PROTEIN DESIGN LABS INC/DE - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[ X ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1996 or

[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

Commission File Number: 0-19756

PROTEIN DESIGN LABS, INC.
(Exact name of registrant as specified in its charter)

Delaware 94-3023969
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

2375 Garcia Avenue
Mountain View, CA 94043
(Address of principal executive offices)
Telephone Number (415) 903-3700

Securities registered pursuant to Section 12(b) of the Act:

Name of each exchange
Title of each class on which registered
------------------- ---------------------

None None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par value $.01
(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on January 31,
1997, as reported on the NASDAQ National Market System, was approximately
$577,473,617.

As of January 31, 1997, registrant had outstanding 15,821,195 shares of Common
Stock.

DOCUMENTS INCORPORATED BY REFERENCE

None

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PART I

This Annual Report for Protein Design Labs, Inc. ("PDL" or the
"Company") contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to those discussed in "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business" as well as those discussed elsewhere in
this document. Actual events or results may differ materially from those
discussed in this Annual Report.

ITEM 1. BUSINESS

OVERVIEW

PDL is a leader in the development of humanized and human monoclonal
antibodies for the prevention and treatment of a variety of disease conditions,
including autoimmune diseases, inflammatory conditions, cancers and viral
infections. The Company uses proprietary computer software and other
technologies to develop its SMART(TM) humanized antibodies for potential use as
effective pharmaceuticals without the limitations of mouse-derived (murine)
antibodies. PDL believes that its technologies are broadly applicable to a
variety of diseases, as demonstrated by the Company's diverse product
development pipeline and its collaborative arrangements with eight
pharmaceutical companies. The Company and its collaborative partners currently
have four product candidates in multiple clinical trials and numerous additional
product candidates in preclinical studies. The Company's most advanced potential
product, Zenapax(R), has successfully completed two multinational Phase III
clinical trials for the prevention of kidney transplant rejection. In 1996, PDL
received U.S. and European patents that the Company believes cover most
humanized antibodies, and that may lead to additional corporate partnering,
patent licensing and and other revenue opportunities.

Antibodies have long had promise as therapeutic compounds to treat a
variety of disease conditions. Murine antibodies, however, have significant
drawbacks which in most cases prevent them from becoming effective therapeutics.
The most important of these is the human anti-mouse antibody ("HAMA") response,
whereby the murine antibody is recognized by the body's immune system as being
foreign and is rapidly neutralized and rendered ineffective. PDL's antibodies
are designed to avoid these drawbacks, including the HAMA response. PDL's SMART
antibodies are predominantly human antibodies that incorporate the structural
information from the binding region of promising murine antibodies. By applying
its proprietary SMART antibody technology, the Company is able to create such
recombinant antibodies with molecular structures that are approximately 90%
human and 10% murine. The Company also has technologies to produce fully human
antibodies to treat additional diseases using antibody therapy.

PDL's business strategy is to leverage its technologies, research expertise
and intellectual property in the field of antibodies to become a profitable,
research-based biopharmaceutical company that manufactures and, in North
America, markets its own products. Key aspects of PDL's strategy are to: (i)
expand the Company's product portfolio to provide multiple product candidates to
treat a variety of diseases and conditions; (ii) establish collaborative
relationships with pharmaceutical companies to reduce development costs and
risks and to enhance commercial

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opportunities; (iii) leverage its patent position by licensing certain rights in
exchange for near-term revenues and future royalty opportunities; and (iv)
retain and obtain North American marketing or co-promotion rights to certain
products to provide for greater revenue opportunities.

The Company actively seeks partnerships with pharmaceutical companies. The
breadth of the Company's antibody technology and its patent position are key
assets in attracting other companies to enter into such collaborative
relationships with the Company. In one type of collaborative arrangement, the
Company licenses certain marketing rights to one or more potential products
developed by PDL in return for a licensing fee, research funding and milestone
payments, and royalties on potential product sales. In another type of
arrangement, PDL uses its proprietary technology to develop a SMART antibody
based on a promising murine antibody developed by its corporate partner. In such
cases, PDL typically receives a licensing fee and other payments, royalties on
potential sales and, in some cases, an option to co-promote in North America.

PRODUCTS UNDER DEVELOPMENT

The Company believes it is a leader in the development of antibody-based
therapeutics and has one of the broadest product pipelines in this area. The
Company has four product candidates under clinical development and a number of
product candidates in preclinical development for the treatment of a variety of
disease conditions, including autoimmune diseases, inflammatory conditions,
cancers and viral infections.

CLINICAL PRODUCT CANDIDATES

The following table summarizes the potential therapeutic indications,
development status and commercial rights for the four PDL products that have
entered clinical trials. The development and commercialization of the Company's
clinical product candidates are subject to numerous risks and uncertainties.

POTENTIAL THERAPEUTIC DEVELOPMENT COMMERCIAL
PRODUCT INDICATIONS STATUS RIGHTS(1)
- ----------------------- ---------------------------- ------------------ ------------------

Zenapax (SMART Organ transplant rejection Completed two Roche
Anti-Tac Antibody) Phase II trials
(kidney)

Certain autoimmune diseases
Tropical spastic
paraparesis Phase I/II
Uveitis Phase I/II
Psoriasis Phase I/II planned
Certain blood cancers Phase II
SMART M195 Acute myelogenous leukemia Phase II/III PDL and Kanebo
Antibody Acute promyelocytic leukemia Phase II
Myeloid leukemia Phase I (Japan)

OST 577 (Human Chronic hepatitis B ("CHB") Phase II PDL, Boehringer
Anti-Hepatitis B Liver transplantation Completed Phase I/II Mannheim and

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Antibody due to CHB Novartis
PROTOVIR (Human Cytomegalovirus ("CMV") Phase II PDL, Boehringer
Anti-Cytomegalovirus infections in BMT Mannheim and
Antibody) Novartis

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(1) The development and marketing rights for each of these products differ. See
"-- Collaborative and Licensing Arrangements."

ZENAPAX (SMART ANTI-TAC ANTIBODY). Zenapax is a humanized antibody,
developed by PDL and licensed exclusively to Hoffmann-La Roche Inc. and F.
Hoffmann-La Roche & Co. Limited Company, subsidiaries of Roche Holding Ltd
(collectively, "Roche"), which binds to the IL-2 receptor on T cells. IL-2 is a
lymphokine which stimulates T cells to divide and participate in an immune
response. By blocking the binding of IL-2 to its receptor, Zenapax inhibits the
proliferation of activated T cells, and thus could be useful in preventing or
treating organ transplant rejection or certain autoimmune diseases. Such an
agent might be more specific and less toxic than current immunosuppressive drugs
such as cyclosporine or OKT3, because it would suppress only activated T cells
involved in an immune response rather than all T cells and possibly other
unrelated cells.

Organ transplantation. In September 1996, the Company's partner, Roche,
announced results from two multinational Phase III studies of Zenapax for the
prevention of acute rejection episodes in a total of 535 cadaveric kidney
transplant recipients. As set forth in the following table, a preliminary
analysis of the data by Roche indicated that, when administered with a standard
immunosuppressive regimen, Zenapax is effective in reducing the incidence of
acute rejection episodes within six months of transplant, the primary endpoint.
In the double therapy trial, in which all patients received a background therapy
of cyclosporine and prednisone, acute rejection episodes were reduced by 40% in
patients treated with Zenapax. In the triple therapy trial, in which all
patients received background therapy of cyclosporine, prednisone and
azathioprine, the incidence of acute rejection episodes was reduced by 37% in
patients treated with Zenapax.

Incidence of Kidney Rejection Episodes
---------------------------------------
Without With Reduction With
Trial Zenapax Zenapax Zenapax p-Value
- ----- --------- -------- ---------------- -------

Double Therapy . . . . . . . . . . . 47% 28% 40% 0.001
Triple Therapy . . . . . . . . . . . 35% 22% 37% 0.03

Roche also noted that secondary endpoints of reduction in the total number
of rejection episodes per patient and increase in the time to first rejection
episode were achieved with Zenapax in both clinical trials. The addition of
Zenapax to the standard immunosuppressive regimen did not result in an increase
in drug-related serious adverse events.

Based on these trials, Roche stated that it intends to file in the first
half of 1997 for regulatory approval to market Zenapax in the U.S., Canada and
Europe.

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In addition to the studies described above, Roche has completed enrollment
in a controlled pharmacokinetics/safety study with 61 evaluable patients to
assess Zenapax in combination with CellCept in kidney transplant patients.
CellCept, marketed by Roche, is used to prevent kidney transplant rejection.
Roche also plans to conduct a study of Zenapax in pediatric kidney
transplantation.

According to industry sources, approximately 20,000 solid organs are
transplanted into patients in the U.S. each year, with kidney transplants
accounting for about 12,000 of the total. A comparable number of kidney
transplants are performed outside of the U.S. The majority of kidney transplant
patients receive cadaveric kidneys.

Roche previously evaluated Zenapax in a Phase II/III trial for the
prevention of graft-versus-host disease ("GvHD"), a complication of bone marrow
transplants. Analysis of the trial results led Roche to conclude that Zenapax
was not effective in reducing the incidence of GvHD in the patient population
studied. The reason for this lack of efficacy of Zenapax in GvHD despite its
effectiveness in kidney transplantation is unknown. However, Roche stated that
Zenapax was found to be safe and well-tolerated in the GvHD trial.

Autoimmune disease. Because of the ability of Zenapax to inhibit the
proliferation of T cells, the Company believes that Zenapax may have potential
for the treatment of certain autoimmune diseases. Investigators at the National
Institutes of Health ("NIH") are evaluating Zenapax in a preliminary clinical
trial in patients with tropical spastic paraparesis, a rare autoimmune disease
of the nerves considered by these investigators to be a model for multiple
sclerosis. In addition, proof-of-concept clinical trials of Zenapax have
commenced for uveitis and are planned for psoriasis.

Cancer. The Company believes that Zenapax may also have potential for the
treatment of certain blood cancers, because the IL-2 receptor is present on
these types of cancer cells. The murine anti-Tac antibody has been tested at NIH
in patients with adult T-cell leukemia, and several of the patients experienced
remissions, especially when the antibody was linked to a radioisotope. A pilot
Phase I clinical trial of Zenapax for the treatment of certain cancers was
completed in 1993 at the National Cancer Institute ("NCI") of NIH, and a Phase
II trial of a radiolabeled form of Zenapax for certain blood cancers is in
progress at NCI.

There can be no assurance that Roche will file for or receive regulatory
approval to market Zenapax for use in preventing kidney transplant rejections in
a timely manner, if at all, or that it will pursue or continue clinical trials
in autoimmune diseases or other indications.

SMART M195 ANTIBODY. The SMART M195 Antibody is a humanized antibody that
binds to the cancer cells of most patients with myeloid leukemia. Myeloid
leukemia, the major form of leukemia in adults, is classified into two types --
acute myelogenous leukemia ("AML") and chronic myelogenous leukemia ("CML").
There are at least 11,000 new cases of myeloid leukemia in the U.S. each year,
of which more than half are AML. Currently, the survival rate of myeloid
leukemia patients is very low, despite aggressive chemotherapy and multiple,
expensive hospitalizations.

PDL has adopted strategies designed to achieve improved efficacy of
antibodies in certain cancers. First, PDL's anti-cancer antibodies are
humanized, which allows for longer term treatment by minimizing the HAMA
response, and potentially makes the antibodies more effective in killing

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cancer cells. Second, the Company is initially focusing on treatment of blood
cancers, such as myeloid leukemia, which may be more susceptible to antibody
therapy than solid tumors because the cancer cells are more readily accessible.
Third, PDL will often conduct trials of its antibodies in combination with, or
following, other chemotherapeutic agents.

PDL is conducting a randomized Phase II/III trial of the SMART M195
Antibody for AML, which was initiated in June 1994. Patients in the trial first
receive a specific regimen of chemotherapy. Those patients entering clinical
remission are randomized either to observation or to receive 20 doses of SMART
M195 given over an eight month period. The primary clinical endpoint is the
median duration of disease-free survival, which in the absence of SMART M195
therapy has historically been about eight months. The study is planned to
evaluate 112 patients in remission, but a substantially larger number will need
to receive chemotherapy in order to reach that number of patients in remission.
The study is currently expected to require several additional years to complete.
The Company is exploring the addition of other U.S. or foreign medical centers
and other actions to accelerate patient accrual in the study. See "Risk
Factors."

SMART M195 is also being studied in a Phase II trial under a
physician-sponsored IND at the Memorial Sloan-Kettering Cancer Center
("Sloan-Kettering"), in patients with acute promyelocytic leukemia ("APL"), one
of several types of AML. This trial is designed to examine whether SMART M195
alone can eliminate minimal residual leukemia that remains after treatment with
retinoic acid, a drug recently approved to treat APL. The effectiveness is
measured by elimination of cells having the characteristic genetic mutation
found in APL to below detectable levels ("molecular remission"). Four of seven
evaluable newly diagnosed patients have entered complete molecular as well as
clinical remission after therapy with retinoic acid and SMART M195 prior to
receiving chemotherapy. In the more difficult relapsed setting, one of seven APL
patients entered molecular remission. Normally, one to three rounds of expensive
and toxic chemotherapy are required to bring newly diagnosed APL patients into
molecular remission after therapy with retinoic acid. More patients and
longer-term follow-up are necessary to evaluate the significance of the observed
remissions. While these results suggest that SMART M195 may be biologically
active in APL, the Company currently has no plans to conduct pivotal clinical
trials in this subpopulation of AML patients.

A Phase I clinical trial of the SMART M195 Antibody linked to Bismuth-213,
an alpha particle-emitting isotope, was initiated in 1996 under a
physician-sponsored IND at Sloan-Kettering in advanced myeloid leukemia
patients. The Company is supporting this trial to obtain preliminary evidence of
the safety and potential efficacy of SMART M195-Bismuth-213 used as a single
agent to induce remissions of advanced myeloid leukemia. Generators to produce
the Bismuth-213 isotope are being supplied by PharmActinium Inc. and associated
companies. The Company believes that this study is the first clinical trial of
an antibody combined with an alpha-emitting isotope. In previous clinical trials
of radiolabeled antibodies, the antibodies have been linked to radioisotopes
that emit beta or gamma particles. Alpha particles release more energy over a
shorter path than beta or gamma particles and, therefore, may be more effective
in destroying the targeted cancer cells without damaging nearby normal cells.

Exclusive development and marketing rights for therapeutic uses of SMART
M195 in Asia have been licensed to PDL's collaborative partner, Kanebo, Ltd.
("Kanebo"), which is currently conducting a Phase I trial in Japan in patients
with AML.

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OST 577 (HUMAN ANTI-HEPATITIS B ANTIBODY). OST 577 is a human antibody,
developed using the trioma technology and licensed by PDL from Sandoz Pharma,
Sandoz Ltd. and Sandoz Pharmaceuticals Corporation (collectively, "Novartis").
OST 577 binds to the major protein present on hepatitis B virus ("HBV"), the
hepatitis B surface antigen. Infection with HBV is a common cause of liver
disease. In most cases of infection, the patient's immune response is sufficient
to ultimately eliminate the virus. However, an estimated 2% to 10% of
HBV-infected patients become chronic carriers of the virus, and about one-fourth
of these patients develop chronic hepatitis B ("CHB"), which is characterized by
progressive liver damage and often cirrhosis and liver cancer. In the U.S. there
are an estimated one million chronic carriers of HBV, with 300,000 new HBV
infections and more than 10,000 patients hospitalized due to HBV infections each
year. While interferon-alpha is approved in the U.S. for treatment of CHB, only
30-40% of treated patients respond to this treatment, which must be given over
four months and has significant side effects.

In patients receiving liver transplants due to end-stage CHB, the virus
remaining after the transplant usually will rapidly infect and in many cases
destroy the new liver. An initial Phase I/II clinical trial of OST 577 enrolled
five patients receiving liver transplants due to end-stage CHB. In the clinical
trial, each patient received doses of OST 577 for up to 18 months after
transplantation. Three of the five treated patients showed no evidence of viral
recurrence more than one year after transplantation. The other two patients did
develop recurrence but remained asymptomatic for four years, after which one of
them developed symptoms.

A Phase I/II clinical trial of OST 577 has also been completed in 12
patients with CHB. OST 577 was well tolerated by patients treated at the two
lower dose levels, but some reversible side effects were seen at the highest
level. Key markers for HBV infection decreased at least temporarily by 50% or
more in many of the patients during treatment. Specifically, such reductions
were seen in 5 of 10 patients for liver enzyme levels; in 10 of 12 for hepatitis
B surface antigen; and in 5 of 9 for viral DNA levels. Results obtained in early
clinical trials may not be predictive of results in larger, later-stage trials.
See "Risk Factors."

PDL's development partner, Boehringer Mannheim GmbH ("Boehringer
Mannheim"), which has development and marketing rights for therapeutic
applications to OST 577 outside of North America, has primary clinical
development responsibility for this potential product. In 1996, Boehringer
Mannheim initiated a multinational, controlled Phase II trial in patients with
CHB, and has stated that it is designing a Phase II/III trial in patients
receiving liver transplants for end-stage liver disease due to CHB. The Phase II
trial in CHB is planned to enroll 200 patients and will evaluate OST 577 both as
a single agent and in combination with interferon-alpha. PDL is considering the
possibility of conducting independent clinical trials with designs complementary
to the Boehringer Mannheim trials. In addition, Novartis has certain rights to
co-promote or co-market this antibody in North America or to receive royalties
on product sales. See "--Collaborative and Licensing Arrangements."

PROTOVIR(TM) (HUMAN ANTI-CMV ANTIBODY). PROTOVIR is a human antibody,
derived using the trioma technology, that binds to all tested strains of human
cytomegalovirus ("CMV"). CMV is an important cause of morbidity and death in
patients with suppressed immune systems, such as AIDS patients and recipients of
solid organ and bone marrow transplants ("BMT").

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Bone marrow transplantation. In BMT patients, CMV can cause often fatal
infections, such as pneumonia. Many transplant centers treat patients with
pooled human immunoglobulin preparations in an attempt to prevent CMV infection,
despite the high cost and limited efficacy of this treatment. The Company has
completed enrollment in a randomized, placebo-controlled, double-blinded Phase
II trial to assess the potential safety and efficacy of PROTOVIR for the
prevention of CMV infections in allogeneic (non-self) bone marrow transplant
patients. The study is comparing two dose levels of PROTOVIR against placebo in
approximately 168 evaluable patients. The primary endpoint of this study is the
incidence of CMV infections during the 100 days following the BMT. Historically,
such infections occur in 50-60% of these patients. Results of the study are
expected to be available in the first half of 1997 but there can be no assurance
that the results of the trial will be favorable. See "Risk Factors."

CMV retinitis. The potential safety and efficacy of PROTOVIR was evaluated
in a Phase II/III clinical trial conducted by NEI SOCA for the treatment of CMV
retinitis, a common ophthalmic condition in AIDS patients that often leads to
blindness. In August 1996, the National Eye Institute Studies of Ocular
Complications of AIDS ("NEI SOCA"), acting on the recommendation of an
independent data and safety monitoring board, halted the study based on lack of
evidence of efficacy. Concurrently with the NEI SOCA trial, PROTOVIR also was
being evaluated in a Phase II clinical trial being conducted by National
Institute of Allergy and Infectious Disease, Division of AIDS, AIDS Clinical
Trials Group ("NIAID ACTG") for treatment of CMV retinitis. Based on the NEI
SOCA findings and actions, enrollment in the Phase II trial had been suspended,
and the trial was recently terminated.

Exclusive rights for the therapeutic application of this antibody outside
of North America and Asia have been licensed to Boehringer Mannheim. In
addition, Novartis, from whom PDL licensed the antibody, has certain rights to
co-promote or co-market this antibody in North America and Asia or to receive
royalties on product sales. See "--Collaborative and Licensing Arrangements."

PRECLINICAL PRODUCT CANDIDATES

The following table summarizes the potential therapeutic indications and
commercial rights for certain of PDL's preclinical product candidates.
"Preclinical" development includes in vitro testing, efficacy and toxicology
testing in animals, process development and manufacturing scale-up prior to
initiation of clinical trials. The Company has other compounds in development in
addition to those described in the table below and is conducting research in
other areas. The development and commercialization of the Company's preclinical
product candidates are subject to numerous risks and uncertainties. See "Risk
Factors."

COMMERCIAL
PRODUCT POTENTIAL THERAPEUTICS INDICATIONS RIGHTS(1)
- ------------------------- -------------------------------------- --------------------

AUTOIMMUNE AND INFLAMMATORY CONDITIONS

SMART Anti-L-Selectin Trauma, adult respiratory distress PDL and Boehringer
Antibody syndrome ("ARDS"), reperfusion Mannheim
injury

SMART Anti-E/P- Stroke, trauma, certain autoimmune PDL

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Selectin Antibody diseases (e.g. psoriasis), asthma

SMART Anti-CD3 Organ transplant rejection and PDL
Antibody certain autoimmune diseases

SMART Anti-Gamma Certain autoimmune diseases (e.g. PDL
Interferon Antibody inflammatory bowel disease)

CANCER

SMART ID10 Antibody B-cell lymphoma PDL

SMART ABL 364 Certain epithelial cell cancers PDL and Novartis
Antibody including breast, lung and colon
VIRAL INFECTIONS

Human Anti-Varicella Shingles (herpes zoster) PDL and Novartis
Zoster Antibody

Human Anti-Herpes Neonatal and genital herpes PDL and Novartis
Antibody

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(1) The development and marketing rights for each of these products differ. See
"--Collaborative and Licensing Arrangements."

AUTOIMMUNE DISEASE AND INFLAMMATION. Recent discoveries in immunology have
made possible a new therapeutic approach to inflammation resulting from such
causes as injury or autoimmune disease. Certain proteins called adhesion
molecules, located on the surface of various types of cells, play a key role in
inflammation by directing the movement of white blood cells from the bloodstream
into the sites of tissue inflammation. In laboratory experiments conducted by
PDL and others, antibodies have been shown to block the function of these
adhesion molecules, and in animal models these anti-adhesion antibodies have
been shown to be effective at reducing many types of inflammation.

PDL has developed several SMART antibodies against adhesion molecules. One
of these antibodies, the SMART Anti-L-Selectin Antibody, binds to L-selectin, an
adhesion molecule on the surface of white blood cells. The Company believes that
potential indications for this antibody may include trauma, ARDS, reperfusion
injury (e.g., due to myocardial infarction or stroke) and possibly certain
autoimmune diseases. In studies conducted by independent investigators,
treatment with the SMART Anti-L-Selectin Antibody resulted in a statistically
significant improvement in survival in a primate model that simulates severe
trauma. Boehringer Mannheim, which has licensed rights to this antibody outside
of North America and Asia from PDL, plans to begin clinical trials of the
antibody in 1997, with an initial indication of trauma.

PDL's SMART Anti-E/P-Selectin Antibody binds to two different adhesion
molecules, Eand P-selectin, that occur on the surface of the cells on the inner
lining of blood vessels. The Company believes that potential indications for
such an antibody may include stroke, trauma, certain

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autoimmune diseases, psoriasis and asthma. The Company is developing additional
forms of the SMART Anti-E/P-Selectin Antibody, from which it intends to select
the final form.

PDL's SMART Anti-CD3 Antibody binds to the CD3 antigen, a key receptor for
stimulation of T cells. The Company believes that potential indications for this
antibody may include treatment of organ transplant rejection and certain
autoimmune diseases.

PDL's SMART Anti-Gamma-Interferon Antibody binds to and neutralizes gamma
interferon, a lymphokine that stimulates several types of white blood cells. The
Company believes that potential indications for this antibody may include
inflammatory bowel disease, multiple sclerosis, and other autoimmune diseases.

CANCER. B-cell lymphomas, like leukemias, are a type of blood cancer that
the Company believes may be accessible to antibody-based treatments. PDL has
developed the SMART 1D10 Antibody, which binds to many malignant B cells, and is
currently evaluating it in preclinical studies. The Company is also evaluating a
bispecific antibody that incorporates the SMART 1D10 Antibody. To date
bispecific antibodies developed by PDL have not been tested in humans.

PDL's SMART ABL 364 Antibody has potential for the treatment of many solid
tumors, including colon, lung and breast cancer. Initial laboratory tests have
shown that the SMART ABL 364 Antibody, in conjunction with other components of
the immune system, can kill cancer cells.

VIRAL INFECTIONS. Varicella zoster virus ("VZV") is the virus responsible
for causing chickenpox and shingles (herpes zoster). Shingles, a painful
blistering condition of the skin, results from reactivation of the latent VZV
that initially infected the patient years earlier. In the U.S., 10-20% of the
population will develop shingles, with the incidence and severity increasing
with age. A significant percentage of patients with shingles experience
post-herpetic neuralgia, a very painful nerve condition which may last from
weeks to years in some patients. Current anti-viral therapies are moderately
effective in treating shingles, but have little or no effect on post-herpetic
neuralgia. PDL's Human Anti-Varicella Zoster Antibody effectively neutralizes
all tested strains of VZV in in vitro studies.

Herpes simplex virus ("HSV") causes a painful recurring genital infection.
The virus also causes neonatal herpes, an uncommon but very serious disease of
newborn infants. PDL's Human Anti-Herpes Antibody binds to and effectively
neutralizes all strains of HSV tested, and is well-tolerated and non-immunogenic
in primates. In animal studies sponsored by the National Institute of Allergy
and Infectious Disease Collaborative Antiviral Studies Group ("NIAID-CASG"), the
antibody effectively protected mice from a lethal herpes infection when
administered up to 72 hours after the virus. The Company believes that
competition from antiviral drugs and the present reimbursement environment may
limit the market opportunities for the Human Anti-Herpes Antibody in treating
genital herpes. The Company is currently exploring the possibility of providing
the antibody to NIAID-CASG under a Cooperative Research and Development
Agreement primarily for studies in neonatal herpes.

PDL TECHNOLOGIES

BACKGROUND ON ANTIBODIES. Antibodies are protective proteins released by
the immune system's B cells, a type of white blood cell, in response to the
presence of a foreign substance in the body, such as a virus. B cells produce
millions of different kinds of antibodies, which have slightly

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different shapes that enable them to bind to and thereby inactivate different
targets. Antibodies of identical molecular structure that bind to a specific
target are called monoclonal antibodies. Typically mice have been used to
produce monoclonal antibodies to a wide variety of molecular targets, including
targets to which the human body does not normally produce antibodies. In
particular, many murine antibodies have been developed as potential therapeutics
to neutralize viruses, destroy cancer cells or inhibit immune function.

Although murine monoclonal antibodies are relatively easy to generate, they
have significant drawbacks as therapeutics. Murine antibodies have a relatively
short half-life in human patients, requiring them to be administered frequently.
Moreover, murine antibodies are not adapted to work effectively with the human
immune system and therefore often have limited ability to destroy the target,
such as cancer cells. Most importantly, when injected into human patients, a
murine antibody is usually recognized by the body's immune system as being
foreign. The immune system therefore responds with a HAMA response, which
rapidly neutralizes the murine antibody and renders it ineffective for further
therapy. These problems have largely prevented murine antibodies from fulfilling
their promise as therapeutics.

More recently, improved forms of antibodies, such as humanized and chimeric
antibodies, have been developed using recombinant DNA technology. These new
antibodies can minimize or avoid many of the problems associated with murine
antibodies and have led to a resurgence of interest in antibody therapeutics by
the pharmaceutical and biotechnology industries. As a result of these advances,
many recombinant antibodies are now progressing into clinical trials. In a list
of biotechnology medicines under clinical development published in 1996 by the
Pharmaceutical Research and Manufacturers of America, antibodies comprised the
single largest category, representing 78 of 284 products listed. In particular,
PDL is aware of more than twenty recombinant antibodies in clinical trials,
including several antibodies addressing large markets that are being developed
by major pharmaceutical companies. Furthermore, ReoPro, a recombinant antibody
fragment developed by Centocor for reducing complications in patients undergoing
angioplasty is being marketed by Eli Lilly and Company.

PDL'S SMART ANTIBODY TECHNOLOGY. PDL believes that its patented SMART
antibody technology has positioned the Company as a leader in the development of
therapeutic antibodies that overcome the problems associated with murine
antibodies. PDL's SMART antibodies are human-like antibodies designed using
structural information from promising murine antibodies to capture the benefits
of such antibodies while overcoming many of their limitations in treating
humans. Clinical trials and preclinical studies have shown that PDL's SMART
antibodies generally avoid a HAMA response and have a longer half-life than
murine antibodies.

Every antibody contains two regions, a variable domain that binds to the
target and a constant domain that interacts with other portions of the immune
system. The variable domain is composed of the complementarity determining
regions ("CDRs") that directly bind to the target and the framework region that
holds the CDRs in position and helps maintain their required shape. Researchers
have used genetic engineering to construct "humanized" antibodies that consist
of the CDRs from a murine antibody with the framework region and constant domain
from a human antibody. However, when the CDRs from the murine antibody are
combined with the framework of the human antibody, the human framework often
distorts the shape of the CDRs so they no longer bind well to the target.
Therefore, it is usually necessary to substitute one or more amino acids from
the murine antibody into the framework of the humanized antibody for it to
maintain the binding ability of the murine antibody.

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A SMART antibody is a humanized antibody designed by using PDL's
proprietary computer technology to guide the choice of substitutions of amino
acids from the murine antibody into the human antibody framework, based on
structural information derived from the murine antibody. The construction of a
SMART antibody starts with the identification of a murine antibody that has
demonstrated favorable results in laboratory, animal or human studies. A model
of the murine antibody is generated using proprietary computer modeling software
that predicts the shapes of antibodies and eliminates the need for more
time-consuming laboratory techniques. The resulting model is carefully analyzed
to identify the few key amino acids in the framework most responsible for
maintaining the shape of the CDRs. Software developed at PDL as well as the
experience of the Company's computational chemists is important in this
analysis. These few key murine amino acids are substituted into the human
framework of the SMART antibody along with the murine CDRs in order to maintain
their ability to bind well to the target. The resulting SMART antibody retains
most or all of the binding ability of the murine antibody, but is about 90%
human.

In 1996, the Company was issued U.S. and European patents which cover, in
most circumstances, humanized antibodies that contain amino acid substitutions
from the murine antibody in their framework. The Company believes that most
humanized antibodies require such amino acid substitutions in order to maintain
high binding ability. The patents also cover pharmaceutical compositions
containing such humanized antibodies and other aspects of PDL's SMART antibody
technology. PDL has filed similar patent applications in Japan and other
countries. See "--Patents and Proprietary Technology."

OTHER PDL TECHNOLOGIES. In addition to its SMART antibody technology, PDL
employs additional antibody-based drug development technologies to overcome
shortcomings of murine antibodies. The Company is also pursuing a rational drug
design program that leverages its computer expertise to potentially develop new
drug candidates.

Human Antibodies. The use of fully human monoclonal antibodies is another
approach to avoiding many of the problems associated with murine antibodies. In
April 1993, PDL exclusively licensed from Novartis its patented "trioma"
technology to generate certain human antibodies, along with four human anti-
viral antibodies. Two of these human antibodies, OST 577 and PROTOVIR, are in
clinical development. The trioma technology is used to produce fully human
antibodies against viruses and potentially other organisms which infect humans.
A key aspect of the technology is the use of a mouse-human hybrid cell line as
the fusion partner to immortalize human antibody-producing B cells. Trioma cell
lines generated in this manner often stably produce human antibodies. As with
SMART antibodies, clinical trials and preclinical studies have shown that PDL's
human antibodies generally avoid a HAMA response and have a longer half-life
than murine antibodies. See "--Collaborative and Licensing Arrangements."

New Technologies. The Company is pursuing a rational drug design program
focusing on small molecules by extending the Company's computer modeling tools
originally developed for its SMART antibody program. Rational drug design
utilizes computer models of proteins and their interactions with smaller
molecules in order to accelerate discovery and optimization of new drug
compounds. Although PDL's technology is at an early stage, the Company believes
that this application of its modeling algorithms may ultimately be used to
develop non-antibody drug candidates. In addition, the Company plans to extend
its research activities into other new areas, potentially including the
development of novel classes of antibiotics for treating infections.

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BUSINESS STRATEGY

PDL's objective is to leverage its research expertise and intellectual
property in the field of antibodies to become a profitable, research-based
biopharmaceutical company that manufactures and, in North America, markets its
own products. PDL's strategy to achieve this objective involves the following
elements:

Expand Product Portfolio. The Company believes that its SMART antibody
technology is capable of converting essentially any promising murine antibody
into a humanized antibody better suited for therapeutic use. As a result, the
Company has been able to rapidly develop a broad portfolio of product candidates
with potential applications to the prevention and treatment of autoimmune and
inflammatory conditions, cancers, viral infections, and other diseases. This
diverse product pipeline enhances commercial opportunities and reduces the
Company's reliance on individual products.

Establish Collaborative Arrangements. The Company actively seeks corporate
partnerships with pharmaceutical companies, and to date has entered into
partnerships with eight such companies. Typically, the Company receives a
licensing fee, research funding and/or milestone payments, and royalties on
potential product sales in return for certain marketing rights to one or more
potential products developed at PDL. These revenues help to defray PDL's own
product development expenses, while the partner typically bears significant
direct responsibility for certain product development activities and expenses.

Leverage Patent Position. An important new aspect of PDL's business
strategy is to obtain both near-term revenues and potential royalties by
licensing limited rights under its issued humanized antibody patents and
corresponding patent applications to other companies developing humanized
antibodies. In December 1996, PDL entered into its first such licensing
agreement, with Sankyo Co., Ltd. ("Sankyo"). The Company's patents are also
helpful in inducing other companies to enter into collaborative relationships
with the Company, in which PDL uses its proprietary technology to develop SMART
antibodies based on promising murine antibodies developed by the other
companies. PDL has entered into six such relationships, including four since
December 1995. In addition to paying PDL license and other fees, in some cases
the other companies have granted PDL options to obtain North American
co-promotion rights.

Retain and Obtain North American Marketing Rights. Where appropriate, PDL
retains and obtains North American marketing or co-promotion rights to many of
its potential products. This strategy provides the Company with future
opportunities to generate greater revenues.

COLLABORATIVE AND LICENSING ARRANGEMENTS

Roche. In 1989, PDL entered into agreements with Roche to collaborate on
the research and development of SMART antibodies against the IL-2 receptor,
including Zenapax. Under these agreements, Roche has exclusive, worldwide rights
to manufacture, market and sell Zenapax. The arrangement provides for research
and development funding, milestone and bonus payments and future royalties that
could be received by PDL under the agreements. Most of such milestone and bonus
payments have already been received from Roche, and Roche has completed its
research funding to PDL under these agreements, although Roche will continue to
fund its own clinical development activities.

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In October 1996, PDL entered into a collaborative agreement with Roche
providing for the humanization by PDL of a murine antibody that has potential
for treating rheumatoid arthritis. PDL received a licensing and signing fee and
can earn milestone payments and royalties on potential product sales of this
compound by Roche.

Corange/Boehringer Mannheim. In October 1993, PDL and Corange entered into
a collaborative arrangement providing for the grant of exclusive marketing
rights in certain territories for a number of products in development. In
consideration for these rights, Corange paid to PDL a $10 million licensing and
signing fee and $30 million in research and development funding over three years
and agreed to certain milestone payments and the payment of royalties on future
product sales. As part of this arrangement, PDL and Corange further committed to
negotiate additional agreements under which each company would manufacture and
supply the other with certain of the antibodies covered by the collaborative
arrangement for use in clinical trials and potential future product sales. As
part of this collaborative arrangement, PDL and Corange also entered into a
stock purchase agreement, a standstill agreement and a registration rights
agreement pursuant to which Corange invested an aggregate of $75 million in PDL
through the purchase of approximately 2.433 million newly issued shares of
common stock in December 1993 and 1994. Product rights and duties under this
arrangement were subsequently assigned and delegated to Corange's subsidiary,
Boehringer Mannheim.

In 1994 and 1995, the parties amended certain of the agreements in this
collaborative arrangement. As part of these amendments, the parties agreed to
terminate Boehringer Mannheim's rights to certain preclinical products. As a
result, Boehringer Mannheim currently has exclusive marketing rights outside of
North America and Asia for PROTOVIR and the SMART Anti-L-Selectin Antibody,
exclusive marketing rights outside of North America for OST 577, and North
American co-promotion rights and exclusive marketing rights outside of North
America for an additional antibody to an undisclosed cardiovascular target. The
parties further agreed to allocate primary responsibility for clinical
development and manufacturing of PDL's Human Anti-Hepatitis B Antibody to
Boehringer Mannheim and for clinical development and manufacturing of PROTOVIR
to PDL. In addition, as part of these amendments, Boehringer Mannheim agreed to
provide certain clinical material manufactured by Boehringer Mannheim to PDL
without charge for PDL's use in preclinical and clinical research. The amendment
also provides that Boehringer Mannheim will assume the development and
manufacturing expenses related to the OST 577 Human Anti-Hepatitis B Antibody,
subject to reimbursement of certain clinical trial expenses by PDL of up to $2
million toward Phase II studies and up to $8.8 million for Phase III studies, if
certain conditions are met. As a result of these amendments, PDL is no longer
eligible to receive milestone payments with respect to OST 577 and PROTOVIR. In
the first quarter of 1996, Boehringer Mannheim made a milestone payment to PDL
with respect to the SMART Anti-L-Selectin Antibody.

Yamanouchi. In February 1991, PDL and Yamanouchi Pharmaceutical Co., Ltd.
("Yamanouchi") entered into a collaborative agreement providing for the
humanization of a murine anti-platelet (anti-gpIIb/IIIa) antibody developed by
Yamanouchi for potentially treating certain cardiovascular disorders. PDL has
completed humanization of the antibody and Yamanouchi is currently in the
preclinical stage of development with this humanized antibody. Yamanouchi has
exclusive, worldwide rights to the resulting SMART antibody and is responsible
for all clinical trials and for obtaining necessary government regulatory
approvals. The agreement provides for milestone payments, all of which have been
received, and royalties on future product sales.

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Kanebo. In February 1992, PDL and Kanebo entered into a product licensing
agreement whereby Kanebo received an exclusive license to the SMART M195
Antibody for therapeutic uses in certain Asian countries including Japan in
exchange for a licensing and signing fee, research funding, milestone payments
and royalties on future product sales. The research funding period under the
agreement expired in September 1993. Also in September 1993 and May 1995, PDL
entered into purchase agreements with Kanebo pursuant to which PDL sold Kanebo
preclinical and clinical quantities of the SMART M195 Antibody. Kanebo is
currently conducting a Phase I clinical trial of the SMART M195 Antibody in
Japan.

Novartis. In April 1993, PDL and Novartis entered into agreements providing
for the grant of exclusive licenses to PDL of four human anti-viral antibodies
and other related technology and antibodies from Novartis. The human monoclonal
antibodies target cytomegalovirus, the hepatitis B virus, herpes simplex
viruses, and varicella zoster virus. In addition, PDL received an exclusive
license to the SMART ABL 364 Antibody, an antibody previously humanized by PDL
for Novartis, and the related murine antibody, ABL 364, of Novartis. This
arrangement also included exclusive licenses to the Novartis trioma human
antibody technology and patents as well as the purchase of certain antibody
supplies and related manufacturing equipment. In consideration for the licenses
and assets transferred, PDL initially paid Novartis $5 million and agreed to
provide up to an additional $5 million in future milestone payments in the event
of certain product approvals under the agreements.

Under the terms of the Novartis agreements, PDL has the right to
manufacture and market the antibodies acquired from Novartis throughout the
world. Novartis retained certain co-promotion and co-marketing rights, and
rights to royalties on sales by PDL of licensed products in countries where
Novartis does not sell these antibodies with PDL under the co-promotion and
co-marketing arrangements. In November 1993, PDL paid Novartis an additional
$2.75 million to amend the April 1993 agreement relating to the human antibodies
in order to terminate certain of Novartis' co-promotion and co-marketing rights
in countries outside of the U.S., Canada and Asia and to reduce royalties
Novartis may earn from the sale of human antibody products in countries outside
of the U.S., Canada and Asia.

Mochida. In December 1995, PDL and Mochida Pharmaceutical Co., Ltd,
("Mochida") entered into a collaborative agreement providing for the
humanization by PDL of a murine antibody that has potential for treating certain
infectious diseases. To date, PDL has received a licensing and signing fee and
milestone payment and can earn a further milestone payment and royalties on
potential product sales of this compound by Mochida. In addition, PDL has an
option to co-promote the compound in North America.

Japanese Collaborator. In September 1996, PDL entered into a collaborative
agreement with another Japanese company providing for the humanization by PDL of
a murine antibody that has potential for treating cancer. PDL received a
licensing and signing fee and can earn milestone payments and royalties on
potential product sales of this compound by the Japanese company. PDL also has
an option to co-promote the compound in North America. The name of the Japanese
company has not been disclosed.

Sankyo. In December 1996, PDL entered into a patent license agreement with
Sankyo pursuant to which PDL granted a worldwide, nonexclusive license under its
humanized antibody patents to that company for an antibody to a specific target
antigen. PDL received a $1 million licensing and

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signing fee and will receive royalties on future product sales. The name of the
antibody target has not been disclosed.

Genetics Institute. In December 1996, PDL and Genetics Institute, Inc.
("Genetics Institute"), a wholly-owned subsidiary of American Home Products
Corporation, entered into a collaborative agreement pursuant to which PDL will
initially develop three humanized monoclonal antibodies based on murine
antibodies developed by Genetics Institute that modulate the immune
co-stimulatory pathway. In addition, Genetics Institute received a worldwide,
nonexclusive license for those antibodies under PDL's humanized antibody
patents. PDL received a $2.5 million licensing and signing fee and is entitled
to receive milestone payments and royalties on potential product sales. In
addition, PDL received an option to co-promote the products in North America
(U.S. and Canada). The agreement contemplates that PDL may collaborate with
Genetics Institute to humanize additional antibodies in the field.

For a discussion of certain risks related to the Company's collaborations,
see "Risk Factors."

Molecular Applications Group. PDL has licensed from Molecular Applications
Group exclusive rights to certain protein modeling software. PDL uses this
software in designing its SMART antibodies. PDL paid an initial license fee upon
execution of this license and is obligated to pay an additional fixed fee each
year, subject to certain adjustments.

Certain Patent Licenses. In July 1989, PDL obtained a nonexclusive license
under certain patents from the Medical Research Council of the United Kingdom
("MRC License") to an antibody "reshaping" process, which allows the exchange of
complementarity determining regions from different antibodies. PDL paid an
initial license fee upon execution of the MRC License and is obligated to pay
royalties on sales of products covered by the licensed patents. Each of PDL's
SMART antibody products may be within the scope of the MRC License. In addition,
the MRC License includes a sublicense to the Boss Patent held by Celltech
relating to PDL's current process for producing SMART antibodies. In October
1994, PDL obtained a non-exclusive license from Celltech to the Boss Patent
relating to PDL's current process for producing certain other PDL potential
products, including OST 577 and PROTOVIR.

MANUFACTURING

PDL currently leases approximately 45,000 square feet housing its
manufacturing facility in Plymouth, Minnesota. The Company intends to
manufacture the SMART M195 Antibody, PROTOVIR, if clinical trials warrant
continued development, and some of its other products in preclinical
development. PDL intends to continue to manufacture potential products for use
in preclinical studies and clinical trials using this manufacturing facility in
accordance with standard procedures that comply with cGMP and appropriate
regulatory standards. Roche is responsible for manufacturing Zenapax and
Boehringer Mannheim is responsible for manufacturing OST 577.

In order to obtain regulatory approvals and to expand its capacity to
produce its products for commercial sale at an acceptable cost, PDL will need to
improve and expand its existing manufacturing capabilities and demonstrate to
the FDA its ability to manufacture its products using controlled, reproducible
processes. Accordingly, the Company is evaluating plans to improve and expand
the capacity of its current facility. Such plans, if instituted, would result in
substantial costs to the Company and may require a suspension of manufacturing
operations during construction. See "Risk Factors."

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PATENTS AND PROPRIETARY TECHNOLOGY

The Company's success is significantly dependent on its ability to obtain
patent protection for its products and technologies and to preserve its trade
secrets and operate without infringing on the proprietary rights of third
parties. PDL files and prosecutes patent applications to protect its inventions.
No assurance can be given that the Company's pending patent applications will
result in the issuance of patents or that any patents will provide competitive
advantages or will not be invalidated or circumvented by its competitors.
Moreover, no assurance can be given that patents are not issued to, or patent
applications have not been filed by, other companies which would have an adverse
effect on the Company's ability to use, manufacture or market its products or
maintain its competitive position with respect to its products. Other companies
obtaining patents claiming products or processes useful to the Company may bring
infringement actions against the Company. As a result, the Company may be
required to obtain licenses from others or not be able to use, manufacture or
market its products. Such licenses may not be available on commercially
reasonable terms, if at all.

PDL has several patents and has exclusively licensed certain patents
regarding the trioma technique and related antibodies from Novartis. In
particular with respect to humanization technology, in June 1996, PDL was issued
a U.S. patent covering Zenapax and certain related antibodies against the IL-2
receptor. In addition, PDL is currently prosecuting other patent applications
with the U.S. Patent and Trademark Office ("PTO") and in other countries,
including members of the European Patent Convention, Canada, Japan and
Australia. The patent applications are directed to various aspects of PDL's
SMART and human antibodies, antibody technology and other programs, and include
claims relating to compositions of matter, methods of preparation and use of a
number of PDL's compounds. However, PDL does not know whether any pending
applications will result in the issuance of patents or whether such patents will
provide protection of commercial significance. Further, there can be no
assurance that PDL's patents will prevent others from developing competitive
products using related technology.

Patents in the U.S. are issued to the party that is first to invent the
claimed invention. Since patent applications in the U.S. are maintained in
secrecy until patents issue, PDL cannot be certain that it was the first
inventor of the invention covered by its pending patent applications or patents
or that it was the first to file patent applications for such inventions. The
patent positions of biotechnology firms generally are highly uncertain and
involve complex legal and factual questions. No consistent policy has emerged
regarding the breadth of claims in biotechnology patents, and patents of
biotechnology products are uncertain, so that even issued patents may later be
modified or revoked by the PTO or the courts. Moreover, the issuance of a patent
in one country does not assure the issuance of a patent with similar claims in
another country, and claim interpretation and infringement laws vary among
countries, so the extent of any patent protection may vary in different
territories.

In January and December 1996, PDL was issued patents by the European Patent
Office ("EPO") and PTO, respectively. PDL believes the patent claims cover
Zenapax and, based on its review of the scientific literature, most humanized
antibodies. The EPO patent applies in the United Kingdom, Germany, France, Italy
and eight other Western European countries. The EPO (but not PTO) procedures
provide for a nine-month opposition period in which other parties may submit
arguments as to why the patent was incorrectly granted and should be withdrawn
or limited. The entire opposition process, including appeals, may take several
years to complete, and during this

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lengthy process, the validity of the EPO patent will be at issue, which may
limit the Company's ability to negotiate or collect royalties or to negotiate
future collaborative research and development agreements based on this patent.
Eighteen notices of opposition to PDL's European patent were filed during the
opposition period, including oppositions by major pharmaceutical and
biotechnology companies, which cited references and made arguments not
considered by the EPO and PTO before grant of the respective patents. The
oppositions currently are being reviewed by the Company's patent counsel. PDL
intends to vigorously defend the European and, if necessary, the U.S. patent;
however there can be no assurance that the Company will prevail in the
opposition proceedings or any litigation contesting the validity or scope of
these patents. In addition, such proceedings or litigation, or any other
proceedings or litigation to protect the Company's intellectual property rights
or defend against infringement claims by others, could result in substantial
costs and a diversion of management's time and attention, which could have a
material adverse effect on the business and financial condition of the Company.

A number of companies, universities and research institutions have filed
patent applications or received patents in the areas of antibodies and other
fields relating to PDL's programs. Some of these applications or patents may be
competitive with PDL's applications or contain claims that conflict with those
made under PDL's patent applications or patents. Such conflict could prevent
issuance of patents to PDL, provoke an interference with PDL's patents or result
in a significant reduction in the scope or invalidation of PDL's patents, if
issued. An interference is an administrative proceeding conducted by the PTO to
determine the priority of invention and other matters relating to the decision
to grant patents. Moreover, if patents are held by or issued to other parties
that contain claims relating to PDL's products or processes, and such claims are
ultimately determined to be valid, no assurance can be given that PDL would be
able to obtain licenses to these patents at a reasonable cost, if at all, or to
develop or obtain alternative technology.

The Company is aware that Celltech Limited ("Celltech") has been granted a
patent by the EPO covering certain humanized antibodies, which PDL has opposed,
and Celltech has announced that it has received a notice of allowance of a
corresponding U.S. patent (the "U.S. Adair Patent") and expects the patent to
issue in early 1997. Because U.S. patent applications are maintained in secrecy,
PDL cannot review the scope of the claims in the U.S. Adair Patent. Accordingly,
there can be no assurance that such claims would not cover any of PDL's SMART
antibodies or be competitive with or conflict with claims in PDL's patents or
patent applications. If the U.S. Adair Patent issues and if it is determined to
be valid and to cover any of PDL's SMART antibodies, there can be no assurance
that PDL would be able to obtain a license on commercially reasonable terms, if
at all. If the claims of the U.S. Adair Patent conflict with claims in PDL's
patents or patent applications, there can be no assurance that an interference
would not be declared by the PTO, which could take several years to resolve and
could involve significant expense to the Company. Also, such conflict could
prevent issuance of patents to PDL relating to humanization of antibodies or
result in a significant reduction in the scope or invalidation of PDL's patents,
if issued. Moreover, uncertainty as to the validity or scope of patents issued
to PDL relating generally to humanization of antibodies may limit the Company's
ability to negotiate or collect royalties or to negotiate future collaborative
research and development agreements based on this patent.

PDL has obtained a nonexclusive license under a patent held by Celltech
(the "Boss Patent") relating to PDL's current process for producing SMART and
human antibodies. An interference proceeding was declared in early 1991 by the
PTO between the Boss Patent and a patent application filed by Genentech to which
PDL does not have a license. PDL is not a party to the

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interference proceeding, and the timing and outcome of the proceeding or the
scope of any patent that may be subsequently issued cannot be predicted. If the
Genentech patent application were held to have priority over the Boss Patent,
and if it were determined that PDL's processes and products were covered by a
patent issuing from such patent application, PDL may be required to obtain a
license under such patent or to significantly alter its processes or products.
There can be no assurance that PDL would be able to successfully alter its
processes or products to avoid infringing such patent or to obtain such a
license on commercially reasonable terms, if at all, and the failure to do so
could have a material adverse effect on PDL.

The Company is aware that Lonza Biologics, Inc. has a patent issued in
Europe to which PDL does not have a license (although Roche has advised the
Company that it has a license covering Zenapax), which may cover the process the
Company uses to produce its potential products. If it were determined that PDL's
processes were covered by such patent, PDL may be required to obtain a license
under such patent or to significantly alter its processes or products, if
necessary to manufacture or import its products in Europe. There can be no
assurance that PDL would be able to successfully alter its processes or products
to avoid infringing such patent or to obtain such a license on commercially
reasonable terms, if at all, and the failure to do so could have a material
adverse effect on the business and financial condition of the Company.

Also, Genentech has patents in the U.S. and Europe that relate to chimeric
antibodies. The European patent is currently in the opposition process. If
Genentech were to assert that the Company's SMART antibodies infringe these
patents, PDL may have to choose whether to seek a license or to challenge in
court the validity of such patents or Genentech's claim of infringement. There
can be no assurance that PDL would be successful in either obtaining such a
license on commercially reasonable terms, if at all, or that it would be
successful in such a challenge of the Genentech patents, and the failure to do
so would have a material adverse effect on the business and financial condition
of the Company.

In addition to seeking the protection of patents and licenses, PDL also
relies upon trade secrets, know-how and continuing technological innovation
which it seeks to protect, in part, by confidentiality agreements with employees
consultants, suppliers and licensees. There can be no assurance that these
agreements will not be breached, that PDL would have adequate remedies for any
breach or that PDL's trade secrets will not otherwise become known or
independently developed by competitors.

GOVERNMENT REGULATION

The manufacturing, testing and marketing of PDL's products are subject to
regulation by numerous governmental authorities in the U.S. and other countries
based upon their safety and efficacy. In the U.S., pharmaceutical (biologic)
products are subject to rigorous FDA regulation. The federal Food, Drug and
Cosmetic Act ("FD&C Act"), Public Health Service Act ("PHS Act") and other
federal, state and local regulations govern the manufacture, testing, labeling,
storage, record keeping, clinical and nonclinical studies to assess safety and
efficacy, approval, advertising and promotion of pharmaceutical products. The
process of developing and obtaining approval for a new pharmaceutical product
within this regulatory framework requires a number of years and the expenditure
of substantial resources. There can be no assurance that necessary approvals
will be obtained on a timely basis, if at all.

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In addition to the requirement for FDA approval of each pharmaceutical
product, each pharmaceutical product manufacturing facility must be registered
with, and approved by, the FDA. The manufacturing and quality control procedures
must conform to cGMP in order to receive FDA approval. Pharmaceutical product
manufacturing establishments are subject to inspections by the FDA and local
authorities as well as inspections by authorities of other countries. To supply
pharmaceutical products for use in the U.S., foreign manufacturing
establishments must comply with cGMP and are subject to periodic inspection by
the FDA or by corresponding regulatory agencies in such countries under
reciprocal agreements with the FDA. Moreover, pharmaceutical product
manufacturing facilities may also be regulated by state, local and other
authorities.

For marketing of pharmaceutical products outside the U.S., PDL is subject
to foreign regulatory requirements governing marketing approval, and FDA and
other U.S. export provisions should the pharmaceutical product be manufactured
in the U.S. Requirements relating to the manufacturing, conduct of clinical
trials, product licensing, promotion, pricing and reimbursement vary widely in
different countries. Difficulties or unanticipated costs or price controls may
be encountered by PDL or its licensees or its marketing partners in their
respective efforts to secure necessary governmental approvals to market the
potential pharmaceutical products, which could delay or preclude PDL or its
licensees or its marketing partners from marketing their potential
pharmaceutical products.

The basic steps required by the FDA before a new pharmaceutical product for
human use may be marketed in the U.S. include (i) preclinical laboratory and
animal tests, (ii) submission to the FDA of an application for an
Investigational New Drug ("IND") which must be reviewed by the FDA before
clinical trials may begin, (iii) completion of adequate and well-controlled
human clinical trials to establish the safety and efficacy of the pharmaceutical
product for its intended use, (iv) as of May 1996 for therapeutic monoclonal
antibodies, submission of a Biologics License Application ("BLA") to the FDA,
and (v) FDA approval of the BLA prior to any commercial sale or shipment of the
pharmaceutical product.

Preclinical tests for safety are conducted in the laboratory and in animals
in compliance with FDA good laboratory practices regulations and other
additional tests are conducted to assess the potential safety and biological
activity of the pharmaceutical product in order to support a sponsor's
contention that it is reasonably safe to conduct proposed clinical
investigations. The results of these studies are submitted to the FDA as part of
an IND. Testing in humans may begin 30 days after filing an IND unless the FDA
requests additional information or raises questions or concerns that must be
resolved before the FDA will permit the study to proceed. In such cases, there
can be no assurance that resolution will be achieved in a timely manner, if at
all.

Clinical trials are conducted in accordance with good clinical practices
based on regulations promulgated by the FDA and under protocols that include
detail on the objectives of the trial, the parameters to be used to monitor
safety, and the efficacy criteria to be evaluated. Each protocol must be
submitted to the FDA as part of an IND. Further, each clinical trial must be
reviewed and approved by an independent institutional review board ("IRB") at
each of the medical institutions at which the trial will be conducted. There can
be no assurance that submission of a protocol to an IRB or an IND to the FDA
will result in the initiation or completion of a clinical investigation.
Clinical trials are typically conducted in three sequential phases, although the
phases may overlap. In Phase I, the pharmaceutical product is typically tested
in a small number of healthy people or patients to initially determine safety,
dose tolerance (including side effects associated with increasing doses),
metabolism, distribution and excretion. Phase II usually involves studies in a

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limited patient population to obtain a preliminary determination of efficacy, to
identify an optimal dose and to further identify safety risks. Phase III trials
are larger, multi-center trials undertaken to provide further confirmation of
efficacy and provide additional safety information in a specific patient
population. The FDA reviews the results of the trials and may discontinue them
at any time for safety reasons or other reasons if they were deemed to be
non-compliant with FDA regulations. There can be no assurance that Phase I, II
or III clinical trials will be completed successfully within any specific time
period, if at all, with respect to any of the Company's or its collaborators'
pharmaceutical products, each of which is subject to such testing requirements.

Recently, the FDA has been engaged in regulatory reform efforts aimed at
reducing the regulatory burden on manufacturers of certain biotechnology
products. For example, in May 1996, the FDA issued regulations that eliminate
the previous requirement of a separate establishment license application, in
addition to the product license application, for certain categories of
biotechnology products, including the pharmaceutical products of the Company.
Furthermore, the FDA has announced its intention to adopt a single approval
application for all pharmaceutical products. There can be no assurance, however,
that implementation of these changes will benefit the Company or otherwise
reduce the regulatory requirements applicable to the Company or that these
changes will not result in the imposition of other, more burdensome obligations
on the Company in connection with regulatory review of the Company's products.
In any event, the results of the preclinical and clinical trials and a
description of the manufacturing process and tests to control the quality of the
pharmaceutical product must be submitted to the FDA in a BLA for approval. The
approval process is likely to require substantial time and resource commitment
by an applicant. Approval is influenced by a number of factors, including the
severity of the disease being treated, availability of alternative treatments,
and the risks and benefits of the proposed therapeutic as demonstrated in the
clinical trials. Additional data or clinical trials may be requested by the FDA
and may delay approval. There is no assurance that FDA approval will be granted
on a timely basis, if at all. After FDA approval for the initial indications and
dosage forms, further studies may be required by the FDA to gain approval for
labeling of the pharmaceutical product for other disease indications or dosage
forms, or to monitor for adverse effects. Both before and after approval is
obtained, a pharmaceutical product, its manufacturer and the holder of the BLA
for the pharmaceutical product are subject to comprehensive regulatory
oversight. The FDA may deny a BLA if applicable regulatory criteria are not
satisfied, require additional testing or information or require postmarketing
testing and surveillance to monitor the safety or efficacy of the pharmaceutical
product. Moreover, even if regulatory approval is granted, such approval may be
subject to limitations on the indicated uses for which the pharmaceutical
product may be marketed. Further, approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems with the pharmaceutical
product occur following approval. Among the conditions for BLA approval is the
requirement that the manufacturer of the pharmaceutical product comply with
cGMP. In addition, under a BLA, the manufacturer continues to be subject to
facility inspection and the applicant must assume responsibility for compliance
with applicable pharmaceutical product and establishment standards. Violations
of regulatory requirements at any stage may result in various adverse
consequences, including FDA refusal to accept a license application, total or
partial suspension of licensure, delay in approving or refusal to approve the
pharmaceutical product or pending marketing approval applications, warning
letters, fines, injunctions, withdrawal of the previously approved
pharmaceutical product or marketing approvals and/or the imposition of criminal
penalties against the manufacturer and/or BLA holders. In addition, later
discovery of previously unknown problems may result in new restrictions on such
pharmaceutical product, manufacturer and/or BLA holders, including withdrawal of
the pharmaceutical product or marketing approvals and pharmaceutical product
recalls or seizures.

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In addition to regulations enforced by the FDA, the Company is subject to
federal, state and local laws and regulations governing the use, generation,
manufacture, storage, discharge, handling and disposal of certain materials and
wastes used in its operations, some of which are classified as "hazardous."
There can be no assurance that the Company will not be required to incur
significant costs to comply with environmental laws, the Occupational Safety and
Health Act, and state, local and foreign counterparts to such laws, rules and
regulations as its manufacturing and research activities are increased or that
the operations, business and future profitability of the Company will not be
adversely affected by current or future laws, rules and regulations.

Although the Company believes that its safety processes and procedures and
its handling and disposing of materials and wastes comply with applicable laws,
rules and regulations, the risk of accidental contamination or injury from these
materials cannot be eliminated. In the event of such an accident, the Company
could be held liable for any damages that result and any such liability could
exceed the resources of the Company. In addition, the Company cannot predict the
extent of the adverse effect on its business or the financial and other costs
that might result from any new government requirements arising out of future
legislative, administrative or judicial actions. Compliance with such laws,
rules and regulations does not have, nor is such compliance presently expected
to have, a material adverse effect on its business. However, the Company cannot
predict the extent of the adverse effect on its business or the financial and
other costs that might result from any new government requirements arising out
of future legislative, administrative or judicial actions.

COMPETITION

The Company's potential products are intended to address a wide variety of
disease conditions, including autoimmune diseases, inflammatory conditions,
cancers and viral infections. Competition with respect to these disease
conditions is intense and is expected to increase. This competition involves,
among other things, successful research and development efforts, obtaining
appropriate regulatory approvals, establishing and defending intellectual
property rights, successful product manufacturing, marketing, distribution,
market and physician acceptance, patient compliance, price and potentially
securing eligibility for reimbursement or payment for the use of the Company's
product. The Company believes its most significant competitors may be fully
integrated pharmaceutical companies with substantial expertise in research and
development, manufacturing, testing, obtaining regulatory approvals, marketing
and securing eligibility for reimbursement or payment, and substantially greater
financial and other resources than the Company. Smaller companies also may prove
to be significant competitors, particularly through collaborative arrangements
with large pharmaceutical companies. Furthermore, academic institutions,
governmental agencies and other public and private research organizations
conduct research, seek patent protection, and establish collaborative
arrangements for product development, clinical development and marketing. These
companies and institutions also compete with the Company in recruiting and
retaining highly qualified personnel. The biotechnology and pharmaceutical
industries are subject to rapid and substantial technological change. The
Company's competitors may develop and introduce other technologies or approaches
to accomplishing the intended purposes of the Company's products which may
render the Company's technologies and products noncompetitive and obsolete.

In addition to currently marketed competitive drugs, the Company is aware
of potential products in research or development by its competitors that address
all of the diseases being

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targeted by the Company. These and other products may compete directly with the
potential products being developed by the Company. In this regard, the Company
is aware that potential competitors are developing antibodies or other compounds
for treating autoimmune diseases, inflammatory conditions, cancers and viral
infections. In particular, a number of other companies have developed and will
continue to develop human antibodies and humanized antibodies. In addition,
protein design is being actively pursued at a number of academic and commercial
organizations, and several companies have developed or may develop technologies
that can compete with the Company's SMART and human antibody technologies. There
can be no assurance that competitors will not succeed in more rapidly developing
and marketing technologies and products that are more effective than the
products being developed by the Company or that would render the Company's
products or technology obsolete or noncompetitive. Further, there can be no
assurance that the Company's collaborative partners will not independently
develop products competitive with those licensed to such partners by the
Company, thereby reducing the likelihood that the Company will receive revenues
under its agreements with such partners.

Any potential product that the Company succeeds in developing and for which
it gains regulatory approval must then compete for market acceptance and market
share. For certain of the Company's potential products, an important factor will
be the timing of market introduction of competitive products. Accordingly, the
relative speed with which the Company and competing companies can develop
products, complete the clinical testing and approval processes, and supply
commercial quantities of the products to the market is expected to be an
important determinant of market success. Other competitive factors include the
capabilities of the Company's collaborative partners, product efficacy and
safety, timing and scope of regulatory approval, product availability, marketing
and sales capabilities, reimbursement coverage, the amount of clinical benefit
of the Company's products relative to their cost, method of administration,
price and patent protection. There can be no assurance that the Company's
competitors will not develop more efficacious or more affordable products, or
achieve earlier product development completion, patent protection, regulatory
approval or product commercialization than the Company. The occurrence of any of
these events by the Company's competitors could have a material adverse effect
on the business and financial condition of the Company.

HUMAN RESOURCES

As of December 31, 1996, PDL had 208 full-time employees, of whom 25 hold
Ph.D. or M.D. degrees. Of the total, 72 employees were engaged in research and
development, 35 in quality assurance and compliance, 17 in clinical and
regulatory, 55 in manufacturing and 29 in general and administrative functions.
PDL's scientific staff members have diversified experience and expertise in
molecular and cell biology, biochemistry, virology, immunology, protein
chemistry, computational chemistry and computer modeling. PDL's success will
depend in large part on its ability to attract and retain skilled and
experienced employees. None of PDL's employees are covered by a collective
bargaining agreement, and PDL considers its relations with its employees to be
good.

ENVIRONMENT

PDL seeks to comply with environmental statutes and the regulations of
federal, state and local governmental agencies. PDL has put into place processes
and procedures and maintains records in order to monitor its environmental
compliance. PDL may invest additional resources, if required, to comply with
applicable regulations, and the cost of such compliance may increase
significantly.

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RISK FACTORS

This Annual Report contains forward-looking statements which involve risks
and uncertainties. The Company's actual results may differ significantly from
the results discussed in the forward-looking statements. Factors that might
cause such a difference include, but are not limited to those discussed in this
section as well as those discussed elsewhere in this document.

HISTORY OF LOSSES; FUTURE PROFITABILITY UNCERTAIN. The Company has a history
of operating losses and expects to incur substantial additional expenses with
resulting quarterly losses over at least the next several years as it continues
to develop its potential products and to devote significant resources to
preclinical studies, clinical trials, and manufacturing. As of December 31,
1996, the Company had accumulated net losses of approximately $35.5 million. To
date, the Company has not received regulatory approval to distribute any
products. The time and resource commitment required to achieve market success
for any individual product is extensive and uncertain and in some cases
controlled by the Company's collaborators. No assurance can be given that the
Company's, or any of its collaborative partners', product development efforts
will be successful, that required regulatory approvals can be obtained, that
potential products can be manufactured at an acceptable cost and with
appropriate quality, or that any approved products can be successfully marketed.

The Company has not generated any material revenues from product sales or
royalties from licenses to the Company's technology, and potential products that
may be marketed by the Company, if any, are not expected to be approved for
marketing for at least the next several years. The Company's revenues to date
have consisted, and for the near future are expected to consist, principally of
research and development funding, licensing and signing fees and milestone
payments from pharmaceutical companies under collaborative research and
development agreements. These revenues may vary considerably from quarter to
quarter and from year to year, and revenues in any period may not be predictive
of revenues in any subsequent period, and variations may be significant
depending on the terms of the particular agreements. In particular, revenues for
the fourth quarter of 1996, which included several non-recurring payments in
connection with new licensing agreements, may not be indicative of revenues in
future quarters. While the Company historically has received significant revenue
pursuant to certain of its collaborations, the Company has recognized
substantially all of the research and development and milestone revenue due
under these collaborations. Although the Company anticipates entering into new
collaborations from time to time, the Company presently does not anticipate
realizing non-royalty revenue from its new and proposed collaborations at levels
commensurate with the revenue historically recognized under its older
collaborations. Moreover, the Company anticipates that its operating expenses
will continue to increase significantly as the Company increases its research
and development, manufacturing, preclinical, clinical, administrative and patent
activities. Accordingly, in the absence of substantial revenues from new
corporate collaborations, royalties on Zenapax sales or other sources, the
Company expects to incur substantial and increased operating losses in the
foreseeable future as certain of its earlier stage potential products move into
later stage clinical development, as additional potential products are selected
as clinical candidates for further development, as the Company invests in
additional manufacturing facilities or capacity, as the Company defends or
prosecutes its patents and patent applications, and as the Company invests in
research or acquires additional technologies, product candidates or businesses.
The amount of net losses and the time required to reach sustained profitability
are highly uncertain. To achieve sustained profitable operations, the Company,
alone or with its collaborative partners, must

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successfully discover, develop, manufacture, obtain regulatory approvals for and
market its potential products. No assurances can be given that the Company will
be able to achieve or sustain profitability, and results are expected to
fluctuate from quarter to quarter.

UNCERTAINTY OF CLINICAL TRIAL RESULTS. Before obtaining regulatory approval
for the commercial sale of any of its potential products, the Company must
demonstrate through preclinical studies and clinical trials that the product is
safe and efficacious for use in the clinical indication for which approval is
sought. There can be no assurance that the Company will be permitted to
undertake or continue clinical trials for any of its potential products or, if
permitted, that such products will be demonstrated to be safe and efficacious.
Moreover, the results from preclinical studies and early clinical trials may not
be predictive of results that will be obtained in later-stage clinical trials.
Thus there can be no assurance that the Company's present or future clinical
trials will demonstrate the safety and efficacy of any potential products or
will result in approval to market products.

In advanced clinical development, numerous factors may be involved that may
lead to different results in larger, later-stage trials from those obtained in
earlier stage trials. For example, early stage trials usually involve a small
number of patients and thus may not accurately predict the actual results
regarding safety and efficacy that may be demonstrated with a large number of
patients in a later-stage trial. Also, differences in the clinical trial design
between an early-stage and late-stage trial may cause different results
regarding the safety and efficacy of a product to be obtained. In addition, many
early stage trials are unblinded and based on qualitative evaluations by
clinicians involved in the performance of the trial, whereas later stage trials
are generally required to be blinded in order to provide more objective data for
assessing the safety and efficacy of the product. The Company may at times elect
to aggressively enter potential products into Phase I/II trials to determine
preliminary efficacy in specific indications. In addition, in certain cases the
Company has commenced clinical trials without conducting preclinical animal
testing where an appropriate animal model does not exist. Similarly, the Company
or its partners at times will conduct potentially pivotal Phase II/III or Phase
III trials based on limited Phase I or Phase I/II data. As a result of these and
other factors, the Company anticipates that only some of its potential products
will show efficacy in clinical trials and that the number of products that fail
to show efficacy may be significant.

The Company is conducting a Phase II trial evaluating PROTOVIR for the
prevention of CMV infections in bone marrow transplant recipients based on very
limited and inconclusive data from Phase I trials primarily designed to obtain
safety data. Thus, there can be no assurance that the results of this trial will
be favorable.

The Company and a number of other companies in the biotechnology industry
have suffered significant setbacks in advanced clinical trials, even after
promising results in earlier-stage trials. For example, in June 1995, Roche
Holding Ltd and its subsidiary Hoffmann-La Roche Inc. ("Roche") and the Company
announced the results of a Phase II/III clinical trial using the Company's SMART
Anti-Tac Antibody, Zenapax, for the prevention of graft-versus-host disease
("GvHD"). The analysis of this data led Roche to conclude that Zenapax was not
effective in reducing the incidence of GvHD in the patient population studied.
In addition, in August 1996, the Company announced the halt of a Phase II/III
clinical trial using PROTOVIR for treatment of CMV retinitis in AIDS patients
conducted by the National Eye Institute ("NEI SOCA") due to lack of evidence of
efficacy. Based on the findings and actions in the above study, enrollment in a
Phase II clinical trial for treatment of CMV retinitis in AIDS patients
conducted by the National Institute

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of Allergy and Infectious Disease ("NIAID ACTG") had been suspended, and the
trial was recently terminated.

DEPENDENCE ON COLLABORATIVE PARTNERS. The Company has collaborative
agreements with several pharmaceutical companies to develop, manufacture and
market certain potential products, which include the most advanced products
under development by the Company. The Company granted to its collaborative
partners certain exclusive rights to commercialize the products covered by these
collaborative agreements. In some cases, the Company is relying on its
collaborative partners to conduct clinical trials, to compile and analyze the
data received from such trials, to obtain regulatory approvals and, if approved,
to manufacture and market these licensed products, including Zenapax and the
Company's Human Anti-Hepatitis B Virus Antibody (OST 577). As a result, the
Company often has little or no control over the development of these potential
products and little or no opportunity to review clinical data prior to or
following public announcement.

The Company's collaborative research agreements are generally terminable by
its partners on short notice. Suspension or termination of certain of the
Company's current collaborative research agreements could have a material
adverse effect on the Company's operations and could significantly delay the
development of the affected products. Continued funding and participation by
collaborative partners will depend not only on the timely achievement of
research and development objectives by the Company and the successful
achievement of clinical trial goals, neither of which can be assured, but also
on each collaborative partner's own financial, competitive, marketing and
strategic considerations. Such considerations include, among other things, the
commitment of management of the collaborative partners to the continued
development of the licensed products, the relationships among the individuals
responsible for the implementation and maintenance of the collaborative efforts,
the relative advantages of alternative products being marketed or developed by
the collaborators or by others, including their relative patent and proprietary
technology positions, and their ability to manufacture potential products
successfully. In this regard, the Company has, at times, experienced difficulty
in its continuing relationship with Boehringer Mannheim GmbH ("Boehringer
Mannheim") due to a number of factors, including disagreements regarding the
timing of the initiation and design of certain proposed clinical trials
involving the development of certain products licensed to Boehringer Mannheim,
particularly OST 577.

In addition, certain collaborative partners have developed and may be
developing competitive products that may result in delay or a relatively smaller
resource commitment to product launch and support efforts than might otherwise
be obtained if the potentially competitive product were not under development or
being marketed. For example, Roche controls the development of Zenapax, the most
advanced of the Company's products in development, and the Company is dependent
upon the resources and activities of Roche to pursue commercialization of
Zenapax in order for the Company to achieve milestones or royalties from the
development of this product. There can be no assurance that Roche will proceed
to bring this product to market in a rapid and timely manner, if at all, or if
marketed, that other independently developed products of Roche (including its
recently introduced product CellCept) or others will not compete with or prevent
Zenapax from achieving meaningful sales. Also Roche has stated that it plans to
conduct or support other clinical trials of Zenapax in autoimmune indications.
There can be no assurance that Roche will continue or pursue additional clinical
trials in these indications or that, even if the additional clinical trials are
completed, Zenapax will be shown to be safe and efficacious, or that the trials
will result in approval to market Zenapax in these indications. Any adverse
event or

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announcement related to Zenapax would have a material adverse effect on the
business and financial condition of the Company.

Further, because the Company expects, in some cases, to rely on its
contractual rights to access data collected by its collaborative partners in
various phases of its clinical development efforts, the Company is dependent on
the continued satisfaction by such parties of their contractual obligations to
provide such access and cooperate with the Company in the preparation and
submission of appropriate filings with the FDA and equivalent foreign government
regulatory agencies. The Company currently relies on Boehringer Mannheim for the
manufacturing and clinical development of OST 577. Boehringer Mannheim has
marketing rights to this antibody in countries outside of North America. There
can be no assurance that Boehringer Mannheim will provide timely access to the
manufacturing and clinical data, that the U.S. Food and Drug Administration
("FDA") will permit the Company to rely on that data or that the trials
conducted by Boehringer Mannheim will produce data appropriate for approval by
the FDA. If the Company were unable to rely on the clinical data collected by
Boehringer Mannheim or its other collaborative partners, the Company may be
required to repeat clinical trials or perform supplemental clinical trials in
order to achieve regulatory approval in North America. Compliance with these
requirements could significantly delay commercialization efforts and require
substantially greater investment by the Company, either of which would have a
material adverse effect on the business and financial condition of the Company.

The Company's ability to enter into new collaborations and the willingness
of the Company's existing collaborators to continue development of the Company's
potential products is dependent upon, among other things, the Company's patent
position with respect to such products. In this regard, the Company recently was
issued patents by the U.S. Patent and Trademark Office ("PTO") and European
Patent Office ("EPO") with claims that the Company believes, based on its survey
of the scientific literature, cover most humanized antibodies. Eighteen notices
of opposition to the European patent have been filed with the EPO, and either or
both patents may be further challenged through administrative or judicial
proceedings. The Company has applied for similar patents in Japan and other
countries. The Company recently entered into several new collaborations related
to the humanization of certain antibodies whereby it granted nonexclusive
licenses to its patent rights relating to such antibodies, and the Company
anticipates entering into additional collaborations partially as a result of the
Company's patent and patent applications with respect to humanized antibodies.
As a result, the inability of the Company to successfully defend the opposition
proceeding before the EPO or, if necessary, to defend patents granted by the PTO
or EPO or to successfully prosecute the corresponding patent applications in
Japan or other countries could adversely affect the ability of the Company to
enter into additional collaborations and could therefore have a material adverse
effect on the Company's business or financial condition.

LIMITED EXPERIENCE WITH CLINICAL TRIALS; RISK OF DELAY. The Company has
conducted only a limited number of clinical trials to date. There can be no
assurance that the Company will be able to successfully commence and complete
all of its planned clinical trials without significant additional resources and
expertise. In addition, there can be no assurance that the Company will meet its
contemplated development schedule for any of its potential products. The
inability of the Company or its collaborative partners to commence or continue
clinical trials as currently planned, to complete the clinical trials on a
timely basis or to demonstrate the safety and efficacy of its potential
products, would have a material adverse effect on the business and financial
condition of the Company.

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The rate of completion of the Company's or its collaborators' clinical
trials is significantly dependent upon, among other factors, the rate of patient
enrollment. Patient enrollment is a function of many factors, including, among
others, the size of the patient population, perceived risks and benefits of the
drug under study, availability of competing therapies, access to reimbursement
from insurance companies or government sources, design of the protocol,
proximity of and access by patients to clinical sites, patient referral
practices, eligibility criteria for the study in question and efforts of the
sponsor of and clinical sites involved in the trial to facilitate timely
enrollment in the trial. Delays in the planned rate of patient enrollment may
result in increased costs and expenses in completion of the trial or may require
the Company to undertake additional studies in order to obtain regulatory
approval if the applicable standard of care changes in the therapeutic
indication under study. For example, patient accrual in the Company's ongoing
Phase II/III trial of the SMART M195 Antibody in myeloid leukemia has been
negatively affected by changes in referral patterns, with such patients now more
commonly being treated in local hospitals rather than being referred to tertiary
care hospitals where the Company's trial is being conducted. There can be no
assurance that any actions by the Company to accelerate accrual in this trial
will be successful or, to the extent that they involve modifications in the
design of the trial, will not cause that trial to be considered a Phase II
clinical trial and thereby require one or more additional potentially pivotal
trials to be conducted.

UNCERTAINTY OF PATENTS AND PROPRIETARY TECHNOLOGY; OPPOSITION PROCEEDINGS.
The Company's success is significantly dependent on its ability to obtain patent
protection for its products and technologies and to preserve its trade secrets
and operate without infringing on the proprietary rights of third parties. PDL
files and prosecutes patent applications to protect its inventions. No assurance
can be given that the Company's pending patent applications will result in the
issuance of patents or that any patents will provide competitive advantages or
will not be invalidated or circumvented by its competitors. Moreover, no
assurance can be given that patents are not issued to, or patent applications
have not been filed by, other companies which would have an adverse effect on
the Company's ability to use, manufacture or market its products or maintain its
competitive position with respect to its products. Other companies obtaining
patents claiming products or processes useful to the Company may bring
infringement actions against the Company. As a result, the Company may be
required to obtain licenses from others or not be able to use, manufacture or
market its products. Such licenses may not be available on commercially
reasonable terms, if at all.

Patents in the U.S. are issued to the party that is first to invent the
claimed invention. Since patent applications in the U.S. are maintained in
secrecy until patents issue, PDL cannot be certain that it was the first
inventor of the inventions covered by its pending patent applications or that it
was the first to file patent applications for such inventions. The patent
positions of biotechnology firms generally are highly uncertain and involve
complex legal and factual questions. No consistent policy has emerged regarding
the breadth of claims in biotechnology patents, and patents of biotechnology
products are uncertain so that even issued patents may later be modified or
revoked by the PTO or the courts in proceedings instituted by third parties.
Moreover, the issuance of a patent in one country does not assure the issuance
of a patent with similar claims in another country and claim interpretation and
infringement laws vary among countries, so the extent of any patent protection
may vary in different territories.

PDL has several patents and has exclusively licensed certain patents from
Novartis Pharmaceuticals Corporation ("Novartis") (formerly known as Sandoz
Pharmaceuticals Corporation). In particular with respect to humanization
technology, in June 1996, PDL was

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issued a U.S. patent covering Zenapax and certain related antibodies against
the IL-2 receptor. In addition, PDL is currently prosecuting other patent
applications with the PTO and in other countries, including members of the
European Patent Convention, Canada, Japan and Australia. The patent applications
are directed to various aspects of PDL's SMART and human antibodies, antibody
technology and other programs, and include claims relating to compositions of
matter, methods of preparation and use of a number of PDL's compounds. However,
PDL does not know whether any pending applications will result in the issuance
of patents or whether such patents will provide protection of commercial
significance. Further, there can be no assurance that PDL's patents will prevent
others from developing competitive products using related technology.

In January and December 1996, PDL was issued patents by the EPO and PTO,
respectively. PDL believes the patent claims cover Zenapax and, based on its
review of the scientific literature, most humanized antibodies. The EPO (but not
PTO) procedures provide for a nine-month opposition period in which other
parties may submit arguments as to why the patent was incorrectly granted and
should be withdrawn or limited. The entire opposition process, including
appeals, may take several years to complete, and during this lengthy process,
the validity of the EPO patent will be at issue, which may limit the Company's
ability to negotiate or collect royalties or to negotiate future collaborative
research and development agreements based on this patent. Eighteen notices of
opposition to PDL's European patent were filed during the opposition period,
including oppositions by major pharmaceutical and biotechnology companies, which
cited references and made arguments not considered by the EPO and PTO before
grant of the respective patents. The oppositions currently are being reviewed by
the Company's patent counsel. PDL intends to vigorously defend the European and,
if necessary, the U.S. patent; however, there can be no assurance that the
Company will prevail in the opposition proceedings or any litigation contesting
the validity or scope of these patents. In addition, such proceedings or
litigation, or any other proceedings or litigation to protect the Company's
intellectual property rights or defend against infringement claims by others,
could result in substantial costs and a diversion of management's time and
attention, which could have a material adverse effect on the business and
financial condition of the Company.

A number of companies, universities and research institutions have filed
patent applications or received patents in the areas of antibodies and other
fields relating to PDL's programs. Some of these applications or patents may be
competitive with PDL's applications or contain claims that conflict with those
made under PDL's patent applications or patents. Such conflict could prevent
issuance of patents to PDL, provoke an interference with PDL's patents or result
in a significant reduction in the scope or invalidation of PDL's patents, if
issued. An interference is an administrative proceeding conducted by the PTO to
determine the priority of invention and other matters relating to the decision
to grant patents. Moreover, if patents are held by or issued to other parties
that contain claims relating to PDL's products or processes, and such claims are
ultimately determined to be valid, no assurance can be given that PDL would be
able to obtain licenses to these patents at a reasonable cost, if at all, or to
develop or obtain alternative technology.

The Company is aware that Celltech Limited ("Celltech") has been granted a
patent by the EPO covering certain humanized antibodies, which PDL has opposed,
and Celltech has announced that it has received a notice of allowance of a
corresponding U.S. patent (the "U.S. Adair Patent") and expects the patent to
issue in early 1997. Because U.S. patent applications are maintained in secrecy,
PDL cannot review the scope of the claims in the U.S. Adair Patent. Accordingly,
there can be no assurance that such claims would not cover any of PDL's SMART
antibodies or be competitive with or conflict with claims in PDL's patents or
patent applications. If the U.S. Adair

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Patent issues and if it is determined to be valid and to cover any of PDL's
SMART antibodies, there can be no assurance that PDL would be able to obtain a
license on commercially reasonable terms, if at all. If the claims of the U.S.
Adair Patent conflict with claims in PDL's patents or patent applications, there
can be no assurance that an interference would not be declared by the PTO, which
could take several years to resolve and could involve significant expense to the
Company. Also, such conflict could prevent issuance of patents to PDL relating
to humanization of antibodies or result in a significant reduction in the scope
or invalidation of PDL's patents, if issued. Moreover, uncertainty as to the
validity or scope of patents issued to PDL relating generally to humanization of
antibodies may limit the Company's ability to negotiate or collect royalties or
to negotiate future collaborative research and development agreements based on
these patents.

PDL has obtained a nonexclusive license under a patent held by Celltech
(the "Boss Patent") relating to PDL's current process for producing SMART and
human antibodies. An interference proceeding was declared in early 1991 by the
PTO between the Boss Patent and a patent application filed by Genentech, Inc.
("Genentech") to which PDL does not have a license. PDL is not a party to this
proceeding, and the timing and outcome of the proceeding or the scope of any
patent that may be subsequently issued cannot be predicted. If the Genentech
patent application were held to have priority over the Boss Patent, and if it
were determined that PDL's processes and products were covered by a patent
issuing from such patent application, PDL may be required to obtain a license
under such patent or to significantly alter its processes or products. There can
be no assurance that PDL would be able to successfully alter its processes or
products to avoid infringing such patent or to obtain such a license on
commercially reasonable terms, if at all, and the failure to do so could have a
material adverse effect on PDL.

The Company is aware that Lonza Biologics, Inc. has a patent issued in
Europe to which PDL does not have a license (although Roche has advised the
Company that it has a license covering Zenapax), which may cover the process the
Company uses to produce its potential products. If it were determined that PDL's
processes were covered by such patent, PDL may be required to obtain a license
under such patent or to significantly alter its processes or products, if
necessary to manufacture or import its products in Europe. There can be no
assurance that PDL would be able to successfully alter its processes or products
to avoid infringing such patent or to obtain such a license on commercially
reasonable terms, if at all, and the failure to do so could have a material
adverse effect on the business and financial condition of the Company.

Also, Genentech has patents in the U.S. and Europe that relate to chimeric
antibodies. The European patent is currently in the opposition process. If
Genentech were to assert that the Company's SMART antibodies infringe these
patents, PDL may have to choose whether to seek a license or to challenge in
court the validity of such patents or Genentech's claim of infringement. There
can be no assurance that PDL would be successful in either obtaining such a
license on commercially reasonable terms, if at all, or that it would be
successful in such a challenge of the Genentech patents, and the failure to do
so would have a material adverse effect on the business and financial condition
of the Company.

In addition to seeking the protection of patents and licenses, PDL also
relies upon trade secrets, know-how and continuing technological innovation
which it seeks to protect, in part, by confidentiality agreements with
employees, consultants, suppliers and licensees. There can be no assurance that
these agreements will not be breached, that PDL would have adequate remedies
for

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31
any breach or that PDL's trade secrets will not otherwise become known or
independently developed by competitors.

ABSENCE OF MANUFACTURING EXPERIENCE; DEPENDENCE ON MANUFACTURING BY
BOEHRINGER MANNHEIM. Of the products developed by the Company which are
currently in clinical development, Roche is responsible for manufacturing
Zenapax and Boehringer Mannheim is responsible for manufacturing OST 577. The
Company intends to manufacture the SMART M195 Antibody, PROTOVIR and some of its
other products in preclinical development. PDL currently leases approximately
45,000 square feet housing its manufacturing facility in Plymouth, Minnesota.
PDL intends to continue to manufacture potential products for use in preclinical
and clinical trials using this manufacturing facility in accordance with
standard procedures that comply with current Good Manufacturing Practices
("cGMP") and appropriate regulatory standards. The manufacture of sufficient
quantities of antibody products in accordance with such standards is an
expensive, time-consuming and complex process and is subject to a number of
risks that could result in delays. For example, PDL has experienced some
difficulties in the past in manufacturing certain potential products on a
consistent basis. Production interruptions, if they occur, could significantly
delay clinical development of potential products, reduce third party or clinical
researcher interest and support of proposed clinical trials, and possibly delay
commercialization of such products and impair their competitive position, which
would have a material adverse effect on the business and financial condition of
the Company.

PDL has no experience in manufacturing commercial quantities of its
potential products and currently does not have sufficient capacity to
manufacture its potential products on a commercial scale. In order to obtain
regulatory approvals and to expand its capacity to produce its products for
commercial sale at an acceptable cost, PDL will need to improve and expand its
existing manufacturing capabilities, including demonstration to the FDA of its
ability to manufacture its products using controlled, reproducible processes.
Accordingly, the Company is evaluating plans to improve and expand the capacity
of its current manufacturing facility. Such plans, if instituted, would result
in substantial costs to the Company and may require a suspension of
manufacturing operations during construction. There can be no assurance that
construction delays would not occur, and any such delays could impair the
Company's ability to produce adequate supplies of its potential products for
clinical use or commercial sale on a timely basis. There can be no assurance
that PDL will successfully improve and expand its manufacturing capability
sufficiently to obtain necessary regulatory approvals and to produce adequate
commercial supplies of its potential products on a timely basis. Failure to do
so could delay commercialization of such products and impair their competitive
position, which could have a material adverse effect on the business or
financial condition of the Company.

In addition, PDL and Boehringer Mannheim have agreed to negotiate
additional agreements under which each company could manufacture and supply the
other with certain of the antibodies covered by the agreement. There can be no
assurance that the parties will enter into an agreement that will provide for
the Company's potential product requirements to be met in a consistent, timely
and cost effective manner. Specifically, with respect to OST 577, the Company
currently does not manufacture this product and has no alternative manufacturing
sources for this product. In the event that Boehringer Mannheim and the Company
are unable to reach an acceptable agreement, or if material is not supplied in
accordance with such an agreement, there can be no assurance that the Company
could make alternative manufacturing arrangements on a timely basis, if at all,
and the inability to do so could have a material adverse effect on the business
and financial condition of the Company.

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UNCERTAINTIES RESULTING FROM MANUFACTURING CHANGES. Manufacturing of
antibodies for use as therapeutics in compliance with regulatory requirements is
complex, time-consuming and expensive. When certain changes are made in the
manufacturing process, it is necessary to demonstrate to the FDA that the
changes have not caused the resulting drug material to differ significantly from
the drug material previously produced, if results of prior preclinical studies
and clinical trials performed using the previously produced drug material are to
be relied upon in regulatory filings. Such changes could include, for example,
changing the cell line used to produce the antibody, changing the fermentation
or purification process or moving the production process to a new manufacturing
plant. Depending upon the type and degree of differences between the newer and
older drug material, various studies could be required to demonstrate that the
newly produced drug material is sufficiently similar to the previously produced
drug material, possibly requiring additional animal studies or human clinical
trials. Manufacturing changes have been made or are likely to be made for the
production of PDL's products currently in clinical development. There can be no
assurance that such changes will not result in delays in development or
regulatory approvals or, if occurring after regulatory approval, in reduction or
interruption of commercial sales. Such delays could have an adverse effect on
the competitive position of those products and could have a material adverse
effect on the business and financial condition of the Company.

Roche has equipped a manufacturing facility that is expected to be used to
produce Zenapax. Phase III trials of Zenapax in kidney transplantation were
conducted using material produced for Roche by a third party contract
manufacturer at a different facility using a different cell line and a different
manufacturing process. Roche has produced Zenapax at its facility using the new
cell line and process and has produced data indicating that the newly produced
material is substantially similar to the material used in the Phase III clinical
trials. However, there can be no assurance that changes in the manufacturing
site or any other manufacturing changes by Roche will not cause delays in the
development or commercialization of Zenapax. Such delays could have an adverse
effect on the competitive position of Zenapax and could have a material adverse
effect on the business and financial condition of the Company.

In addition, with respect to two of the antibodies in clinical development
licensed from Novartis, PROTOVIR and OST 577, the cell lines developed by PDL
for both antibodies and the production processes developed by PDL for PROTOVIR
and Boehringer Mannheim for OST 577 are different from those utilized by
Novartis for the manufacture of the antibody supplies used in earlier clinical
trials. There can be no assurance that this new material, when used in humans,
will have the same characteristics or produce results similar to the antibody
material originally developed and used by Novartis in earlier clinical trials.
Accordingly, Boehringer Mannheim or the Company may be required to conduct
additional laboratory or clinical testing, which could result in significant
delays and/or additional expenses and could have a material adverse effect on
the competitive position of these potential products and on the business and
financial condition of the Company.

DEPENDENCE ON SUPPLIERS. The Company is dependent on outside vendors for
the supply of raw materials used to produce its product candidates. The Company
currently qualifies only one or a few vendors for its source of certain raw
materials. Therefore, once a supplier's materials have been selected for use in
the Company's manufacturing process, the supplier in effect becomes a sole or
limited source of such raw materials to the Company due to the extensive
regulatory compliance procedures governing changes in manufacturing processes.
Although the Company

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believes it could qualify alternative suppliers, there can be no assurance that
the Company would not experience a disruption in manufacturing if it experienced
a disruption in supply from any of these sources. Any significant interruption
in the supply of any of the raw materials currently obtained from such sources,
or the time and expense necessary to transition a replacement supplier's product
into the Company's manufacturing process, could disrupt its operations and have
a material adverse effect on the business and financial condition of the
Company. A problem or suspected problem with the quality of raw materials
supplied could result in a suspension of clinical trials, notification of
patients treated with products or product candidates produced using such
materials, potential product liability claims, a recall of products or product
candidates produced using such materials, and an interruption of supplies, any
of which could have a material adverse effect on the business or financial
condition of the Company.

COMPETITION; RAPID TECHNOLOGICAL CHANGE. The Company's potential products
are intended to address a wide variety of disease conditions, including
autoimmune diseases, inflammatory conditions, cancers and viral infections.
Competition with respect to these disease conditions is intense and is expected
to increase. This competition involves, among other things, successful research
and development efforts, obtaining appropriate regulatory approvals,
establishing and defending intellectual property rights, successful product
manufacturing, marketing, distribution, market and physician acceptance, patient
compliance, price and potentially securing eligibility for reimbursement or
payment for the use of the Company's product. The Company believes its most
significant competitors may be fully integrated pharmaceutical companies with
substantial expertise in research and development, manufacturing, testing,
obtaining regulatory approvals, marketing and securing eligibility for
reimbursement or payment, and substantially greater financial and other
resources than the Company. Smaller companies also may prove to be significant
competitors, particularly through collaborative arrangements with large
pharmaceutical companies. Furthermore, academic institutions, governmental
agencies and other public and private research organizations conduct research,
seek patent protection, and establish collaborative arrangements for product
development, clinical development and marketing. These companies and
institutions also compete with the Company in recruiting and retaining highly
qualified personnel. The biotechnology and pharmaceutical industries are subject
to rapid and substantial technological change. The Company's competitors may
develop and introduce other technologies or approaches to accomplishing the
intended purposes of the Company's products which may render the Company's
technologies and products noncompetitive and obsolete.

In addition to currently marketed competitive drugs, the Company is aware
of potential products in research or development by its competitors that address
all of the diseases being targeted by the Company. These and other products may
compete directly with the potential products being developed by the Company. In
this regard, the Company is aware that potential competitors are developing
antibodies or other compounds for treating autoimmune diseases, inflammatory
conditions, cancers and viral infections. In particular, a number of other
companies have developed and will continue to develop human anti-viral
antibodies and humanized antibodies. In addition, protein design is being
actively pursued at a number of academic and commercial organizations, and
several companies have developed or may develop technologies that can compete
with the Company's SMART and human antibody technologies. There can be no
assurance that competitors will not succeed in more rapidly developing and
marketing technologies and products that are more effective than the products
being developed by the Company or that would render the Company's products or
technology obsolete or noncompetitive. Further, there can be no assurance that
the Company's collaborative partners will not independently develop products

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34

competitive with those licensed to such partners by the Company, thereby
reducing the likelihood that the Company will receive revenues under its
agreements with such partners.

Any potential product that the Company succeeds in developing and for which
it gains regulatory approval must then compete for market acceptance and market
share. For certain of the Company's potential products, an important factor will
be the timing of market introduction of competitive products. Accordingly, the
relative speed with which the Company and competing companies can develop
products, complete the clinical testing and approval processes, and supply
commercial quantities of the products to the market is expected to be an
important determinant of market success. Other competitive factors include the
capabilities of the Company's collaborative partners, product efficacy and
safety, timing and scope of regulatory approval, product availability, marketing
and sales capabilities, reimbursement coverage, the amount of clinical benefit
of the Company's products relative to their cost, method of administration,
price and patent protection. There can be no assurance that the Company's
competitors will not develop more efficacious or more affordable products, or
achieve earlier product development completion, patent protection, regulatory
approval or product commercialization than the Company. The occurrence of any of
these events by the Company's competitors could have a material adverse effect
on the business and financial condition of the Company.

NO ASSURANCE OF REGULATORY APPROVAL; GOVERNMENT REGULATION. The
manufacturing, testing and marketing of PDL's products are subject to regulation
by numerous governmental authorities in the U.S. and other countries based upon
their safety and efficacy. In the U.S., pharmaceutical products are subject to
rigorous FDA regulation. The federal Food, Drug and Cosmetic Act ("FD&C Act"),
Public Health Service Act ("PHS Act") and other federal, state and local
regulations govern the manufacture, testing, labeling, storage, record keeping,
clinical and nonclinical studies to assess safety and efficacy, approval,
advertising and promotion of pharmaceutical products. The process of developing
and obtaining approval for a new pharmaceutical product within this regulatory
framework requires a number of years and the expenditure of substantial
resources. There can be no assurance that necessary approvals will be obtained
on a timely basis, if at all.

In addition to the requirement for FDA approval of each pharmaceutical
product, each pharmaceutical product manufacturing facility must be registered
with, and approved by, the FDA. The manufacturing and quality control procedures
must conform to cGMP in order to receive FDA approval. Pharmaceutical product
manufacturing establishments are subject to inspections by the FDA and local
authorities as well as inspections by authorities of other countries. To supply
pharmaceutical products for use in the U.S., foreign manufacturing
establishments must comply with cGMP and are subject to periodic inspection by
the FDA or by corresponding regulatory agencies in such countries under
reciprocal agreements with the FDA. Moreover, pharmaceutical product
manufacturing facilities may also be regulated by state, local and other
authorities.

For marketing of pharmaceutical products outside the U.S., PDL is subject
to foreign regulatory requirements governing marketing approval, and FDA and
other U.S. export provisions should the pharmaceutical product be manufactured
in the U.S. Requirements relating to the manufacturing, conduct of clinical
trials, product licensing, promotion, pricing and reimbursement vary widely in
different countries. Difficulties or unanticipated costs or price controls may
be encountered by PDL or its licensees or marketing partners in their respective
efforts to secure necessary governmental approvals to market the potential
pharmaceutical products, which could

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35

delay or preclude PDL or its licensees or its marketing partners from marketing
their potential pharmaceutical products.

The basic steps required by the FDA before a new pharmaceutical product for
human use may be marketed in the U.S. include (i) preclinical laboratory and
animal tests, (ii) submission to the FDA of an application for an
Investigational New Drug ("IND") which must be reviewed by the FDA before
clinical trials may begin, (iii) completion of adequate and well-controlled
human clinical trials to establish the safety and efficacy of the pharmaceutical
product for its intended use, (iv) as of May 1996 for therapeutic monoclonal
antibodies, submission of a Biologics License Application ("BLA") to the FDA,
and (v) FDA approval of the BLA prior to any commercial sale or shipment of the
pharmaceutical product.

The FDA reviews the results of the trials and may discontinue them at any
time for safety reasons or other reasons if they were deemed to be non-compliant
with FDA regulations. There can be no assurance that Phase I, II or III clinical
trials will be completed successfully within any specific time period, if at
all, with respect to any of the Company's or its collaborators' pharmaceutical
products, each of which is subject to such testing requirements.

Both before and after approval is obtained, a pharmaceutical product, its
manufacturer and the holder of the BLA for the pharmaceutical product are
subject to comprehensive regulatory oversight. The FDA may deny a BLA if
applicable regulatory criteria are not satisfied, require additional testing or
information or require postmarketing testing and surveillance to monitor the
safety or efficacy of the pharmaceutical product. Moreover, even if regulatory
approval is granted, such approval may be subject to limitations on the
indicated uses for which the pharmaceutical product may be marketed. Further,
approvals may be withdrawn if compliance with regulatory standards is not
maintained or if problems with the pharmaceutical product occur following
approval. Among the conditions for BLA approval is the requirement that the
manufacturer of the pharmaceutical product comply with cGMP. In addition, under
a BLA, the manufacturer continues to be subject to facility inspection and the
applicant must assume responsibility for compliance with applicable
pharmaceutical product and establishment standards. Violations of regulatory
requirements at any stage may result in various adverse consequences, including
FDA refusal to accept a license application, total or partial suspension of
licensure, delay in approving or refusal to approve the pharmaceutical product
or pending marketing approval applications, warning letters, fines, injunctions,
withdrawal of the previously approved pharmaceutical product or marketing
approvals and/or the imposition of criminal penalties against the manufacturer
and/or BLA holders. In addition, later discovery of previously unknown problems
may result in new restrictions on such pharmaceutical product, manufacturer
and/or BLA holders, including withdrawal of the pharmaceutical product or
marketing approvals and pharmaceutical product recalls or seizures.

LIMITED SALES AND MARKETING EXPERIENCE. The Company intends to market and
sell certain of its products, if successfully developed and approved, through a
direct sales force in the U.S. and through sales and marketing partnership
arrangements outside the U.S. However, PDL does not expect to establish a direct
sales capability for at least the next few years. The Company has no history or
experience in sales, marketing or distribution. To market its products directly,
the Company must either establish a marketing group and direct sales force or
obtain the assistance of another company. There can be no assurance that the
Company will be able to establish sales and distribution capabilities or succeed
in gaining market acceptance for its products. If the Company enters into
co-promotion or other marketing or licensing arrangements with established

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36

pharmaceutical companies, the Company's revenues will be subject to the payment
provisions of such arrangements and dependent on the efforts of third parties.
There can be no assurance that the Company will be able to successfully
establish a direct sales force or that its collaborators will effectively market
any of the Company's potential products, and the inability of the Company or its
collaborators to do so could have a material adverse effect on the business and
financial condition of the Company.

DEPENDENCE ON KEY PERSONNEL. The Company's success is dependent to a
significant degree on its key management personnel. To be successful, the
Company will have to retain its qualified clinical, manufacturing, scientific
and management personnel. The Company faces competition for personnel from other
companies, academic institutions, government entities and other organizations.
There can be no assurance that the Company will be successful in hiring or
retaining qualified personnel, and its failure to do so could have a material
adverse effect on the business and financial condition of the Company.

PRODUCT LIABILITY AND INSURANCE. The Company faces an inherent business
risk of exposure to product liability claims in the event that the use of
products during research and development efforts or after commercialization
results in adverse effects. There can be no assurance that the Company will
avoid significant product liability exposure. The Company maintains product
liability insurance for clinical trials. However, there can be no assurance that
such coverage will be adequate or that adequate insurance coverage for future
clinical trials or commercial activities will be available at an acceptable
cost, if at all, or that a product liability claim would not materially
adversely affect the business or financial condition of the Company.

POTENTIAL VOLATILITY OF STOCK PRICE. The market for the Company's securities
is volatile and investment in these securities involves substantial risk. The
market prices for securities of biotechnology companies (including the Company)
have been highly volatile, and the stock market from time to time has
experienced significant price and volume fluctuations that may be unrelated to
the operating performance of particular companies. Factors such as results of
clinical trials, delays in manufacturing or clinical trial plans, fluctuations
in the Company's operating results, disputes or disagreements with collaborative
partners, market reaction to announcements by other biotechnology or
pharmaceutical companies, announcements of technological innovations or new
commercial therapeutic products by the Company or its competitors, initiation,
termination or modification of agreements with collaborative partners, failures
or unexpected delays in manufacturing or in obtaining regulatory approvals or
FDA advisory panel recommendations, developments or disputes as to patent or
other proprietary rights, loss of key personnel, litigation, public concern as
to the safety of drugs developed by the Company, regulatory developments in
either the U.S. or foreign countries (such as opinions, recommendations or
statements by the FDA or FDA advisory panels, health care reform measures or
proposals), and general market conditions could result in the Company's failure
to meet the expectations of securities analysts or investors. In such event, or
in the event that adverse conditions prevail or are perceived to prevail with
respect to the Company's business, the price of PDL's common stock would likely
drop significantly. In the past, following significant drops in the price of a
company's common stock, securities class action litigation has often been
instituted against such a company. Such litigation against the Company could
result in substantial costs and a diversion of management's attention and
resources, which would have a material adverse effect on the Company's business
and financial condition.

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FUTURE REQUIREMENTS FOR SIGNIFICANT ADDITIONAL CAPITAL. The Company's
operations to date have consumed substantial amounts of cash. Negative cash flow
from operations is expected to increase significantly beyond current levels over
at least the next two years as the Company expects to spend substantial funds in
conducting clinical trials, to expand its research and development programs and
to develop and expand its manufacturing capability. The Company's future capital
requirements will depend on numerous factors, including, among others, the
progress of the Company's product candidates in clinical trials; the continued
or additional support by collaborative partners or other third parties of
research and clinical trials; enhancement of research and development programs;
the time required to gain regulatory approvals; the resources the Company
devotes to self-funded products, manufacturing methods and advanced
technologies; third party manufacturing commitments; the ability of the Company
to obtain and retain funding from third parties under collaborative agreements;
the development of internal marketing and sales capabilities; the demand for the
Company's potential products, if and when approved; potential acquisitions of
technology, product candidates or businesses by the Company; and the costs of
defending or prosecuting any patent opposition or litigation necessary to
protect the Company's proprietary technology. In order to develop and
commercialize its potential products, the Company may need to raise substantial
additional funds following this offering through equity or debt financings,
collaborative arrangements, the use of sponsored research efforts or other
means. No assurance can be given that such additional financing will be
available on acceptable terms, if at all, and such financing may only be
available on terms dilutive to existing stockholders. The inability of the
Company to secure adequate funds on a timely basis could result in the delay or
cancellation of programs that the Company might otherwise pursue and, in any
event, could have a material adverse effect on the business and financial
condition of the Company.

ENVIRONMENTAL REGULATION. The Company is subject to federal, state and
local laws and regulations governing the use, generation, manufacture, storage,
discharge, handling and disposal of certain materials and wastes used in its
operations, some of which are classified as "hazardous." There can be no
assurance that the Company will not be required to incur significant costs to
comply with environmental laws, the Occupational Safety and Health Act, and
state, local and foreign counterparts to such laws, rules and regulations as its
manufacturing and research activities are increased or that the operations,
business and future profitability of the Company will not be adversely affected
by current or future laws, rules and regulations. The risk of accidental
contamination or injury from hazardous materials cannot be eliminated. In the
event of such an accident, the Company could be held liable for any damages that
result and any such liability could exceed the resources of the Company. In any
event, the cost of defending claims arising from such contamination or injury
could be substantial. In addition, the Company cannot predict the extent of the
adverse effect on its business or the financial and other costs that might
result from any new government requirements arising out of future legislative,
administrative or judicial actions.

UNCERTAINTY RELATED TO HEALTH CARE INDUSTRY. The health care industry is
subject to changing political, economic and regulatory influences that may
significantly affect the purchasing practices and pricing of human therapeutics.
Cost containment measures, whether instituted by health care providers or
enacted as a result of government health administration regulators or new
regulations, such as pricing limitations or formulary eligibility for
dispensation by medical providers, could result in greater selectivity in the
availability of treatments. Such selectivity could have an adverse effect on the
Company's ability to sell its products and there can be no assurance that
adequate third-party coverage will be available for the Company to maintain
price levels sufficient to generate an appropriate return on its investment in
product development. Third-party payors are increasingly focusing on the
cost-benefit profile of alternative therapies and prescription drugs and

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challenging the prices charged for such products and services. Also, the trend
towards managed health care in the U.S. and the concurrent growth of
organizations such as health maintenance organizations, which could control or
significantly influence the purchase of health care services and products, as
well as legislative proposals to reform health care or reduce government
insurance programs, may all result in lower prices or reduced markets for the
Company's products. The cost containment measures that health care providers and
payors are instituting and the effect of any health care reform could adversely
affect the Company's ability to sell its products and may have a material
adverse effect on the Company. To date, the Company has conducted limited
marketing studies on certain of its potential products and has not undertaken
any pharmacoeconomic analysis with respect to its products under development.
The cost containment measures and reforms that government institutions and third
party payors are considering instituting could result in significant and
unpredictable changes to the marketing, pricing and reimbursement practices of
biopharmaceutical companies such as the Company. The adoption of any such
measures or reforms could have a material adverse effect on the business and
financial condition of the Company.

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ITEM 2. PROPERTIES

The Company leases approximately 43,000 square feet of laboratory and office
space in Mountain View, California. The Company's lease will terminate on
December 31, 2000. The Company has also leased an additional 10,000 square feet
of office space located adjacent to its current facility in Mountain View,
California through May 31, 1998. The Company believes that it will need to
obtain additional laboratory and office space in 1997 to supplement or replace
the facilities at its Mountain View site.

The Company also leases approximately 45,000 square feet of manufacturing,
laboratory and office space in Plymouth, Minnesota. The Company's lease will
terminate on February 29, 2004, subject to the Company's options to extend the
lease for two additional five year terms. Although these facilities currently
leased by the Company are sufficient for its present manufacturing operations,
the Company believes that it may have to obtain additional manufacturing space
in the future and may lease or acquire additional space as required.

The Company owns substantially all of the equipment used in its facilities.
See Note 4 to the financial statements.

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in administrative opposition proceedings being
conducted by the EPO with respect to its European patent relating to humanized
antibodies. Eighteen oppositions have been filed with respect to the issuance of
the patent to the Company in January 1996. The oppositions argue that the patent
was incorrectly granted and should be withdrawn or limited. See
"Business--Patents and Proprietary Technology" and "Risk Factors--Uncertainty of
Patents and Proprietary Technology; Opposition Proceedings." Other than such
administrative proceedings, the Company is not a party to any material
administrative or legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

Not applicable.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS

MARKET INFORMATION AND DIVIDEND POLICY ($)

1995 High Low
---- ---- ---

First Quarter 22.25 13.88
Second Quarter 26.75 19.25
Third Quarter 20.63 13.13
Fourth Quarter 24.00 14.63

1996 High Low
---- ---- ---
First Quarter 28.38 20.38
Second Quarter 30.00 22.00
Third Quarter 27.25 12.00
Fourth Quarter 38.38 21.75

The Company's common stock trades on the Nasdaq National Market under
the symbol "PDLI". Prices indicated above are the sale prices as reported by the
Nasdaq National Market for the periods indicated. The Company has never paid any
cash dividends on its capital stock and does not anticipate paying any cash
dividends in the foreseeable future.

As of December 31, 1996, the approximate number of common stockholders
of record was 224. The market for the Company's securities is volatile. See
"Risk Factors."

In October 1993, the Company entered into a Stock Purchase Agreement
with Corange International Limited ("Corange") pursuant to which the Company
sold 1.2 million and 1.233 million newly issued shares of Common Stock of the
Company in December 1993 and 1994 at a price of $25 per share and $36.50 per
share, respectively. The Company offered and sold the shares to Corange, a
sophisticated investor who purchased such shares for investment purposes, as
transactions not involving a public offering pursuant to the exemption from
registration provisions of Section 4(2) of the Securities Act of 1933, as
amended.

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ITEM 6. SELECTED FINANCIAL DATA

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

YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------

STATEMENTS OF OPERATIONS DATA:
Revenues:
Research and development
revenue under
collaborative agreements-
related parties $ 11,500 $ 10,408 $ 10,233 $ 14,233 $ 3,400
Research and development
revenue-other 5,000 1,000 1,627 456 2,746
Interest and other income 6,100 6,205 3,349 2,111 2,239
---------- ---------- ---------- ---------- ----------
Total revenues 22,600 17,613 15,209 16,800 8,385

Costs and expenses:
Research and development 28,795 20,803 16,367 12,329 7,264
Purchase of in-process
technology -- -- -- 7,725 --
General and administrative 5,601 5,163 4,051 2,653 1,997
Interest expense -- 1 7 25 44
---------- ---------- ---------- ---------- ----------
Total costs and expenses 34,396 25,967 20,425 22,732 9,305
---------- ---------- ---------- ---------- ----------
Net loss $ (11,796) $ (8,354) $ (5,216) $ (5,932) $ (920)
========== ========== ========== ========== ==========

Net loss per share(1) $ (0.76) $ (0.54) $ (0.37) $ (0.47) $ (0.07)
========== ========== ========== ========== ==========
Shares used in computation
of net loss per share 15,604 15,343 14,060 12,747 12,491
========== ========== ========== ========== ==========

DECEMBER 31,
--------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------

BALANCE SHEET DATA:
Cash, cash equivalents and
investments $ 99,667 $ 107,065 $ 113,245 $ 72,732 $ 50,904
Working capital 74,221 43,522 95,450 29,843 18,188
Total assets 110,331 116,412 121,054 80,294 55,623
Capital lease obligations,
less current portion -- -- -- 25 93
Accumulated deficit (35,507) (23,711) (15,357) (10,141) (4,209)
Total stockholders' equity 105,112 112,856 117,783 77,921 53,534
Number of employees 208 181 145 112 86

- -----------------
(1) For a description of the computation of net loss per share, see Note 1
to the Financial Statements.

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ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This Annual Report contains forward-looking statements which involve
risks and uncertainties. The Company's actual results may differ significantly
from the results discussed in the forward-looking statements. Factors that might
cause such a difference include, but are not limited to those discussed in "Risk
Factors" as well as those discussed elsewhere in this document.

OVERVIEW

Since the Company's founding in 1986, a primary focus of its operations
has been research and development. Achievement of successful research and
development and commercialization of products derived from such efforts is
subject to high levels of risk and significant resource commitments. The Company
has a history of operating losses and expects to incur substantial additional
expenses over at least the next few years, as it continues to develop its
proprietary products and devote significant resources to preclinical studies,
clinical trials, and manufacturing. The Company's revenues to date have
consisted, and for the near future are expected to consist, principally of
research and development funding, licensing and signing fees and milestone
payments from pharmaceutical companies under collaborative research and
development and licensing agreements. These revenues may vary considerably from
quarter to quarter and from year to year and revenues in any period may not be
predictive of revenues in any subsequent period, and variations may be
significant depending on the terms of the particular agreements. In particular,
revenues for the fourth quarter of 1996, which included several non-recurring
payments in connection with new licensing agreements, may not be indicative of
revenues in future quarters.

While the Company historically has received significant revenue pursuant
to certain of its research and development agreements, the Company has
recognized substantially all of the research and development and milestone
revenue due under these collaborations. Although the Company anticipates
entering into new collaborations from time to time, the Company presently does
not anticipate realizing non-royalty revenue from its new and proposed
collaborations at levels commensurate with the non-royalty revenue historically
recognized under its older collaborations. Moreover, the Company anticipates
that its operating expenses will continue to increase significantly as the
Company increases its research and development, manufacturing, preclinical and
clinical activity, and administrative and patent activities. Accordingly, in the
absence of substantial revenues from new corporate collaborations or licensing
agreements, royalties on Zenapax sales, if any, or other sources, the Company
expects to incur substantial and increased operating losses in the foreseeable
future as certain of its earlier stage potential products move into later stage
clinical development, as additional potential products are selected as clinical
candidates for further development, as the Company invests in additional
manufacturing facilities or capacity, as the Company defends or prosecutes its
patents and patent applications and as the Company invests in research or
acquires additional technologies or businesses.

The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of management's estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. For example, certain of the Company's accrued liabilities
with respect to clinical trials represent management's estimates of the timing
and expenses associated with patient accrual and the termination or winding down
of the

42
43

Company's clinical trials. These estimates and assumptions could differ
significantly from the amounts which may actually be realized.

Nonrefundable signing or licensing fee payments that are not dependent
on future performance under collaborative agreements are recognized as revenue
when received. Payments for research and development performed by the Company
under contractual arrangements are recognized as revenue ratably over the
quarter in which the payment is received and the related work is performed.
Revenue from achievement of milestone events is recognized when the funding
party agrees that the scientific or clinical results stipulated in the agreement
have been met. Deferred revenue arises principally due to timing of cash
payments received under research and development contracts.

RESULTS OF OPERATIONS

Years ended December 31, 1996, 1995 and 1994

The Company's total revenues were $22.6 million in 1996 as compared to
$17.6 million in 1995 and $15.2 million in 1994. Total research and development
revenues represented $16.5 million, $11.4 million and $11.9 million of total
revenues in 1996, 1995 and 1994, respectively. Interest and other income were
$6.1 million in 1996, $6.2 million in 1995, and $3.3 million in 1994.

The increase in total research and development revenues in 1996 over the
prior years was primarily attributable to an increase in up-front licensing and
signing fees, and receipt of a milestone payment from Boehringer Mannheim in
January 1996. Increased funding during 1995 and 1994 from Boehringer Mannheim
was partially offset by reduced funding from Roche, whose funding arrangement
ended in January 1995. Reimbursement funding under the agreement with Boehringer
Mannheim ended in October 1996. The Company received $5.0 million in up-front
licensing and signing fees in 1996, compared to $1.0 million and $2.5 million in
1995 and 1994 respectively. Of the amounts spent by the Company for research and
development, $10.0 million in 1996, $10.4 million in 1995 and $9.2 million in
1994 represented third-party funded research and development activities (not
including licensing fees, milestone payments and product sales).

Interest and other income of $6.1 million in 1996 was comparable to $6.2
million in 1995. The increase in 1995 from $3.3 million in 1994 was attributable
primarily to higher cash and investment balances in 1995 resulting from the sale
of stock to Corange, an affiliate of Boehringer Mannheim, in December 1994.

Total costs and expenses increased to $34.4 million in 1996 from $26.0
million in 1995 and $20.4 million in 1994. The increase in costs and expenses in
1996 compared to 1995 and 1994 was due primarily to increases in research and
development expenses in each of those periods.

Research and development expenses in 1996 increased to $28.8 million
from $20.8 million in 1995 and $16.4 million in 1994, primarily as a result of
the Company's conducting additional development efforts independently and under
its agreements with its collaborative partner, Boehringer Mannheim. These
expenses included the addition of staff, the initiation and continuation of
clinical trials, costs of conducting preclinical tests, expansion of
pharmaceutical development capabilities including support for both clinical
development and manufacturing process development, and higher costs in the
expanded operation of the manufacturing facility.

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44

General and administrative expenses for 1996 increased to $5.6 million
from $5.2 million in 1995 and $4.1 million in 1994. These increases were
primarily the result of increased staffing and associated expenses necessary to
manage and support the Company's expanding operations.

LIQUIDITY AND CAPITAL RESOURCES

To date the Company has financed its operations primarily through public
and private placements of equity, research and development revenue, capital
lease financing and interest income on invested capital. At December 31, 1996,
the Company had cash, cash equivalents and investments in the aggregate of $99.7
million, compared to $107.1 million at December 31, 1995 and $113.2 million at
December 31, 1994. Pursuant to the agreement with Boehringer Mannheim, the
Company may be required to reimburse Boehringer Mannheim up to $2.0 million for
Phase II studies and up to $8.8 million for Phase III studies of OST 577 in the
event certain conditions are met.

Net cash used in operating activities was approximately $7.0 million for
the year ended December 31, 1996 compared to approximately $7.1 million in 1995
and $1.9 million in 1994.

The Company's future capital requirements will depend on numerous
factors, including, among others, the progress of the Company's product
candidates in clinical trials; the continued or additional support by
collaborative partners or other third parties of research and clinical trials;
enhancement of research and development programs; the time required to gain
regulatory approvals; the resources the Company devotes to self-funded products,
manufacturing methods and advanced technologies; third party manufacturing
commitments; the ability of the Company to obtain and retain funding from third
parties under collaborative agreements; the development of internal marketing
and sales capabilities; the demand for the Company's potential products, if and
when approved; potential acquisitions of technology, product candidates or
businesses by the Company; and the costs of defending or prosecuting any patent
opposition or litigation necessary to protect the Company's proprietary
technology. In order to develop and commercialize its potential products the
Company may need to raise substantial additional funds following this offering
through equity or debt financings, collaborative arrangements, the use of
sponsored research efforts or other means. No assurance can be given that such
additional financing will be available on acceptable terms, if at all, and such
financing may only be available on terms dilutive to existing stockholders. The
Company believes that existing capital resources will be adequate to satisfy its
capital needs through 1999.

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45

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PROTEIN DESIGN LABS, INC.
BALANCE SHEETS

DECEMBER 31,
-----------------------------
1996 1995
------------- -------------

ASSETS

Current assets:
Cash and cash equivalents $ 14,141,184 $ 4,686,259
Short-term investments 64,050,165 41,743,675
Other current assets 1,249,772 648,536
------------- -------------
Total current assets 79,441,121 47,078,470
Property and equipment, net 8,589,555 7,850,485
Long-term investments 21,475,483 60,635,550
Other assets 825,246 847,891
------------- -------------
$ 110,331,405 $ 116,412,396
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 1,029,157 $ 637,637
Accrued compensation 635,729 605,127
Other accrued liabilities 3,554,869 1,313,805
Deferred revenue -- 1,000,000
------------- -------------
Total current liabilities 5,219,755 3,556,569

Commitments

Stockholders' equity:
Preferred stock, par value $0.01 per
share, 10,000,000 shares authorized;
no shares issued and outstanding -- --
Common stock, par value $0.01 per share,
40,000,000 shares authorized; 15,759,089
and 15,405,761 issued and outstanding at
December 31, 1996 and December 31, 1995,
respectively 157,591 154,058
Additional paid-in capital 140,328,297 135,616,420
Accumulated deficit (35,507,154) (23,711,056)
Unrealized gain on investments 132,916 796,405
------------- -------------
Total stockholders' equity 105,111,650 112,855,827
------------- -------------
$ 110,331,405 $ 116,412,396
============= =============

See accompanying notes

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46

PROTEIN DESIGN LABS, INC.
STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31,
--------------------------------------------
1996 1995 1994
------------ ------------ ------------

Revenues:
Research and development revenue
under collaborative agreements
- related parties $ 11,500,000 $ 10,408,333 $ 10,233,333
Research and development revenue
- other 5,000,000 1,000,000 1,626,500
Interest and other income 6,099,519 6,204,663 3,349,237
------------ ------------ ------------
Total revenues 22,599,519 17,612,996 15,209,070

Costs and expenses:
Research and development 28,794,355 20,802,661 16,366,746
General and administrative 5,601,262 5,162,738 4,050,895
Interest expense -- 1,366 7,479
------------ ------------ ------------
Total costs and expenses 34,395,617 25,966,765 20,425,120
------------ ------------ ------------
Net loss $(11,796,098) $ (8,353,769) $ (5,216,050)
============ ============ ============
Net loss per share $ (0.76) $ (0.54) $ (0.37)
============ ============ ============
Shares used in computation
of net loss per share 15,604,000 15,343,000 14,060,000
============ ============ ============

See accompanying notes

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47

PROTEIN DESIGN LABS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY

Common Stock Additional
------------------------------ Paid-In
Shares Amount Capital
------------- ------------- -------------

Balance at December 31, 1993 13,925,172 $ 139,252 $ 88,168,082

Repurchase of common stock from
officers, employees and consultants at
$0.05 to $0.125 per share for cash (755) (8) (55)
Issuance of common stock to employees for cash 90,622 906 976,350
Issuance of common stock to investor at $36.50
per share 1,232,877 12,329 44,987,682
Amortization of deferred compensation
Change in unrealized gain (loss) on investments
Net loss
------------- ------------- -------------
Balance at December 31, 1994 15,247,916 152,479 134,132,059

Issuance of common stock to employees
and outside directors for cash 157,845 1,579 1,484,361
Amortization of deferred compensation
Change in unrealized gain (loss) on investments
Net loss
------------- ------------- -------------
Balance at December 31, 1995 15,405,761 154,058 135,616,420

Issuance of common stock to employees
and outside directors for cash 353,328 3,533 4,711,877
Change in unrealized gain (loss) on investments
Net loss
------------- ------------- -------------
Balance at December 31, 1996 15,759,089 $ 157,591 $ 140,328,297
------------- ------------- -------------

Unrealized Total
Accumulated Deferred Gain (Loss) Stockholders'
Deficit Compensation on Investments Equity
------------- ------------- ------------- -------------

Balance at December 31, 1993 $ (10,141,237) $ (244,641) -- $ 77,921,456

Repurchase of common stock from
officers, employees and consultants at
$0.05 to $0.125 per share for cash (63)
Issuance of common stock to employees for cash 977,256
Issuance of common stock to investor at $36.50
per share 45,000,011
Amortization of deferred compensation 150,000 150,000
Change in unrealized gain (loss) on investments (1,049,656) (1,049,656)
Net loss (5,216,050) (5,216,050)
------------ ------------ ------------ -------------
Balance at December 31, 1994 (15,357,287) (94,641) (1,049,656) 117,782,954

Issuance of common stock to employees
and outside directors for cash 1,485,940
Amortization of deferred compensation 96,641 96,641
Change in unrealized gain (loss) on investments 1,846,061 1,846,061
Net loss (8,353,769) (8,353,769)
------------ ------------ ------------ -------------
Balance at December 31, 1995 (23,711,056) -- 796,405 112,855,827

Issuance of common stock to employees
and outside directors for cash 4,715,410
Change in unrealized gain (loss) on investments (663,489) (663,489)
Net loss (11,796,098) (11,796,098)
------------ ------------ ------------ -------------
Balance at December 31, 1996 $(35,507,154) $ -- $ 132,916 $ 105,111,650
------------ ------------ ------------ -------------

See accompanying notes

48

PROTEIN DESIGN LABS, INC.
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

YEARS ENDED DECEMBER 31,
--------------------------------------------
1996 1995 1994
------------ ------------ ------------

Cash flows from operating activities:
Net loss $(11,796,098) $ (8,353,769) $ (5,216,050)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 3,241,775 2,533,448 2,164,512
Other 466,496 (1,923,950) (189,602)
Changes in assets and liabilities:
Other current assets (601,236) 377,090 373,163
Accounts payable 391,520 (120,315) (1,156)
Accrued liabilities 2,271,666 339,257 781,894
Deferred revenue (1,000,000) 91,667 166,666
------------ ------------ ------------
Total adjustments 4,770,221 1,297,197 3,295,477
------------ ------------ ------------
Net cash used in operating activities (7,025,877) (7,056,572) (1,920,573)

Cash flows from investing activities:
Purchases of short and long term investments (24,458,022) (74,161,730) (76,249,102)
Maturities of short and long term investments 39,900,000 46,900,000 34,008,428
Proceeds from sales of short and long term 36,348,806
investments -- 36,348,806 --
Capital expenditures (3,669,231) (3,585,812) (2,378,737)
(Increase) decrease in other assets 22,645 (659,467) 53,138
------------ ------------ ------------
Net cash provided by investing activities 11,765,392 4,841,797 (44,566,273)

Cash flows from financing activities:
Principal payments on capital lease obligations -- (24,971) (49,469)
Proceeds from issuance of capital stock 4,715,410 1,485,940 45,977,267
Payments for repurchases of common stock -- -- (63)
------------ ------------ ------------
Net cash provided by financing activities 4,715,410 1,460,969 45,927,735
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents 9,454,925 (753,806) (559,111)

Cash and cash equivalents at beginning of year 4,686,259 5,440,065 5,999,176
------------ ------------ ------------
Cash and cash equivalents at end of year $ 14,141,184 $ 4,686,259 $ 5,440,065
============ ============ ============
Supplemental disclosure of cash flow information
Interest paid $ -- $ 1,366 $ 7,479
============ ============ ============

See accompanying notes

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49

PROTEIN DESIGN LABS, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1996

1. Summary of Significant Accounting Policies

Organization and Business

Since the Company's founding in 1986, a primary focus of its operations
has been research and development. Achievement of successful research
and development and commercialization of products derived from such
efforts is subject to high levels of risk and significant resource
commitments. The Company has a history of operating losses and expects
to incur substantial additional expenses over at least the next few
years, as it continues to develop its proprietary products and devote
significant resources to preclinical studies, clinical trials, and
manufacturing. The Company's revenues to date have consisted, and for
the near future are expected to consist, principally of research and
development funding, licensing and signing fees and milestone payments
from pharmaceutical companies under collaborative research and
development and licensing agreements. These revenues may vary
considerably from quarter to quarter and from year to year and revenues
in any period may not be predictive of revenues in any subsequent
period, and variations may be significant depending on the terms of the
particular agreements. For example, revenues for the fourth quarter of
1996, which included several non-recurring payments in connection with
new licensing agreements, may not be indicative of revenues in future
quarters.

While the Company historically has received significant revenue
pursuant to certain of its research and development agreements, the
Company has recognized substantially all of the research and
development and milestone revenue due under these collaborations.
Although the Company anticipates entering into new collaborations from
time to time, the Company presently does not anticipate realizing
non-royalty revenue from its new and proposed collaborations at levels
commensurate with the non-royalty revenue historically recognized under
its older collaborations. Moreover, the Company anticipates that its
operating expenses will continue to increase significantly as the
Company increases its research and development, manufacturing,
preclinical and clinical activity, and administrative and patent
activities. Accordingly, in the absence of substantial revenues from
new corporate collaborations or licensing agreements, royalties on
Zenapax sales, if any, or other sources, the Company expects to incur
substantial and increased operating losses in the foreseeable future as
certain of its earlier stage potential products move into later stage
clinical development, as additional potential products are selected as
clinical candidates for further development, as the Company invests in
additional manufacturing facilities or capacity, as the Company defends
or prosecutes its patents and patent applications and as the Company
invests in research or acquires additional technologies or businesses.

Cash Equivalents, Investments and Concentration of Credit Risk

The Company considers all highly liquid investments purchased with a
maturity of three months or less at the date of acquisition to be cash
equivalents. The Company places its cash and short-term and long-term
investments with high-credit-quality financial

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50

institutions and in securities of the U.S. government and U.S.
government agencies, and by policy, limits the amount of credit
exposure in any one financial instrument. To date, the Company has not
experienced credit losses on investments in these instruments.

Revenue Recognition Under Development Contracts

Nonrefundable signing or licensing fee payments that are not dependent
on future performance under collaborative agreements are recognized as
revenue when received. Payments for research and development performed
by the Company under contractual arrangements are recognized as revenue
ratably over the quarter in which the payment is received and the
related work is performed. Revenue from achievement of milestone events
is recognized when the funding party agrees that the scientific or
clinical results stipulated in the agreement have been met. Deferred
revenue arises principally due to timing of cash payments received
under research and development contracts.

Net Loss Per Share

Net loss per share is computed using the weighted average number of
shares of common stock outstanding. Common equivalent shares from
options are included in the computation (using the treasury stock
method) when their effect is dilutive.

New Accounting Standards

Effective on January 1, 1996, the Company adopted Statement of
Financial Accounting Standards 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS
121"), which required the Company to review for impairment long-lived
assets, certain identifiable intangibles and goodwill related to those
assets whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In certain
situations, an impairment loss would be recognized. The adoption of FAS
121 did not have a material impact on the financial position, results
of operations or cash flows of the Company.

In 1996, the Company implemented the disclosure requirements of
Financial Accounting Standards 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). Under FAS 123, the Company will continue to
account for stock-based compensation under the intrinsic value method
prescribed by Accounting Principles Board Opinion 25, "Accounting for
Stock Issued to Employees," and will provide pro forma disclosures of
net income and earnings per share as if the fair value basis method
prescribed in FAS 123 had been applied in measuring compensation
expense.

Management Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of management's
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. For example, certain of
the Company's accrued liabilities with respect to clinical trials
represent management's estimates of the timing and expenses associated
with patient accrual and the termination or winding down of the
Company's clinical trials. These estimates and assumptions could differ
significantly from the amounts which may actually be realized.

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51

Property and Equipment

Property and equipment are stated at cost less accumulated
straight-line depreciation and amortization and consist of the
following:

December 31,
--------------------------
1996 1995
------------ ------------

Laboratory and manufacturing equipment $ 10,170,750 $ 7,910,701
Office equipment 3,237,572 2,405,900
Furniture and fixtures 4,351,269 3,743,759
------------ ------------
17,759,591 14,060,360
Less accumulated depreciation and amortization (9,170,036) (6,209,875)
------------ ------------
$ 8,589,555 $ 7,850,485
============ ============

Laboratory, manufacturing, office equipment and furniture and fixtures
are depreciated over the estimated useful lives of the assets,
generally three to five years.

2. Collaborative Research and Development Arrangements

Roche

In March 1989, Hoffmann-La Roche Inc. and F. Hoffmann-La Roche & Co.
Limited Company, subsidiaries of Roche Holding Ltd (collectively,
"Roche") entered into a stock purchase agreement and a product
licensing agreement with the Company. Under the product licensing
agreement, the Company received a licensing and signing fee in exchange
for exclusive worldwide manufacturing and marketing rights to the
product which is under development. Revenues related to the achievement
of milestones under this agreement were $2 million in 1993. In 1994 and
1993, Roche provided quarterly payments to fund additional research and
development associated with the product. This funding arrangement ended
in January 1995. Related costs under this arrangement approximated the
related revenues and are included in research and development expenses
in the accompanying financial statements. The Company will receive
further payments if additional milestones are achieved. The product
licensing agreement provides for royalty payments to the Company on net
sales of the licensed product. The royalty rate is subject to reduction
upon the occurrence of certain events. The product licensing agreement
may be terminated by Roche upon 90 days notice, in which event rights
licensed to Roche will revert to the Company.

In October 1996, Roche entered into a humanization agreement with the
Company. Under this agreement, the Company received a nonrefundable
signing fee and can earn additional payments upon the achievement of
certain milestones. The agreement also provides for royalty payments to
the Company on net sales of licensed product.

Corange/Boehringer Mannheim

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52

In October 1993, Corange International Limited ("Corange") entered into
a strategic alliance with the Company pursuant to a stock purchase
agreement, standstill agreement, registration rights agreement and a
joint development, marketing and licensing agreement. Under the equity
agreement, Corange invested $30 million through the purchase of 1.2
million newly issued shares of common stock at a price of $25 per share
in December 1993, and an additional $45 million through the purchase of
approximately 1.233 million newly issued shares of common stock at a
price of $36.50 per share in December 1994. Under the license
agreement, Corange acquired exclusive marketing and co-promotion rights
to certain of the Company's potential products for certain territories.
Corange and the Company have also agreed to negotiate future agreements
under which each party would manufacture and supply to the other
certain of these potential products. In 1994 and 1995, Corange and the
Company agreed to amend certain of these agreements to provide for,
among other matters, the termination of Corange's rights to certain of
the Company's preclinical products, the assignment of the joint
development, marketing and license agreement to Corange's affiliate,
Boehringer Mannheim, the assumption by each party of primary
responsibility for clinical development and manufacturing for specific
products, the termination of certain milestone payments to the Company
with respect to particular products, the reimbursement to Boehringer
Mannheim by the Company up to a limited amount of certain costs with
respect to clinical trials to be conducted by Boehringer Mannheim, if
certain conditions are met, and the termination of certain restrictions
on Corange's ability to sell its equity investment in the Company.

The Company recorded as contract revenue under the license agreement a
milestone payment of $1 million in each of 1996 and 1994, respectively.
In addition, the Company received research and development funding of
approximately $10.0 million, $10.3 million and $8.3 million in 1996,
1995 and 1994, respectively. Related costs under the license agreement
approximated the related research and development funding revenue and
are included in research and development expenses in the accompanying
financial statements. The research and development funding ended in
October 1996. The license agreement provides for additional payments to
the Company upon the achievement of certain milestones related to
certain remaining licensed products under this agreement, as well as
the payment of royalties to the Company on net sales of licensed
products. The royalty rate is subject to reduction upon the occurrence
of certain events.

Novartis

In April 1993, the Company entered into agreements with Sandoz Pharma,
Sandoz, Ltd. and Sandoz Pharmaceuticals Corporation (collectively,
"Novartis") to acquire certain licenses and rights to certain human,
humanized and mouse monoclonal antibodies and certain related know-how,
patent rights, equipment and materials. The Company is pursuing
development of these products with the intent of producing treatments
for certain diseases, and has obtained from Novartis worldwide
manufacturing and marketing rights to these products. The agreements
called for upfront payment to Novartis of $5 million, substantially all
of which was expensed in April 1993 for the acquisition of exclusive
rights to in-process technology. Additional milestone payments of up to
$5 million will be made to Novartis in the event of certain product
approvals. The agreements specify that Novartis has certain
co-promotion and co-marketing rights and will earn royalties on the
Company's sales of certain products in countries where

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53

Novartis does not sell such products. In November 1993, the Company
paid Novartis an additional $2.75 million to amend the April 1993
agreement relating to the human antibodies in order to terminate
certain of Novartis's co-promotion and co-marketing rights to the
products covered by that agreement and to reduce royalties Novartis may
earn from the sale of such antibodies in countries outside of the U.S.,
Canada and Asia.

Yamanouchi

In February 1991, Yamanouchi Pharmaceutical Co., Ltd. entered into a
humanization agreement with the Company. Under this agreement, the
Company received a licensing and signing fee in exchange for exclusive
worldwide rights to the product under development. The agreement also
provides for royalty payments to the Company on net sales of licensed
products. The Company has received all of the additional payments for
achieving milestones under this agreement.

Kanebo

In February 1992, Kanebo, Ltd. ("Kanebo") entered into a product
licensing agreement with the Company. Under this agreement, the Company
received a licensing and signing fee in exchange for a license to the
potential product in certain Asian countries. The Company has received
additional payments for achieving milestones under this agreement. The
agreement also provides for royalty payments to the Company on net
sales of licensed products. Kanebo provided annual payments to fund
additional research and development work associated with the
development of the product. The research and development funding period
ended in September 1993. Related costs under this arrangement
approximated the related revenue and are included in research and
development expenses in the accompanying financial statements. During
1993 and 1994, the Company signed separate agreements to supply Kanebo
with drug substance in order for Kanebo to conduct preclinical and
clinical studies in Japan. The Company received payments for delivery
of manufactured drug substance under these agreements in 1995, 1994 and
1993, respectively. These amounts were not material.

Mochida

In December 1995, the Company entered into a humanization agreement
with Mochida Pharmaceutical Co., Ltd., a Japanese pharmaceutical
company. Under this agreement, the Company received a $1 million
licensing and signing fee and can earn additional payments upon the
achievement of certain milestones. The agreement also provides for
royalty payments to the Company on net sales of licensed product. In
addition, the Company has an option for co-promotion of the product in
North America.

Unnamed Japanese Collaborator

In September 1996, the Company entered into a humanization agreement
with another Japanese company. Under this agreement, the Company
received a $1 million licensing and signing fee and can earn additional
payments upon the achievement of certain milestones. The agreement also
provides for royalty payments to the Company on net sales of licensed
product. In addition, the Company has an option for co-promotion of

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54

the product in North America. The name of the Japanese company has not
been disclosed.

Sankyo

In December 1996, the Company entered into a licensing agreement with
Sankyo Co., Ltd. Under this agreement, the Company received a $1
million licensing and signing fee. The agreement also provides for
royalty payments to the Company on net sales of licensed product.

Genetics Institute (American Home Products)

In December 1996, the Company entered into a humanization agreement
with Genetics Institute, Inc., a wholly-owned subsidiary of American
Home Products Corporation. Under this agreement, the Company received
a $2.5 million licensing and signing fee and can earn additional
payments upon the achievement of certain milestones. The agreement
also provides for royalty payments to the Company on net sales of
licensed products. In addition, the Company has an option to
co-promote the products in North America (U.S. and Canada).

3. Other Accrued Liabilities

At December 31, other accrued liabilities consisted of the following:

1996 1995
----------- ----------

Employee stock purchase plan $ 333,872 $ 277,874
Clinical trials 1,843,206 182,766
Accrued rent 281,614 306,793
Other accrued liabilities 1,096,177 546,372
----------- ----------
$ 3,554,869 $1,313,805
=========== ==========

4. Commitments

The Company occupies leased facilities under agreements that expire in
1998, 2000 and 2004. The Company also has leased certain office
equipment under operating leases. Rental expense under these
arrangements totaled approximately $1,343,000, $1,328,000 and
$1,200,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.

At December 31, 1996 the total future minimum non-cancelable payments
under these agreements are approximately as follows:

1997 $1,359,000
1998 1,214,000
1999 1,297,000
2000 1,309,000
2001 383,000
Thereafter 830,000
-----------

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Total $6,392,000

5. Short-and Long-Term Investments

The Company invests its excess cash balances in short-term and
long-term marketable securities and U.S. government and government
agency notes. These securities are classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the
unrealized gains and losses reported in stockholders' equity. The
amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is
included in interest income. The cost of securities sold is based on
the specific identification method, when applicable.

The following is a summary of available-for-sale securities. Estimated
fair value is based upon quoted market prices for these or similar
instruments.

Available-for-Sale Securities
---------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
---------------------------------------------

December 31, 1996

Securities of the
U.S. Government and
its agencies $ 85,393 $ 133 $ -- $ 85,526
======== ===== ======= ========

December 31, 1995

Securities of the
U.S. Government and
its agencies $101,583 $ 796 $ -- $102,379
======== ===== ======= ========

During 1996, there were no realized gains or losses on the sale of
available-for-sale securities, as all securities liquidated in 1996
were held to maturity. As of December 31, 1996, the maturities of
short-term investments ranged from 1 month to 12 months, and maturities
of long-term investments ranged from 13 months to 20 months.

6. Stockholders' Equity

Stock Purchase Plan

The Company has reserved 1,820,000 shares of its common stock for sale
to employees, consultants and scientific advisors under the 1986 Stock
Purchase Plan (the "Stock Purchase Plan"), which was adopted in
November 1986. Shares issued pursuant to the Plan are issued at the
fair value of such shares (as determined by the Company's Board of
Directors) and are subject to stock purchase agreements which enable
the Company to repurchase unvested shares at the original issuance
price upon termination of employment or services. Shares generally vest
at the rate of 25 percent at the end of the first year, with the
remaining balance vesting monthly over the next three years in the

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56

case of employees, and ratably over five years in the case of
scientific advisors and consultants.

Through December 31, 1996, 1,081,227 shares had been issued under the
Plan, of which none remain subject to repurchase. For certain shares
sold under the Stock Purchase Plan, the Company has recorded
compensation expense for the difference between the purchase and the
deemed value for financial statement presentation purposes of the
Company's common stock. This compensation expense has been amortized
over the vesting period of each share sold and this amortization was
completed during 1995.

1991 Stock Option Plan

In December 1991, the Board of Directors adopted the 1991 Stock Option
Plan (the "Option Plan"). During 1995, the stockholders approved an
increase in the number of shares reserved under the Option Plan from
2,000,000 to 4,000,000 shares of common stock for the grant of options
under the Option Plan.

At December 31, 1996, options to purchase 752,311 shares were
exercisable at prices ranging from $6.25 to $25.75. Options granted
under the Option Plan generally vest at the rate of 25 percent at the
end of the first year, with the remaining balance vesting monthly over
the next three years in the case of employees, and ratably over five
years in the case of advisors and consultants.

1992 Outside Directors' Stock Option Plan

In February 1992 the Board of Directors adopted the 1992 Outside
Directors' Stock Option Plan (the "Directors' Plan"). The Company has
reserved 200,000 shares of common stock for the grant of options under
the Directors' Plan. Through December 31, 1996, the Company granted
options to purchase 75,000 shares at exercise prices ranging from $7.25
to $27.00 per share, of which 22,500 were exercisable at December 31,
1996. Options granted pursuant to the Directors' Plan vest ratably over
five years. A total of 11,666 and 4,167 options were exercised in 1996
and in 1995, respectively.

1993 Employee Stock Purchase Plan

In February 1993, the Board of Directors adopted the 1993 Employee
Stock Purchase Plan (the "Employee Purchase Plan"). The Company has
reserved 300,000 shares of common stock for the purchase of shares by
employees under the Employee Purchase Plan. Eligibility to participate
in the Employee Purchase Plan is essentially limited to full time
employees of the Company who own less than 5% of the outstanding shares
of the Company. Under the Employee Purchase Plan, eligible employees
can purchase shares of the Company's common stock based on a percentage
of their compensation, up to certain limits. The purchase price per
share must equal at least the lower of 85% of the market value on the
date offered or on the date purchased. During 1996, an aggregate of
38,399 shares was purchased by employees under the Employee Purchase
Plan at prices ranging from $17.74 to $19.13 per share.

Accounting for Stock-Based Compensation

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The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting of Stock Issued to Employees" ("APB 25") and
related interpretations, in accounting for its employee stock options
because, as discussed below, the alternative fair value accounting
provided for under FAS 123 requires use of option valuation models that
were not developed for use in valuing employee stock options. Under APB
25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant,
no compensation expense is recognized. Pro forma information regarding
net income and earnings per share in 1996 and 1995 has been determined
as if the Company had accounted for its employee stock options under
the fair value method prescribed by FAS 123. The resulting effect on
pro forma net income and earnings per share on a pro forma basis
disclosed for 1996 and 1995 is not likely to be representative of the
effects on net income and earnings per share on a pro forma basis in
future years, because 1996 and 1995 pro forma results include the
impact of only one and two years, respectively, of options vesting,
while subsequent years will include additional years of vesting.

1996 1995
---- ----

Net loss As reported $ (11,796,098) $ (8,353,796)
Pro forma (14,399,292) (9,219,776)

Loss per share As reported $ (0.76) $ (0.54)
Pro forma (0.92) (0.60)

The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options pricing model with the following
weighted-average assumptions used for grants in 1996 and 1995,
respectively: (a) no dividends; (b) expected volatility of 55%; (c)
risk-free interest rates ranging from 5.25% to 7.5%; and (d) expected
lives of 6 years.

A summary of the status of the Company's stock option plans as of
December 31, 1996 and 1995, and changes during the years ending those
dates is presented below.

1996 1995
----------------------- -----------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
---------- --------- ---------- ----------

Outstanding at beginning of year 1,756,317 $ 15.61 1,412,030 $ 13.72
Granted 608,405 24.90 544,350 18.99
Exercised (309,167) 13.23 (137,250) 9.41
Forfeited (114,123) 21.32 (62,813) 16.75
---------- ----------
Outstanding at end of year 1,941,432 18.44 1,756,317 15.61
========== ==========
Weighted average fair value of

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options granted during the year $ 14.23 $ 11.01
======= =======

The following information applies to all stock options outstanding
under the Company's stock option plans at December 31, 1996:

Options exercisable 774,811
Range of exercise prices $6.25 to $34.25
Weighted average remaining contractual life 8 years

7. Income Taxes

As of December 31, 1996, the Company had federal and state net
operating loss carryforwards of approximately $33.2 million and $2.9
million, respectively. Federal net operating loss carryforwards will
expire at various dates beginning in 2002 through 2011, if not
utilized.

The federal net operating loss carryforward differs from the
accumulated deficit principally due to temporary differences in the
recognition of certain revenue and expense items for financial and
federal tax reporting purposes, consisting primarily of in-process
technology capitalized for federal tax purposes.

Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting and the amount used for income tax purposes.
Significant components of the Company's deferred tax assets and
liabilities for federal and state income taxes as of December 31 are as
follows:

(In thousands)

1996 1995
----------- ----------

Deferred tax assets:
Net operating loss carryforwards $ 11,400 $ 6,100
Research credits 2,400 1,700
Deferred revenue -- 400
Capitalized research and development 2,800 2,400
Other 500 (400)
----------- ----------
Total deferred tax assets 17,100 10,200
Valuation allowance for deferred tax asset (17,100) (10,200)
----------- ----------
Net deferred tax assets $ -- $ --
=========== ==========

Because of the Company's lack of earnings history, the deferred tax
assets have been fully offset by a valuation allowance. The valuation
allowance increased by $3 million during the year ended December 31,
1995.

Utilization of the net operating loss and credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations provided by the

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Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and
credits before utilization.

8. Subsequent Event

On February 3, 1997, the Company filed a Registration Statement on Form
S-3 for the sale of 2,000,000 shares of Common Stock by the Company and
750,000 shares of Common Stock by Corange.

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Report of Ernst & Young LLP, Independent Auditors

Board of Directors and Stockholders
Protein Design Labs, Inc.

We have audited the accompanying balance sheets of Protein Design Labs, Inc., as
of December 31, 1996 and 1995, and the related statements of operations,
stockholders' equity and cash flows for each of three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Protein Design Labs, Inc. at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996 in conformity
with generally accepted accounting principles.

/s/ ERNST & YOUNG LLP

Palo Alto, California
January 27, 1997

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

PART III

ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS

Information with respect to the executive officers and directors of the
Company as of December 31, 1996 is set forth below:

Name Age Positions
----- --- ---------

Laurence Jay Korn, Ph.D. . . . . . 47 Chief Executive Officer and Chairperson of
the Board of Directors

Jon S. Saxe . . . . . . . . . . . 60 President and Director

Cary L. Queen, Ph. D. . . . . . . 46 Senior Vice President, Vice President,
Research and Director

Christine Booker . . . . . . . . . 55 Vice President, Quality and Compliance

Douglas O. Ebersole . . . . . . . 40 Vice President, Licensing and Corporate
Services, General Counsel and Secretary

Fred Kurland . . . . . . . . . . . 46 Vice President and Chief Financial Officer

Daniel J. Levitt, M.D., Ph.D. . . 49 Senior Vice President, Clinical and
Regulatory Affairs

Mark D. Young, Ph.D. . . . . . . . 46 Vice President, Technical Operations

Stanley Falkow, Ph.D.(1) . . . . . 62 Distinguished Investigator (consultant) and
Director

George M. Gould(1)(2) . . . . . . . 59 Director

Max Link, Ph.D.(2) . . . . . . . . 56 Director

- -------------

(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.

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Laurence Jay Korn, Ph.D., has served as a director and Chairperson of the
Board since July 1986 and Chief Executive Officer since January 1987.
Previously, Dr. Korn headed a research laboratory and served on the faculty of
the Department of Genetics at the Stanford University School of Medicine from
March 1981 to December 1986. Dr. Korn received his Ph.D. from Stanford
University and was a Helen Hay Whitney Postdoctoral Fellow at the Carnegie
Institution of Washington and a Staff Scientist at the MRC Laboratory of
Molecular Biology in Cambridge, England, before becoming an Assistant Professor
at Stanford.

Jon S. Saxe has been a director of the Company since March 1989 and has
served as President of the Company since January 1995. Mr. Saxe was a consultant
to the Company from June 1993 to December 1994. He has served as President of
Saxe Associates, a biotechnology consulting firm, since May 1993. Mr. Saxe
served as the President, Chief Executive Officer and a director of Synergen,
Inc., a biopharmaceutical company, from October 1989 to April 1993. Mr. Saxe
served as Vice President, Licensing & Corporate Development for Roche from
August 1984 through September 1989, and Head Patent Law from September 1978
through September 1989. Mr. Saxe is also a director of InSite Vision
Incorporated, Microcide Pharmaceuticals, Inc., Incyte Pharmaceuticals Inc. and
ID Biomedical Corporation. Mr. Saxe received his J.D. from George Washington
University School of Law and his LL.M. from New York University School of Law.

Cary L. Queen, Ph.D., has served as a director since January 1987, as Vice
President, Research, since April 1989 and as Senior Vice President since June
1993. Previously, Dr. Queen held positions at the National Institutes of Health
from 1983 to 1986, where he studied the regulation of genes involved in the
synthesis of antibodies. Dr. Queen received his Ph.D. in Mathematics from the
University of California at Berkeley and subsequently served as an Assistant
Professor of Mathematics at Cornell University.

Christine Booker has served as the Company's Vice President, Quality and
Compliance since February 1996. Prior to joining the Company, from February 1995
through January 1996, Ms. Booker served as a consultant to the Company. Since
August 1994, Ms. Booker has served as the principal consultant for Booker
Associates. From March 1992 to October 1994, Ms. Booker served as Director,
Quality Assurance for Synergen, Inc. From October 1980 to February 1992, Ms.
Booker served in various positions at Genentech, Inc., including Associate
Director, Technical Operations. Ms. Booker received her B.S. in Chemistry from
DePaul University.

Douglas O. Ebersole has served as the Company's Vice President, Licensing,
General Counsel and Secretary since July 1992 and in April 1996 was appointed to
the additional position of Vice President, Corporate Services. Prior to joining
the Company, he served first as Associate General Counsel and later as General
Counsel at NeXT Computer, Inc. Prior to joining NeXT in 1989, he was a partner
in the corporate department of the law firm Ware & Freidenrich (now known as
Gray Cary Ware & Freidenrich). Mr. Ebersole received his J.D. from Stanford Law
School.

Fred Kurland has served as the Company's Vice President and Chief Financial
Officer since February 1996. Prior to joining the Company, from May 1995 to
January 1996, Mr. Kurland served as the Vice President, Chief Financial Officer
and Secretary of Applied Immune Sciences, Inc., a biotechnology company. From
February 1991 to April 1995, Mr. Kurland served as Vice President and Controller
of Syntex Corporation, a pharmaceutical company ("Syntex"). From 1981 to
February 1991, Mr. Kurland served in various senior financial positions in
corporate and operations functions at Syntex. Mr. Kurland received his J.D. and
M.B.A. degrees from the University of Chicago.

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Daniel J. Levitt, M.D., Ph.D., has served as Senior Vice President,
Clinical and Regulatory Affairs of the Company since November 1996. From
February 1995 to October 1996 he served as Vice President of Drug Development
and Chief Medical Officer of Geron Corporation, a biotechnology company. From
1990 until January 1995, Dr. Levitt held various positions at Sandoz Pharma Ltd.
(now known as Novartis Pharma Ltd.), a pharmaceutical company, most recently as
Worldwide Head of Oncology Clinical Research and Development. From 1986 to 1990,
Dr. Levitt held various positions with Roche, including Director of Clinical
Oncology and Immunology. He received post-graduate training at Yale-New Haven
Hospital and the University of Chicago Pritzker School of Medicine. Dr. Levitt
holds an M.D. and Ph.D. from the University of Chicago Pritzker School of
Medicine.

Mark D. Young, Ph.D., has served as the Company's Vice President, Technical
Operations since September 1995. From February 1995 through August 1995, Dr.
Young served as acting Head of Manufacturing of the Company. From 1989 through
January 1995, Dr. Young served in various senior management positions at
Synergen Inc. and its successor Amgen, a biotechnology company, including Vice
President, Process Development and Executive Vice President, Technical
Operations. Dr. Young has over 20 years experience in fermentation and
biotechnology-based pharmaceutical process development and manufacturing. Dr.
Young received his Ph.D. in Chemical Engineering from the University of Michigan
and his M.S. in Chemical Engineering from Columbia University.

Stanley Falkow, Ph.D., has been a director of the Company since December
1991, a consultant to the Company since 1987 and a Distinguished Investigator
for the Company since 1991. Dr. Falkow has served as a Professor of
Microbiology, Immunology and Medicine at the Stanford University School of
Medicine since 1981. Dr. Falkow is a recipient of the Paul Erlich Prize from the
German Federal Republic and the Squibb Award of the Infectious Diseases Society
of America and is a member of the U.S. National Academy of Sciences and the
American Academy of Arts and Sciences. Dr. Falkow is also a director of GalaGen
Inc.

George M. Gould has been a director of the Company since October 1989. Mr.
Gould is of counsel to the law firm Crummy, Del Deo, Dolan, Griffinger &
Vecchione. From May 1996 to December 1996, Mr. Gould was a Senior Vice President
of PharmaGenics, Inc., a biotechnology company. Prior to that time Mr. Gould
served as Vice President of Licensing & Corporate Development and Chief Patent
Counsel for Roche from October 1989 to May 1996.

Max Link, Ph.D., has been a director of the Company since June 1993. Dr.
Link served as the Chief Executive Officer of Boehringer Mannheim --
Therapeutics from October 1993 to May 1994 and as the Chief Executive Officer of
Corange Ltd. from May 1993 to May 1994. Dr. Link served as the Chairman of
Sandoz Pharma Ltd. (now known as Novartis Pharma Ltd.) from April 1992 to April
1993. Dr. Link served in various management positions at Sandoz Ltd. (now known
as Novartis Ltd.) and Sandoz Pharmaceuticals Corporation (now known as Novartis
Pharmaceuticals Corporation) from October 1971 to April 1992. Dr. Link is also a
director of Access Pharmaceuticals, Inc., Alexion Pharmaceutical Inc., CytRx
Corp., Human Genome Sciences, Inc. and Procept, Inc.

SECTION 16(A) REPORTING

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Each director and each executive officer of the Company who is subject to
Section 16 of the Securities Exchange Act of 1934 is required by Section 16(a)
of such act to report to the Securities and Exchange Commission by a specified
date his or her transactions in the Company's securities. To the best of the
Company's knowledge, all reports relating to stock ownership and such other
reports required to be filed during 1996 under Section 16(a) by the Company's
directors and executive officers were timely filed, with the exception of the
Initial Statement of Beneficial Ownership of Securities on Form 3 for Dr.
Levitt, which form was filed late.

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ITEM 11. EXECUTIVE COMPENSATION

COMPENSATION OF EXECUTIVE OFFICERS

The following table sets forth information concerning the compensation of
the Chief Executive Officer of the Company and the four other most highly
compensated executive officers of the Company as of December 31, 1996 as well as
a former executive officer who is required to be identified herein ("Named
Executive Officers"), whose salary and bonus exceeded $100,000 for the fiscal
year ended December 31, 1996, during the fiscal years ended December 31, 1996,
1995 and 1994:

SUMMARY COMPENSATION TABLE

Long Term
Annual Compensation(1) Compensation
----------------------------- ---------------------------------
Awards
---------------------------------
Other
Annual Securities
Salary Compen- Restricted Underlying
Name and Principal Positions Year ($) sation($) Stock ($) Options (#)
- ----------------------------------------------------------- ---------------------------------

Laurence Jay Korn(2) 1996 356,220 -- -- 50,000
Chief Executive Officer 1995 320,300 -- -- --
1994 300,000 -- -- 150,000

Jon S. Saxe 1996 339,915 -- -- 35,000
President 1995 307,610 32,270(3) -- 150,000(4)
1994 -- -- -- --

Paul I. Nadler(5) 1996 281,575 -- -- 50,000
Vice President, Medical and 1995 275,675 -- -- --
Regulatory Affairs 1994 265,760 -- -- --

Cary L. Queen(6) 1996 256,220 -- -- 30,000
Senior Vice President and 1995 240,785 -- -- --
Vice President, Research 1994 225,000 -- -- 120,000

Douglas O. Ebersole(7) 1996 224,255 -- -- --
Vice President, Corporate 1995 201,905 -- -- 70,000
Services and Licensing, 1994 182,500 -- -- --
General Counsel and Secretary

Mark D. Young(8) 1996 218,720 -- -- --
Vice President, Technical 1995 167,640 -- -- 70,000
Operations 1994 -- -- -- --

- ---------------
(1) Compensation deferred at the election of the executive officer under the
Company's 401(k) Plan is included in the year earned. No bonuses were paid
in 1994, 1995 or 1996 to the named individuals and the bonus column is
omitted from the table.

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(2) Stock options granted in 1996 and 1994 to Dr. Korn were granted based on
his reaching his tenth and eighth anniversary dates of employment with the
Company in January 1997 and 1995, respectively.

(3) Amounts received as compensation in connection with Mr. Saxe's relocation
to the Company's headquarters office.

(4) Stock options were granted in 1994 to Mr. Saxe in connection with his
joining the Company as President in January 1995.

(5) Dr. Nadler resigned as an officer and employee of the Company in November
1996. Stock options granted to Dr. Nadler in 1996 did not vest.

(6) Stock options granted in 1996 and 1994 to Dr. Queen were granted based on
his reaching his tenth and eighth anniversary dates of employment with the
Company in January 1997 and 1995, respectively.

(7) Stock options granted in 1995 to Mr. Ebersole were granted based on his
reaching his third anniversary date of employment with the Company in July 1995.

(8) Stock options were granted in 1995 to Dr. Young in connection with his
joining the Company as Acting Head of Manufacturing in February 1995.

STOCK OPTIONS GRANTED IN FISCAL 1996

The following table provides the specified information concerning grants of
options to purchase the Company's Common Stock made during the fiscal year ended
December 31, 1996 to the persons named in the Summary Compensation Table:

OPTION GRANTS IN THE LAST FISCAL YEAR

Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants Option Term(4)
- ------------------------------------------------------------------ ------------------------

Number of % of Total
Securities Options Exercise
Underlying Granted to Or Base
Name Options(1,2) Employees in Price Expiration
Granted (#) Fiscal Year(%)($/Sh)(3) Date 5% ($) 10% ($)
- ------------------------------------------------------------------ ----------- ----------

Laurence Jay Korn 50,000 8.57 26.50 12/14/06 833,285 2,111,709
Jon S. Saxe 35,000 6.00 26.50 12/14/06 583,300 1,478,196
Paul I. Nadler -- -- -- -- -- --
Cary L. Queen 30,000 5.14 26.50 12/14/06 499,971 1,267,025
Douglas O.
Ebersole -- -- -- -- -- --
Mark D. Young -- -- -- -- -- --

- ---------------
(1) Options granted vest over a four year period at the rate of one-fourth
one year after the date specified at the time of grant (typically the hire date
or an anniversary of the hire date) and 1/48 per month thereafter for each full
month of the optionee's continuous employment with the Company. Only vested
shares are exercisable. Options granted to date have had terms of either six or
ten years. The Company has never granted any Stock Appreciation Rights and
references to this security are omitted.

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(2) Under the Option Plan, the Board retains some discretion to modify the
terms of outstanding options; see "Change of Control Arrangements."

(3) All options granted to employees were granted at market value on the date
of grant.

(4) Potential gains are net of exercise price, but before taxes associated
with exercise. These amounts represent certain assumed rates of appreciation
only, based on the Securities and Exchange Commission's rules. Actual gains, if
any, on stock option exercises are dependent on the future performance of the
Common Stock, overall market conditions and the optionholder's continued
employment through the vesting period. Any amounts reflected in this table may
not necessarily be achieved. As an example of the effects such assumed
appreciation would have on a stockholder's investment, one share of stock
purchased at $36.50 (December 31, 1996 closing price) in 1996 would yield
profits of $28.16 per share at 5% appreciation per year over ten years or $58.17
per share at 10% appreciation per year over the same period. The "potential
realizable values" in this table are calculated using the exercise price of the
stock options and assuming 5% or 10% appreciation per year from that price over
the term of the options granted.

OPTION EXERCISES AND FISCAL 1996 YEAR-END VALUES

The following table provides the specified information concerning exercises
of options to purchase the Company's Common Stock in the fiscal year ended
December 31, 1996, and unexercised options held as of December 31, 1996, by the
persons named in the Summary Compensation Table:

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END VALUES(1)

Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at 12/31/96(#)(2) at 12/31/96($)(3)
------------------------- ------------------------
Shares
Acquired
on Value
Exercise Realized
Name (#) ($) Unexercisable Exercisable Unexercisable Exercisable
- ------------------- ------------------ ------------------------- ------------------------

Laurence Jay Korn -- -- 128,125 171,875 2,101,562 3,723,437
Jon S. Saxe -- -- 113,125 101,625 1,863,672 2,236,078
Paul I. Nadler 51,083 674,165 -- -- -- --
Cary L. Queen -- -- 92,500 137,500 1,581,250 2,978,750
Douglas O.
Ebersole 13,000 232,375 45,208 59,792 695,078 1,396,172
Mark D. Young -- -- 37,917 32,083 782,031 661,719

- ---------------
(1) The Company has never granted any Stock Appreciation Rights and references
to this security are omitted.

(2) See footnote 1 of the "OPTION GRANTS IN THE LAST FISCAL YEAR" table for
information concerning the vesting provisions of these stock options.

(3) Based on a value of $36.50 which was the closing price of the Company's
Common Stock as of December 31, 1996.

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COMPENSATION OF DIRECTORS

As of December 31, 1996, each director who is not an employee of the
Company was authorized to receive cash compensation in the amount of $2,500 each
fiscal quarter, or such other amount as the Board may approve, and may be
reimbursed for expenses incurred in attending each Board and committee meeting.

As of December 31, 1996, the Company's Outside Directors Stock Option Plan
(the "Directors Plan") provided for the initial automatic grant of an option to
purchase 25,000 shares of the Company's Common Stock to each director of the
Company who is not an employee of the Company ("Outside Directors"). The
Directors Plan also provides for a subsequent grant to Outside Directors to
purchase 25,000 shares of Common Stock on the date five years from the date of
the initial grant; provided, however, that if the director was granted an option
under the Option Plan prior to February 14, 1992 (the date of adoption of the
Directors Plan), the subsequent grant shall be on the date five years from the
date of such grant. Options under the Directors Plan are granted at the fair
market value of the Company's Common Stock on the date of grant and vest as to
1/60 of the shares subject to the option per month until such time as the
optionee ceases to be a director for any reason. Options granted under the
Directors Plan to date had terms of either 6 or 10 years from the date of grant.

CHANGE OF CONTROL ARRANGEMENTS, TERMINATION OF EMPLOYMENT ARRANGEMENTS

Stock options issued to full-time employees under the Company's Option Plan
contain provisions pursuant to which an additional twenty five percent (25%) of
the total number of options subject to vesting under any oustanding employee
stock option agreement will vest if either (a) in connection with a "transfer of
control," an acquiring corporation fails to assume the outstanding option or to
substitute a substantially equivalent option for the acquiring corporation's
stock, or (b) within one year following a "transfer of control," the option
holder is either terminated by the Company or its successor without cause or
resigns from employment within a reasonable time following "constructive
termination."

Under the terms of the Directors Plan, in the event of the sale,
dissolution, or liquidation of the Company, or a merger or consolidation in
which the Company is not the surviving or resulting corporation or in which the
stockholders of the Company immediately before such event beneficially own,
directly or indirectly, less than 50% of the voting securities of the surviving
corporation immediately after such event, and if the surviving corporation does
not assume or substitute new options for the outstanding options, the Company's
Board may, but is not obligated to, provide that any unexercisable and/or
unvested portion of the outstanding options shall be immediately exercisable and
vested. Any options which are neither assumed nor substituted for by the
acquiring corporation nor exercised as of the date of the transfer of control
shall terminate effective as of the date of the transfer of control.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

George M. Gould served as a member of the Board's Compensation Committee
during the entire year ended December 31, 1996. Mr. Gould, a director of the
Company, was a member of the management of Hoffmann-La Roche Inc. until May
1996. In 1989, Roche entered into a stock purchase agreement and licensing
agreement with the Company for certain potential products. In addition, during
1996 the Company retained the law firm of Crummy, Del Deo, Dolan, Griffinger

68
69

& Vecchione, a law firm in which Mr. Gould is of counsel, to provide
representation on a small patent matter on behalf of the Company.

Laurence Jay Korn and Cary L. Queen, executive officers and directors of
the Company during the entire year ended December 31, 1996, were both also
executive officers and directors of Advanced Software of California, Inc.
(formerly Advanced Software, Inc.). During 1996, Advanced Software of
California, Inc. was a privately held company in which the Board of Directors
performed the same function as a compensation committee. Drs. Korn and Queen are
the only officers and directors of the Company who served as officers or
directors of Advanced Software of California, Inc. during the fiscal year ended
December 31, 1996. Neither Dr. Korn nor Dr. Queen served on the Compensation
Committee of the Board of Directors of the Company.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of December 31, 1996 by (i) each
person who is known by the Company, based on the records of the Company's
transfer agent and relevant documents filed with the U.S. Securities and
Exchange Commission ("SEC"), to own beneficially more than 5% of the outstanding
shares of the Company's Common Stock, (ii) each member of the Company's Board of
Directors, (iii) the Named Executive Officers, and (iv) all members of the Board
of Directors and executive officers of the Company as a group. Except as set
forth below, the address of each named individual is the address of the Company.

Name of Beneficial Owner or Group and Nature of Amount of Beneficial Percent of Common
Beneficial Ownership(1) Ownership Stock Outstanding
- -------------------------------------------------------------------------------------------

Corange International Limited 2,432,877 15.44%
22 Church Street
P.O. Box HM2026
Hamilton HM HX
Bermuda

LGT Asset Management, Inc.(2) 1,989,500 12.62
Chancellor LGT Asset Management, Inc.
Chancellor LGT Trust Company
50 California St., 27th Floor
San Francisco, CA 94111

Hoffmann-La Roche Inc. 1,321,418 8.39
340 Kingsland Street
Nutley, NJ 07110

FMR Corp.(2) 860,300 5.46
82 Devonshire Street
Boston, MA 02109

Cary L. Queen, Ph.D.(3) 881,750 5.54

69
70

Laurence Jay Korn, Ph.D.(4) 853,949 5.36

Jon S. Saxe(5) 127,688 *

Stanley Falkow, Ph.D.(6) 70,167 *

Douglas O. Ebersole(7) 64,069 *

Mark D. Young, Ph.D.(8) 36,228 *

George M. Gould(9) 22,666 *

Max Link, Ph.D.(10) 18,333 *

Paul I. Nadler, M.D.(11) 250 *

All directors and executive officers as a group 2,089,642 12.76%
(11 persons)(3,4,5,6,7,8,9,10,12)

- ---------------
* Less than 1%

(1) Except as indicated in the footnotes to this table, the persons named in
the table have sole voting and investment power with respect to all shares of
Common Stock shown as beneficially owned by them, subject to community property
laws where applicable.

(2) Based solely on information provided in Schedule 13G as filed with the SEC.

(3) Includes 145,000 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996. Also includes 1,600 shares held in trusts for the benefit of certain of
Dr. Queen's relatives with respect to which Dr. Queen disclaims beneficial
ownership.

(4) Includes 181,250 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996. Also includes 12,067 shares held as separate property by Dr. Korn's spouse
with respect to which Dr. Korn disclaims beneficial ownership.

(5) Includes 111,000 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996.

(6) Includes 25,167 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996.

(7) Includes 62,708 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996.

(8) Includes 35,000 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996.

70
71

(9) Includes 21,666 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996. Also includes 1,000 shares held for the benefit of Mr. Gould's daughter,
with respect to which Mr. Gould disclaims beneficial ownership.

(10) Includes 2,500 shares issuable upon the exercise of options which are
currently, or which will become, exercisable within 60 days after December 31,
1996.

(11) Dr. Nadler resigned as an officer and employee of the Company effective as
of November 1, 1996.

(12) Includes all directors and officers who served in that capacity as of
December 31, 1996 and includes 611,791 shares issuable upon the exercise of
options beneficially owned by directors and officers which are currently, or
which will become, exercisable within 60 days after December 31, 1996.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

During 1996, the Company paid Dr. Falkow, a director of the Company, a
total of approximately $60,800 in connection with his providing scientific
consulting services to the Company, which services included, among other
matters, assistance in establishing development priorities for the research
efforts of the Company and identifying the most promising clinical candidates
for advancement out of research and into development. In addition, the Company
has entered into negotiations with Dr. Falkow to increase his consulting
commitment to the Company and with Stanford University to provide funding for up
to three years for Dr. Falkow's laboratory at Stanford. The Company expects that
the funding commitment will involve financial support in an aggregate amount of
up to approximately $3 million over the three-year period.

In November 1996, the Company loaned to Dr. Levitt, an officer of the
Company, an aggregate of $90,000 at an annual interest rate of 6.60% pursuant to
a three-year promissory note. The terms of Dr. Levitt's note provide for, among
other matters, payment of accrued interest annually and forgiveness of one-third
of the principal amount on each anniversary date of his full-time employment
with the Company.

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72

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K

(a) The following documents are filed as part of this report:

(1) Index to financial statements

The following financial statements of the Company and the Report of the
Independent Auditors are included in Part II, Item 8.

Item Page

Balance Sheets 45
Statements of Operations 46
Statements of Stockholders' Equity 47
Statements of Cash Flows 48
Report of Ernst & Young LLP, Independent Auditors 58

(2) No financial statement schedules are required to be filed as
part of this Form 10-K by Regulation S-X. All other financial
statement schedules are omitted because the information is
inapplicable or presented in the Financial Statements or notes.

(3) The items listed on the Index to Exhibits on
page 74 are incorporated herein by reference.

(b) Reports on Form 8-K.

None.

(c) See (a)(3) above.

(d) See (a)(3) above.

72
73

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

PROTEIN DESIGN LABS, INC.
(Registrant)

By: /s/ LAURENCE JAY KORN
-------------------------------
Laurence Jay Korn,
Chief Executive Officer
and Chairperson of the Board
of Directors

February 13, 1997
--------------------------------
Date

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

Signature Title Date
- --------- -------------------------------------- ----

/s/ LAURENCE JAY KORN Chief Executive Officer and February 13, 1997
- ---------------------------- Chairperson of the Board of Directors
(Laurence Jay Korn) (Principal Executive Officer)

/s/ FRED KURLAND Vice President and February 13, 1997
- ---------------------------- Chief Financial Officer
(Fred Kurland) (Principal Accounting Officer)

/s/ CARY L. QUEEN Director February 13, 1997
- ----------------------------
(Cary L. Queen)

/s/ GEORGE M. GOULD Director February 13, 1997
- ----------------------------
(George M. Gould)

/s/ JON S. SAXE Director February 13, 1997
- -----------------------------
(Jon S. Saxe)

/s/ STANLEY FALKOW Director February 13, 1997
- -----------------------------
(Stanley Falkow)

/s/ MAX LINK Director February 13, 1997
- -----------------------------
(Max Link)

73
74

INDEX TO EXHIBITS

Exhibit
Number Exhibit Title Page No.
- ------- ------------- --------

3.1 Restated Certificate of Incorporation. (Incorporated by reference to
Exhibit 3.1 to Annual Report on Form 10-K filed March 31, 1993.)

3.2 Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3.1 to
Annual Report on Form 10-K filed March 31, 1995.)

4.1 Registration Rights Agreement between the Company and certain holders
of Preferred Stock and Common Stock, dated August 21, 1986.
(Incorporated by reference to Exhibit 4.1 to Registration Statement
No. 33-44562 effective January 28, 1992.)

4.2 Amendment to Registration Rights Agreement between the Company and
certain holders of Preferred Stock and Common Stock, dated March 16,
1989. (Incorporated by reference to Exhibit 4.2 to Registration
Statement No.
33-44562 effective January 28, 1992.)

4.3 Registration Rights Agreement between the Company and Hoffmann-La Roche
Inc., dated March 16, 1989. (Incorporated by reference to Exhibit 4.3 to
Registration Statement No. 33-44562 effective January 28, 1992.)

4.4 Standstill Agreement between the Company and Hoffmann-La Roche Inc., dated
March 16, 1989. (Incorporated by reference to Exhibit 4.4 to Registration
Statement No. 33-44562 effective January 28, 1992.)

4.5 Registration Rights Agreement between the Company and Corange
International Limited, dated October 28, 1993. (Incorporated by
Reference to Exhibit 4.5 to Annual Report on Form 10-K filed March
31, 1994.)

4.6 Standstill Agreement between the Company and Corange International
Limited, dated October 28, 1993. (Incorporated by Reference to
Exhibit 4.5 to Annual Report on Form 10-K filed March 31, 1994.)

4.7 Amendment No. 1 to Stock Purchase Agreement, Registration Rights Agreement
and Joint Development, Marketing and Licensing Agreement. (Incorporated
by Reference to Exhibit 5.2 to Current Report on Form 8-K filed December
15, 1994.)

*10.1 1991 Stock Option Plan, as amended on October 20, 1992 and June 15,
1995, together with forms of Incentive Stock Option Agreement and
Nonqualified Stock Option Agreements. (Incorporated by reference to
Exhibit 10.1 to Annual Report on Form 10-K filed March 31, 1996.)

*10.2 Founder Stock Purchase Agreement between the Company and Dr. Laurence Jay
Korn, dated August 21, 1986. (Incorporated by reference to Exhibit 10.3
to Registration Statement No. 33-44562 effective January 28, 1992.)

*10.3 Founder Stock Purchase Agreement between the Company and Dr. Cary Queen,
dated January 1, 1987. (Incorporated by reference to Exhibit 10.4 to
Registration Statement No. 33-44562 effective January 28, 1992.)

75

Exhibit
Number Exhibit Title Page No.
- ------- ------------- --------

*10.4 1986 Stock Purchase Plan. (Incorporated by reference to Exhibit 10.18 to
Registration Statement No. 33-44562 effective January 28, 1992.)

*10.5 Forms of Stock Purchase Agreement under the 1986 Stock Purchase Plan.
(Incorporated by reference to Exhibit 10.19 to Registration Statement No.
33-44562 effective January 28, 1992.)

*10.6 Outside Directors Stock Option Plan, together with form of
Nonqualified Stock Option Agreements. (Incorporated by reference to
Exhibit 10.31 to Annual Report on Form 10-K filed March 31, 1993.)

*10.7 1993 Employee Stock Purchase Plan. (Incorporated by reference to Exhibit
10.32 to Annual Report on Form 10-K filed March 31, 1993.)

*10.8 Letter Agreement between the Company and Saxe Associates, dated June
14, 1993 (with certain confidential information deleted and marked by
a box surrounding the deleted information). (Incorporated by
reference to Exhibit 10.9 to Annual Report on Form 10-K filed March
31, 1994.)

10.9 Lease Agreement between the Company and Charleston Properties, a
California general partnership, dated December 22, 1989. (Incorporated by
reference to Exhibit 10.5 to Registration Statement No. 33-44562 effective
January 28, 1992.)

10.10 First Amendment of Lease between the Company and Charleston
Properties, a California general partnership, dated August 31, 1992.
(Incorporated by reference to Exhibit 10.26 to Annual Report on Form
10-K filed March 31, 1993.)

10.11 Lease Agreement between the Company and Plymouth Business Center I
Partnership, a Minnesota general partnership, dated February 10,
1992. (Incorporated by reference to Exhibit 10.28 to Annual Report on
Form 10-K filed March 31, 1993.)

10.12 Amendment No. 1 to Lease Agreement between the Company and Plymouth
Business Center I Partnership, a Minnesota general partnership, dated July
8, 1993. (Incorporated by reference to Exhibit 10.14 to Annual Report on
Form 10-K filed March 31, 1994.)

10.13 License Agreement between the Company and the National Technical
Information Service effective as of October 31, 1988 (with certain
confidential information deleted and marked by a box surrounding the
deleted information). (Incorporated by reference to Exhibit 10.7 to
Registration Statement No. 33-44562 effective January 28, 1992.)

10.14 License Agreement between the Company and Hoffmann-La Roche Inc. effective
January 31, 1989 (with certain confidential information deleted and marked
by a box surrounding the deleted information). (Incorporated by reference
to Exhibit 10.8 to Registration Statement No. 33-44562 effective January
28, 1992.)

76

Exhibit
Number Exhibit Title Page No.
- ------- ------------- --------

10.15 License Agreement between the Company and F. Hoffmann-La Roche & Co.
effective January 31, 1989 (with certain confidential information deleted
and marked by a box surrounding the deleted information). (Incorporated
by reference to Exhibit 10.9 to Registration Statement No. 33-44562
effective January 28, 1992.)

10.16 License Agreement between the Company and the Medical Research
Council of the United Kingdom dated July 1, 1989, as amended on
January 30, 1990 (with certain confidential information deleted and
marked by a box surrounding the deleted information). (Incorporated
by reference to Exhibit 10.10 to Registration Statement No. 33-44562
effective January 28, 1992.)

10.17 Software License Agreement among the Company, Molecular Applications
Group and Michael Levitt effective September 1, 1990 (with certain
confidential information deleted and marked by a box surrounding the
deleted information). (Incorporated by reference to Exhibit 10.14 to
Registration Statement No. 33-44562 effective January 28, 1992.)

10.18 Development and License Agreement between the Company and Yamanouchi
Pharmaceutical Company, Ltd. effective February 12, 1991, as amended on
February 12, 1991 (with certain confidential information deleted and
marked by a box surrounding the deleted information). (Incorporated by
reference to Exhibit 10.16 to Registration Statement No. 33-44562
effective January 28, 1992.)

10.19 Form of Director and Officer Indemnification Agreement. (Incorporated by
reference to Exhibit 10.1 to Registration Statement No. 33-44562 effective
January 28, 1992.)

10.20 Stock Purchase Agreement between the Company and certain holders of
Preferred Stock and Common Stock dated August 21, 1986. (Incorporated
by reference to Exhibit 10.22 to Registration Statement No. 33-44562
effective January 28, 1992.)

10.21 Stock Purchase Agreement between the Company and Hoffmann-La Roche Inc.
dated March 16, 1989. (Incorporated by reference to Exhibit 10.25 to
Registration Statement No. 33-44562 effective January 28, 1992.)

10.22 Agreement for Purchase and Sale of Assets between the Company and
Helix BioCore, Inc., a Minnesota corporation, dated February 10,
1992. (Incorporated by reference to Exhibit 10.27 to Annual Report on
Form 10-K filed March 31, 1993.)

10.23 Agreement between the Company and Kanebo, Ltd., a Japanese
corporation, dated February 29, 1992. (Incorporated by reference to
Exhibit 10.29 to Annual Report on Form 10-K filed March 31, 1993.)

10.24 Letter dated November 4, 1992 amending the License Agreement between
the Company and Hoffmann-La Roche Inc. effective January 21, 1989.
(Incorporated by reference to Exhibit 10.30 to Annual Report on Form
10-K filed March 31, 1993.)

10.25 Asset Purchase and License Agreement among the Company, Sandoz Pharma
Ltd. and Sandoz Pharmaceuticals Corporation, dated April 13, 1993
(with certain confidential information deleted and marked by a box
surrounding the deleted

77

information). (Incorporated by reference to Exhibit 5.1 to Current
Report on Form 8-K filed April 28, 1993.)

Exhibit
Number Exhibit Title Page No.
- ------- ------------- --------

10.26 License Agreement among the Company, Sandoz Pharma Ltd. and Sandoz
Ltd., dated April 13, 1993 (with certain confidential information
deleted and marked by a box surrounding the deleted information).
(Incorporated by reference to Exhibit 5.2 to Current Report on Form
8-K filed April 28, 1993.)

10.27 Letter dated October 21, 1993 amending the Asset Purchase and License
Agreement among the Company, Sandoz Pharma Ltd. and Sandoz
Pharmaceuticals Corporation, dated April 13, 1993 (with certain
confidential information deleted and marked by a box surrounding the
deleted information). (Incorporated by reference to Exhibit 10.31 to
Annual Report on Form 10-K filed March 31, 1994.)

10.28 Amended and Restated Agreement between the Company and
Sloan-Kettering Institute for Cancer Research, dated April 1, 1993
(with certain confidential information deleted and marked by a box
surrounding the deleted information). (Incorporated by reference to
Exhibit 10.32 to Annual Report on Form 10-K filed March 31, 1994.)

10.29 Stock Purchase Agreement between the Company and Corange
International Limited, dated October 28, 1993. (Incorporated by
reference to Exhibit 5.1 to Current Report on Form 8-K filed November
12, 1993.)

10.30 Joint Development, Marketing and License Agreement between the
Company and Corange International Limited, dated October 28, 1993
(with certain confidential information deleted and marked by a box
surrounding the deleted information). (Incorporated by reference to
Exhibit 5.2 to Current Report on Form 8-K filed November 12, 1993.)

10.31 License Agreement between the Company and The Board of Trustees of
Leland Stanford Junior University effective as of June 30, 1993 (with
certain confidential information deleted and marked by a box
surrounding the deleted information). (Incorporated by reference to
Exhibit 10.35 to Annual Report on Form 10-K filed March 31, 1994.)

10.32 Lease Agreement between the Company and Bio-Shore Holdings, Ltd. dated as
of May 16, 1994 (Incorporated by reference to Exhibit 10.1 to Quarterly
Report on Form 10-Q filed August 2, 1994.)

10.33 Amendment No. 2 to Lease Agreement between the Company and St. Paul
Properties, effective as of October 25, 1994. (Incorporated by reference
to Exhibit 10.36 to Annual Report on Form 10-K filed March 31, 1995.)

10.34 Amendment No.1 to Lease Agreement between the Company and Bio-Shore
Holdings, Ltd. dated as of October 17, 1994. (Incorporated by reference to
Exhibit 10.38 to Annual Report on Form 10-K filed March 31, 1995.)

10.35 Patent License Agreement between the Company and Celltech Limited
dated as of September 30, 1994 (with certain confidential information
deleted and marked by a

78

box surrounding the deleted information). (Incorporated by
reference to Exhibit 10.39 to Annual Report on Form 10-K filed March
31, 1995.)

10.36 Amendment No. 2 to Joint Development, Marketing and Licensing
Agreement between the Company and Boehringer Mannheim GmbH dated and
effective as of November 7, 1995 (with certain confidential
information deleted and marked by a box surrounding the deleted
information). (Incorporated by reference to Exhibit 10.37 to Annual
Report on Form 10-K filed March 31, 1996.)

Exhibit
Number Exhibit Title Page No.
- ------- ------------- --------

10.37 Development and License Agreement between the Company and an Unnamed
Japanese Pharmaceutical Company dated December 28, 1995 (with certain
confidential information deleted and marked by a box surrounding the
deleted information). (Incorporated by Reference to Exhibit 10.38 to
Annual Report on Form 10-K filed March 31, 1996.)

10.38 Amendment No. 3 to Joint Development, Marketing and Licensing
Agreement between the Company and Boehringer Mannheim GmbH dated and
effective as of May 31, 1996 (with certain confidential information
deleted and marked by a box surrounding the deleted information).
(Incorporated by Reference to Exhibit 10.1 to Quarterly Report on
Form 10-Q filed August 14, 1996.)

10.39 Amendment No. 3 to Lease Agreement between the Company and St. Paul
Properties, effective as of November 27, 1996.

24.1 Consent of Ernst & Young LLP, Independent Auditors.

27.1 Financial Data Schedule.

- ------------------
*Management contract or compensatory plan or arrangement.