 shares of Common Stock. Such shares may be authorized and unissued shares or previously issued shares acquired or to be acquired by the Company and held in treasury. Any shares subject to an option which for any reason expires or is terminated unexercised as to such shares may again be subject to an option right under the Plan. The aggregate Fair Market Value, as defined in paragraph 6(k) below (determined at the time the option is granted), of the shares with respect to which incentive stock options are exercisable for the first time by an optionee during any calendar year (under the Plan and all plans of the Company and any parent or subsidiary of the Company) shall not exceed $100,000.

4. Eligibility

     Incentive stock options may be granted only to management and other employees who are employed by the Company or a parent or subsidiary of the Company. Incentive stock options may be granted to a director of the Company or a parent or subsidiary of the Company, provided that the director is also an officer or employee. Non-qualified stock options may be granted to directors, officers, employees and consultants of the Company.

5. Granting of options

     No options pursuant to this Plan may be granted after the close of business on June 22, 2009. The date of the grant of any option shall be the date on which the Committee authorizes the grant of such option.

6. Options

     Options shall be evidenced by stock option agreements in such form, consistent with the Plan, as the Committee shall approve from time to time, which agreements need not be identical and shall be subject to the following terms and conditions:

     (a) Option Price. The purchase price under each incentive stock option shall be not less than 100% of the Fair Market Value of the Common Stock at the time the option is granted and not less than the par value of the Common Stock. In the case of an incentive stock option granted to an employee owning, actually or constructively under Section 424(d) of the Code, more than 10% of the total combined voting power of all classes of stock of the Company or of any parent or subsidiary of the Company (a “10% Stockholder”) the option price shall not be less than 110% of the Fair Market Value of the Common Stock at the time

of the grant. The purchase price under each non-qualified stock option shall be specified by the Committee, but shall in no case be less than the greater of 50% of the Fair Market Value of the Common Stock at the time the option is granted and the par value of such Common Stock.

     (b) Medium and Time of Payment. Stock purchased pursuant to the exercise of an option shall at the time of purchase be paid for in full in cash, or, upon conditions established by the Committee, by delivery of shares of Common Stock owned by the recipient. If payment is made by the delivery of shares, the value of the shares delivered shall be the Fair Market Value of such shares on the date of exercise of the option. In addition, unless otherwise provided by the Committee an “in the money” non-qualified stock option may be exercised on a “cashless” basis in exchange for the issuance to the optionee (or other person entitled to exercise the option) of the largest whole number of shares having an aggregate value equal to the value of such option on the date of exercise. For this purpose, the value of the shares delivered by the Company and the value of the option being exercised shall be determined based on the Fair Market Value of the Common Stock on the date of exercise of the option. Upon receipt of payment and such documentation as the Company may deem necessary to establish compliance with the Securities Act of 1933, as amended (the “Securities Act”), the Company shall, without stock transfer tax to the optionee or other person entitled to exercise the option, deliver to the person exercising the option a certificate or certificates for such shares. It shall be a condition to the performance of the Company’s obligation to issue or transfer Common Stock upon exercise of an option or options that the optionee pay, or make provision satisfactory to the Company for the payment of, any taxes (other than stock transfer taxes) the Company or any subsidiary is obligated to collect with respect to the issue or transfer of Common Stock upon such exercise, including any federal, state, or local withholding taxes.

     (c) Waiting Period. The waiting period and time for exercising an option shall be prescribed by the Committee in each particular case; provided, however, that no option may be exercised after 10 years from the date it is granted. In the case of an incentive stock option granted to a 10% Stockholder, such option, by its terms, shall be exercisable only within five years from the date of grant.

     (d) Rights as a Stockholder. A recipient of options shall have no rights as a stockholder with respect to any shares issuable or transferable upon exercise thereof until the date a stock certificate is issued to him for such shares. Except as otherwise expressly provided in the Plan, no adjustment shall be made for dividends or other rights for which the record date is prior to the date such stock certificate is issued.

     (e) Non-Assignability of Options. No incentive stock option and, except as may otherwise be specifically provided by the Committee, no non-

3

qualified stock options, shall be assignable or transferable by the recipient except by will or by the laws of descent and distribution. During the lifetime of a recipient, incentive stock options and, except as may otherwise be specifically provided by the Committee, non-qualified stock options, shall be exercisable only by such recipient. If the Committee approves provisions in any particular case allowing for assignment or transfer of a non-qualified stock option, then such option will nonetheless be subject to a six-month holding period commencing on the date of grant during which period the recipient will not be permitted to assign or transfer such option, unless the Committee further specifically provides for the assignability or transferability of such option during this period. See paragraph 8 hereof for restrictions on sale of shares.

     (f) Effect of Termination of Employment. If a recipient’s employment (or service as an officer, director or consultant) shall terminate for any reason, other than death or Retirement (as defined below), the right of the recipient to exercise any option otherwise exercisable on the date of such termination shall expire unless such right is exercised within a period of 90 days after the date of such termination. For Options issued prior to January 1, 2006, the term “Retirement” shall mean the voluntary termination of employment (or service as an officer, director or consultant) by a recipient who has attained the age of 55 and who has completed at least five years of service with the Company. For Options issued on or after January 1, 2006, unless otherwise determined by the Committee and defined in the applicable Award Agreement, the term “Retirement” shall mean the voluntary termination of employment (or service as an officer, director or consultant) by a recipient who has attained the age of 60 and who has completed at least twenty years of service with the Company. If a recipient’s employment (or service as an officer, director or consultant) shall terminate because of death or Retirement, the right of the recipient to exercise any option otherwise exercisable on the date of such termination shall be unaffected by such termination and shall continue until the normal expiration of such option. Notwithstanding the foregoing, the tax treatment available pursuant to Section 421 of the Code upon the exercise of an incentive stock option will not be available in connection with the exercise of any incentive stock option more than three months after the date of termination of such option recipient’s employment due to Retirement. Option rights shall not be affected by any change of employment as long as the recipient continues to be employed by either the Company or a parent or subsidiary of the Company. In no event, however, shall an option be exercisable after the expiration of its original term as determined by the Committee pursuant to subparagraph 6(c) above. The Committee may, if it determines that to do so would be in the Company’s best interests, provide in a specific case or cases for the exercise of options which would otherwise terminate upon termination of employment with the Company for any reason, upon such terms and conditions as the Committee determines to be appropriate. Nothing in the Plan or in any option agreement shall confer any right to continue in the employ of the Company or any parent or subsidiary of the Company or interfere

4

in any way with the right of the Company or any parent or subsidiary of the Company to terminate the employment of a recipient at any time.

     (g) Leave of Absence. In the case of a recipient on an approved leave of absence, the Committee may, if it determines that to do so would be in the best interests of the Company, provide in a specific case for continuation of options during such leave of absence, such continuation to be on such terms and conditions as the Committee determines to be appropriate, except that in no event shall an option be exercisable after 10 years from the date it is granted.

     (h) Recapitalization. In the event that dividends payable in Common Stock during any fiscal year of the Company exceed in the aggregate five percent of the Common Stock issued and outstanding at the beginning of the year, or in the event there is during any fiscal year of the Company one or more splits, subdivisions, or combinations of shares of Common Stock resulting in an increase or decrease by more than five percent of the shares outstanding at the beginning of the year, the number of shares available under the Plan shall be increased or decreased proportionately, as the case may be, and the number of shares deliverable upon the exercise thereafter of any options theretofore granted shall be increased or decreased proportionately, as the case may be, without change in the aggregate purchase price. Common Stock dividends, splits, subdivisions, or combinations during any fiscal year that do not exceed in the aggregate five percent of the Common Stock issued and outstanding at the beginning of such year shall be ignored for purposes of the Plan. All adjustments shall be made as of the day such action necessitating such adjustment becomes effective.

     (i) Sale or Reorganization. In case the Company is merged or consolidated with another corporation, or in case the property or stock of the Company is acquired by another corporation, or in case of a separation, reorganization, or liquidation of the Company, the Board of Directors of the Company, or the board of directors of any corporation assuming the obligations of the Company hereunder, shall either (i) make appropriate provisions for the protection of any outstanding options by the substitution on an equitable basis of appropriate stock of the Company, or appropriate options to purchase stock of the merged, consolidated, or otherwise reorganized corporation, provided only that such substitution of options shall, with respect to incentive stock options, comply with the requirements of Section 424(a) of the Code, or (ii) give written notice to optionees that their options, which will become immediately exercisable notwithstanding any waiting period otherwise prescribed by the Committee, must be exercised within 30 days of the date of such notice or they will be terminated.

     (j) General Restrictions. Each option granted under the Plan shall be subject to the requirement that, if at any time the Board of Directors shall determine, in its discretion, that the listing, registration, or qualification of the shares issuable or transferable upon exercise thereof upon any securities exchange or under any state or federal law, or the consent or approval of any governmental

5

regulatory body is necessary or desirable as a condition of, or in connection with, the granting of such option or the issue, transfer, or purchase of shares thereunder, such option may not be exercised in whole or in part unless such listing, registration, qualification, consent, or approval shall have been effected or obtained free of any conditions not acceptable to the Board of Directors.

     The Company shall not be obligated to sell or issue any shares of Common Stock in any manner in contravention of the Securities Act, the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the rules and regulations of the Securities and Exchange Commission, any state securities law, the rules and regulations promulgated thereunder or the rules and regulations of any securities exchange or over the counter market on which the Common Stock is listed or in which it is included for quotation. The Board of Directors may, in connection with the granting of each option, require the individual to whom the option is to be granted to enter into an agreement with the Company stating that as a condition precedent to each exercise of the option, in whole or in part, he shall, if then required by the Company, represent to the Company in writing that such exercise is for investment only and not with a view to distribution, and also setting forth such other terms and conditions as the Committee may prescribe. Such agreements may also, in the discretion of the Committee, contain provisions requiring the forfeiture of any options granted and/or Common Stock held, in the event of the termination of employment or association, as the case may be, of the optionee with the Company. Upon any forfeiture of Common Stock pursuant to an agreement authorized by the preceding sentence, the Company shall pay consideration for such Common Stock to the optionee, pursuant to any such agreement, without interest thereon.

     (k) “Fair Market Value.” Fair Market Value for all purposes under the Plan shall mean the closing price of shares of Common Stock, as reported in The Wall Street Journal, in the NASDAQ National Market Issues or similar successor consolidated transactions reports (or a similar consolidated transactions report for the exchange on which the shares of Common Stock are then trading) for the relevant date, or if no sales of shares of Common Stock were made on such date, the average of the high and low sale prices of shares as reported in such composite transaction report for the preceding day on which sales of shares were made. If the shares are not listed on a national securities exchange or included for quotation in the NASDAQ National Market System at the time Fair Market Value is to be determined, then Fair Market Value shall be determined by the Committee in good faith pursuant to such method as the Committee deems appropriate and equitable. Under no circumstances shall the Fair Market Value of a share of Common Stock be less than its par value.

7. Termination and Amendment of the Plan

     The Board of Directors or the Committee shall have the right to amend, suspend, or terminate the Plan at any time; provided, however, that no such action shall affect or in any way impair the rights of a recipient under any option right theretofore granted under the

6

Plan; and, provided, further, that unless first duly approved by the stockholders of the Company entitled to vote thereon at a meeting (which may be the annual meeting) duly called and held for such purpose, except as provided in subparagraphs 6(h) and 6(i), no amendment or change shall be made in the Plan increasing the total number of shares which may be issued or transferred under the Plan, materially increasing the benefits to Plan participants or modifying the requirements as to eligibility for participation in the Plan.

8. Restriction on Sale of Shares

     Without the written consent of the Company, no stock acquired by an optionee upon exercise of an incentive stock option granted hereunder may be disposed of by the optionee within two years from the date such incentive stock option was granted, nor within one year after the transfer of such stock to the optionee; provided, however, that a transfer to a trustee, receiver, or other fiduciary in any insolvency proceeding, as described in Section 422(c)(3) of the Code, shall not be deemed to be such a disposition. The optionee shall make appropriate arrangements with the Company for any taxes which the Company is obligated to collect in connection with any such disposition, including any federal, state, or local withholding taxes.

     No stock acquired by an optionee upon exercise of a non-qualified stock option granted hereunder may be disposed of by the optionee (or other person eligible to exercise the option) within six months from the date such non-qualified stock option was granted, unless otherwise provided by the Committee.

9. Effective Date of the Plan

     This Plan is effective as of June 23, 1999, provided, however, that the Plan be approved by the stockholders of the Company at the 2000 Annual Meeting of Stockholders. If the Plan is not approved by the stockholders, the Plan and options granted hereunder shall thereupon terminate. In any event, the Plan shall terminate on June 22, 2009, or on such earlier date as the Board of Directors or the Committee may determine. Any option outstanding at the termination date shall remain outstanding until it has either expired or has been exercised.

10. Compliance with Rule 16b-3

     With respect to persons subject to Section 16 of the Exchange Act, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 or its successors. To the extent any provision of the Plan or action by the Committee (or any other person on behalf of the Committee or the Company) fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee.

11. Automatic Grant of Options to Non-Employee Directors

     The purpose of this Section 11 is to continue the program of automatic grants of options to non-employee directors of the Company established pursuant to Section 11 of the

7

Company’s 1993 Incentive and Non-Qualified Stock Option Plan and continued by the Company’s 1997 Incentive and Non-Qualified Stock Option Plan (collectively, the “Prior Plans”). The following options, to the extent not heretofore granted pursuant to the Prior Plans, shall be automatically awarded:

     (a) Each director, who is not also an employee of the Company or any of its affiliates, or the designee of any stockholder of the Company pursuant to a right to designate one or more directors (an “Eligible Director”) shall automatically be awarded a grant of 50,000 non-qualified stock options upon his or her initial election to the Board of Directors. Such options shall vest and be exercisable solely in accordance with the following schedule:

(i)	The options may be exercised with respect to a maximum of one-half of the option shares during the twelve-month period beginning after the date of grant.
(ii)	The options may be exercised with respect to all of the option shares upon the Eligible Director’s reelection to the Board of Directors for a second consecutive term.
(iii)	The options will expire and will no longer be exercisable as of the tenth anniversary of the date of grant, subject to sooner expiration upon the occurrence of certain events as provided elsewhere in this Plan.

     (b) In addition to the grant provided in subsection (a), each Eligible Director shall automatically be awarded a grant of non-qualified stock options upon the reelection of such Eligible Director to a third or subsequent, successive term, in the amount and at the times hereinafter set forth. Such automatic grants of non-qualified stock options commenced on June 21, 1995, pursuant to the Prior Plans, and have occurred and shall continue to occur annually thereafter on the date of the annual meeting of stockholders for such year until the termination of the Plan. The number of options to which each Eligible Director shall be entitled pursuant to this subsection (b) shall be as follows:

(i)	20,000 on the date of the Eligible Director’s reelection to a third one-year term;
(ii)	20,000 on the date of the Eligible Director’s reelection to a fourth one-year term;
(iii)	15,000 on the date of the Eligible Director’s reelection to a fifth one-year term;
(iv)	15,000 on the date of the Eligible Director’s reelection to a sixth one-year term;

8

(v)	10,000 on the date of the Eligible Director’s reelection to a seventh one-year term;
(vi)	10,000 on the later of the date of the annual meeting of stockholders in 2000, or the date of the Eligible Director’s reelection to an eighth one-year term; and
(vii)	10,000 on the later of the date of the annual meeting of stockholders in 2001, or the date of the Eligible Director’s reelection to a ninth one-year term.

Such options shall vest and be exercisable solely in accordance with the following schedule:

(i)	The options shall not be exercisable during the twelve-month period beginning after the date of grant.
(ii)	The options may be exercised with respect to one-third of the option shares after the expiration of twelve months from the date of grant.
(iii)	The remaining two-thirds of the options shall vest and become exercisable ratably on a monthly basis over the two-year period commencing one year from the date of grant and ending three years from the date of grant.
(iv)	The options will expire and will no longer be exercisable as of the tenth anniversary of the date of grant, subject to sooner expiration upon the occurrence of certain events as provided elsewhere in this Plan.

     (c) The option price for all options awarded under this Section 11 shall be equal to 100% of the Fair Market Value of a share of Common Stock on the date of grant.

12. Options granted to employees and directors of any subsidiary in the UK

     In addition to the provisions of paragraphs 1 to 11 (inclusive) above the provisions of this paragraph 12 shall apply as herein set out to options granted to employees and directors of any subsidiary in the United Kingdom. The provisions of this paragraph 12 enable the Plan to be used in a tax efficient manner in the United Kingdom.

     (a) In this paragraph 12 the following terms have the meanings ascribed to them:

9

“Election” means an election in the form envisaged in Paragraph 3B(1) of Schedule 1 to SSCBA to the effect that any Secondary NIC arising on the exercise, assignment or release of a UK Option shall be the liability of the recipient and not the liability of the UK Subsidiary

“Independent Transfer Agent” means any person (other than the Company or any company affiliated with the Company or any individual affiliated with any such company) who is registered as a broker-dealer with the U.S. Securities and Exchange Commission and who is thereby able to sell and transfer shares in the Company on behalf of the Optionholder

“Optionholder” means an employee or director of the UK Subsidiary who is the holder of a UK Option

“Secondary NIC” means secondary national insurance contributions as defined in the SSCBA

“SSCBA” means the Social Security Contributions and Benefits Act 1992 of the United Kingdom

“UK Option” means an option granted to an employee of the UK Subsidiary

“UK Subsidiary” means OSI Pharmaceuticals (UK) Limited (a company incorporated in England under company number [ 1709877 ])

     (b) To the extent that it is lawful to do so, a UK Option may be granted subject to a condition that any liability of the UK Subsidiary (as employer or former employer of the relevant Optionholder) to pay Secondary NIC in respect of the exercise, assignment or release of that UK Option shall be the liability of the relevant Optionholder and payable by that Optionholder and that Optionholder shall be required to enter into an Election to that effect when required to do so by the UK Subsidiary provided that the Committee may in its discretion at any time or times release the Optionholder from this liability or reduce his liability thereunder unless that Election has been entered into between the UK Subsidiary and that Optionholder and that Election (or the legislation which provides for such an Election to be effective) does not allow for such an Election to be subsequently varied.

     (c) If a UK Option is granted subject to the condition referred to in paragraph 12(b) above then the Optionholder shall by completing the Election grant to the UK Subsidiary (as employer or former employer of the relevant Optionholder) the irrevocable authority, as agent of the Optionholder and on his behalf, to appoint an Independent Transfer Agent, to act as agent of the Optionholder and on his behalf, to sell or procure the sale of sufficient of the Stock subject to the UK Option and remit the net sale proceeds to the UK Subsidiary so that the net proceeds payable to the UK Subsidiary are so far as possible equal to

10

but not less than the amount of the Secondary NIC for which the Optionholder is liable under the terms of the Election and the UK Subsidiary shall account to the Optionholder for any balance.

          No Stock shall be allotted or transferred to the Optionholder by the Company until the UK Subsidiary has received an amount in cash equal to the amount of the Secondary NIC for which the Optionholder is liable under the terms of the Election.

     (d) If a UK Option is exercised and the Optionholder is liable to tax duties or other amounts on such exercise and the UK Subsidiary (as his employer or former employer) is liable to make a payment to the appropriate authorities on account of that liability then the Optionholder shall by having completed the Option Agreement grant to the UK Subsidiary (as employer or former employer of the relevant Optionholder) the irrevocable authority, as agent of the Optionholder and on his behalf, to appoint an Independent Transfer Agent, to act as agent of the Optionholder and on his behalf, to sell or procure the sale of sufficient of the Shares subject to the UK Option and remit the net sale proceeds to the UK Subsidiary so that the net proceeds payable to the UK Subsidiary are so far as possible equal to but not less than the amount payable to the appropriate authorities and the UK Subsidiary shall account to the Optionholder for any balance.

          No Shares shall be issued or delivered to the Optionholder by the Company until the UK Subsidiary has received an amount in cash equal to the amount of the Secondary NIC for which the Optionholder is liable under the terms of the Election.

11

EX-31.1

EXHIBIT 31.1

CERTIFICATION

     I, Colin Goddard, certify that:

     1. I have reviewed this Quarterly Report on Form 10-Q of OSI Pharmaceuticals, Inc.;

     2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

     3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

     4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

          a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

          b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

          c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

          d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

     5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

          a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

          b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 9, 2006

/s/ Colin Goddard, Ph.D.  

Colin Goddard, Ph.D. 

Chief Executive Officer 

EX-31.2

EXHIBIT 31.2

CERTIFICATION

     I, Michael G. Atieh, certify that:

     1. I have reviewed this Quarterly Report on Form 10-Q of OSI Pharmaceuticals, Inc.;

     2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

     3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

     4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

          a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

          b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

          c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

          d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

     5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

          a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

          b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 9, 2006

/s/ Michael G. Atieh  

Michael G. Atieh 

Executive Vice President and Chief Financial Officer 

EX-32.1

EXHIBIT 32.1

OSI PHARMACEUTICALS, INC.

CERTIFICATION PURSUANT TO
18 U.S.C. § 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of OSI Pharmaceuticals, Inc. (the “Company”) on Form 10-Q for the quarter ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Colin Goddard, Ph.D., Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: November 9, 2006	/s/ Colin Goddard, Ph.D.
	Colin Goddard, Ph.D.
	Chief Executive Officer

EX-32.2

EXHIBIT 32.2

OSI PHARMACEUTICALS, INC.

CERTIFICATION PURSUANT TO
18 U.S.C. § 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of OSI Pharmaceuticals, Inc. (the “Company”) on Form 10-Q for the quarter ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael G. Atieh, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: November 9, 2006	/s/ Michael G. Atieh
	Michael G. Atieh
	Executive Vice President and Chief Financial Officer