Back to GetFilings.com

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission File Number: 0-19756

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

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

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

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

        The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the average bid and ask price of the common stock on June 30, 2003, as reported on the NASDAQ National Market System, was approximately $1,291,200,000.

        As of January 30, 2004, the registrant had outstanding 93,936,069 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

        None.

        This Annual Report (including all of its Parts) for Protein Design Labs, Inc. includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are "forward looking statements" for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or services, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and for the reasons described elsewhere in this Annual Report. All forward-looking statements and reasons why results may differ included in this Annual Report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

        As used in this Annual Report, the terms "we," "us," "our," the "Company" and "PDL" mean Protein Design Labs, Inc. and its subsidiaries (unless the context indicates a different meaning).

        Protein Design Labs, Nuvion, and Humanizing Science are registered U.S. trademarks, and the PDL logo and HuZAF are trademarks of Protein Design Labs, Inc. Zenapax is a registered U.S. trademark of Hoffmann-La Roche and affiliates (Roche). All other company names and trademarks included in this Annual Report are trademarks, registered trademarks or trade names of their respective owners.

ITEM 1. BUSINESS

OVERVIEW

        We are a recognized leader in the discovery and development of humanized monoclonal antibodies for the treatment of disease. Our patented antibody humanization technology is applied to promising mouse antibodies. By making certain modifications to the mouse antibody that make it more like a human antibody, our technology enhances the utility of such antibodies, while retaining their biological activity, for human therapeutic use. We believe our technology for the creation of humanized therapeutic monoclonal antibodies is the most widely validated in our industry. As of December 31, 2003, a total of six marketed products were licensed under our humanization patents and we are aware of at least approximately 40 humanized antibodies in clinical stage development worldwide by various pharmaceutical and biotechnology companies. Most of these humanized antibodies are potentially covered under patent agreements with PDL.

        Since our founding in 1986, we have actively licensed our antibody humanization technology to, and performed humanization services for, pharmaceutical and biotechnology partners. To date, we have entered into numerous patent licensing agreements, and the resulting fees, milestones and related royalty revenues currently are the primary source of our revenues. In 2003, we recognized total royalties exceeding $52 million on five licensed antibody products. Licensed antibody products for which we have recognized revenue in 2003 include Zenapax®, Mylotarg®, Synagis®, Herceptin® and Xolair®. Zenapax, Mylotarg and Synagis are marketed by Roche, Wyeth, and MedImmune, respectively, and Herceptin and Xolair are marketed by Genentech, Inc. (Genentech) and Genentech's partners. Additionally, Genentech has exercised licenses for its Raptiva™ and Avastin™ antibody products, which

2

were approved, by the U.S. Food and Drug Administration (FDA) in October 2003 and February 2004, respectively. As royalty revenue is recognized one quarter following the quarter in which sales occurred, wewill receive royalties on sales of Raptiva beginning in the first quarter of 2004 and on sales of Avastin in the second quarter of 2004.

        We are leveraging our expertise in antibody humanization to become a fully integrated biopharmaceutical company that creates, develops, manufactures and in North America, markets, proprietary biopharmaceutical products. Toward that end, we currently have four antibodies in clinical development for various disease indications with a near-term emphasis on autoimmune diseases, in particular inflammatory bowel disease, or IBD, and cancer. For each product in clinical development, we conduct multiple activities, including preclinical studies, process development and antibody manufacturing at our facilities in Fremont, California and Plymouth, Minnesota. Revenues generated by our licensing activities and related royalties have contributed to our ability to significantly offset internal development costs associated with developing our proprietary antibody product candidates.

        Based on the strength of our proprietary platform, the number of antibody programs we have in development and the flexibility provided by our current financial position, our goal for our existing pipeline is to initiate at least one pivotal clinical trial by 2005 and, if successful, to launch our first PDL-developed proprietary product into the North American market by the end of 2007. We currently believe that we would be able to achieve positive cash flow based upon revenues from our product sales. Since our goal is to launch our first product or products into the North American market by 2007, our ability to achieve this cash-flow positive position would not occur sooner than that, if we were successful.

BUSINESS AND COMMERCIALIZATION STRATEGY

        Our current business strategy is to transition from a company dependent on licensing activities, humanization services and royalties as the primary source of revenues to a commercial enterprise that derives the majority of its revenues from sales of its proprietary products.

        During 2003, we established initiatives and implemented activities to further improve our capabilities in support of the longer-range objective of marketing a proprietary drug in North America by 2007. In research, we made significant progress in increasing productivity from our ongoing discovery efforts to derive a steady flow of new antibody candidates available for development. In clinical development, we have defined a clear set of product requirements for each step of the development process, with broader and more experienced teams managing these efforts.

        As a result of our efforts to refine our clinical development programs, our near-term pipeline now is focused on the two most prevalent inflammatory bowel disease subtypes, ulcerative colitis and Crohn's disease. In terms of potential timeline for registration, our two most advanced clinical-stage programs are Nuvion (visilizumab) for potential treatment of severe steroid-refractory ulcerative colitis, and daclizumab for potential treatment of moderate-to-severe ulcerative colitis. Additionally, in 2003, we reacquired rights from Roche to market and manufacture the daclizumab (Zenapax®) humanized antibody in indications other than transplantation, and we obtained an option to acquire rights in transplant indications no later than 2007 and as early as 2005 at the election of Roche. We believe that the market potential for daclizumab could be expanded beyond transplantation through potential development of this already-marketed antibody in IBD and other autoimmune or inflammatory disease indications, such as multiple sclerosis (MS) and asthma.

        We believe our current clinical development programs address areas of significant unmet medical need that could, at least in North America, effectively be serviced with a relatively small sales force. If our programs are successful in later stage trials, and subsequently gain regulatory approval for therapeutic use in the United States and Canada, we hope to create by 2007 a North American sales and marketing operation related to our core therapeutic focus in inflammatory bowel disease. We also

3

expect to develop a PDL sales and marketing capability in transplantation in connection with the anticipated reversion of rights to manufacture and market daclizumab, and we believe such infrastructure would be complementary to our potential marketing needs as they relate to Nuvion for severe ulcerative colitis.

        We have retained worldwide rights to the products we are currently developing. While our goal is to market our products in North America, for all our products in development, we may out-license rights, even within the United States, to other biotechnology or pharmaceutical companies with respect to certain indications requiring specific expertise or large development and marketing efforts, such as MS or some oncology indications. In addition, we may receive upfront fees, milestone payments and/or other types of funding, in addition to possible royalties or other profit-sharing arrangements on any product sales by such marketing partners.

PDL PRODUCTS IN CLINICAL STAGE DEVELOPMENT

        The following table summarizes the potential therapeutic applications and development status for our clinical development programs. Not all clinical trials for each program are listed. The development and commercialization of our product candidates are subject to numerous risks and uncertainties, as noted in our "Risk Factors."

*

Investigator-sponsored trial.

        Daclizumab (Zenapax, anti-IL-2 receptor).    The FDA approved daclizumab in December 1997 for the prevention of acute kidney transplant rejection, making it the first humanized antibody to be approved anywhere in the world. It has since been approved in Europe and a number of other countries. Our licensee, Roche, sells Zenapax in the United States, Europe and other territories for the kidney transplant indication and we receive royalties on Zenapax sales.

        Effective October 2003, we amended our 1999 collaborative agreement with Roche and now have exclusive worldwide rights to market, develop, manufacture and sell daclizumab in all disease indications other than transplantation. Roche currently is expected to continue to market Zenapax in transplantation indications until 2007, although an earlier transfer to us of rights in transplantation may occur at Roche's election upon six months' written notice.

        In connection with the new arrangement, we paid Roche $80 million in cash for return of exclusive rights in indications other than transplantation, and we obtained an option to acquire rights in transplant indications no later than 2007 and as early as 2005 at the election of Roche. To effectuate the transfer of Zenapax in the transplantation indications, we will pay an additional exercise fee to Roche based on the average annual gross sales of Zenapax during the period from January 1, 2004,

4

through either the calendar quarter prior to the date of notice of the exercise, or Roche's notice of its decision to transfer the rights to us prior to our exercise date. If we do not receive transplantation rights, we would pay modest royalties to Roche on any sales in all diseases other than transplantation, and we would continue to receive royalties on sales of Zenapax in transplantation.

        Daclizumab binds to the interleukin-2 (IL-2) receptor on immune system cells known as T cells. IL-2 is a lymphokine, one of the substances released by cells as part of the normal immune response as well as in certain autoimmune diseases and often following organ transplants. IL-2 stimulates T cells to divide and participate in an immune response. Daclizumab blocks the binding of IL-2 to its receptor on T cells, suppressing an immune response by inhibiting the proliferation of activated T cells.

        We are evaluating daclizumab in a Phase II clinical study, initiated in the second quarter of 2003, in patients with moderate-to-severe ulcerative colitis. This randomized, placebo-controlled Phase II clinical trial was fully enrolled by the end of December 2003 with more than 150 patients randomized, and we currently anticipate that results will be available by the end of the second quarter of 2004.

        In addition to our work in ulcerative colitis, a Phase II trial of daclizumab in severe asthma is fully enrolled. We expect to report results from this trial in March 2004 at the American Academy of Allergy, Asthma & Immunology (AAAAI) meeting. This Phase II randomized, double blind, placebo-controlled clinical trial enrolled 116 patients who suffer from chronic, persistent asthma and whose disease is not well controlled with high doses of inhaled corticosteroids. Objectives of the study are to obtain safety and preliminary efficacy data.

        In a pilot study conducted in 2002 and 2003 through the National Institutes of Health, daclizumab was evaluated in combination with interferon-beta therapy in patients with relapsing-remitting multiple sclerosis (MS) who had partially or completely failed to respond to interferon-beta therapy. In that study, daclizumab was well tolerated and led to a greater than 75% reduction in inflammatory activity in the majority of patients, as measured by reduction in contrast-enhanced MRI-scanned lesions. We believe that the resources and market expertise of a collaborative partner experienced in MS could facilitate the late-stage development and marketing of daclizumab in this indication. Consequently, we are seeking to establish a collaboration with such a partner for development of daclizumab in MS.

        Daclizumab also is being evaluated in investigator-sponsored studies for uveitis, type I diabetes, aplastic anemia and the ocular manifestations of Behcet's disease. We are not currently planning to pursue registration for these indications; however, additional clinical studies may be conducted by our licensee, Roche, or by physician investigators.

        Nuvion (visilizumab, anti-CD3).    Visilizumab is in Phase I/II clinical studies in patients with severe ulcerative colitis that is refractory to treatment with intravenous steroids. This humanized non-FcR binding monoclonal antibody is directed at the CD3 antigen on activated T cells. Increasing evidence implicates T lymphocytes as the primary immune cells mediating the induction and progression of inflammatory bowel disease. While the mechanism of action of visilizumab in ulcerative colitis is still being characterized in ongoing studies, early research has demonstrated that visilizumab induces selective programmed cell death of activated, but not resting T cells in vitro, which may provide therapeutic benefit in ulcerative colitis.

        In May 2003, we reported partial, preliminary results from a Phase I study in patients with severe ulcerative colitis. The clinical safety profile was reported as satisfactory to date, and evidence of activity was observed in the initial dose cohort of eight patients, given at 15 µg/kg on days 1 and 2. All eight patients responded to treatment and seven of eight achieved remission. The median duration of response was seven months. Following the initial cohort of eight patients, subsequent patients have received 10 µg/kg on days 1 and 2. A significant signal of clinical activity has been observed in the patients treated at this dose, and more than half of the patients monitored beyond day 60 have had a durable remission following treatment. The visilizumab Phase I study is now closed to further

5

enrollment with 32 patients enrolled. An abstract describing this study has been accepted for oral presentation at the May 2004 Digestive Disease Week meeting.

        Having seen a strong signal of activity in the initial Phase I study, we are exploring a range of doses to potentially improve further the risk/benefit profile of visilizumab in ulcerative colitis. We initiated a Phase I/II trial of visilizumab in the same refractory patient population in the fourth quarter of 2003. In this study, we expect to explore four dose levels from 5 µg/kg to 12.5 µg/kg given intravenously on days 1 and 2 as a bolus injection. Following the Phase I portion of the study, up to an additional 20 patients will be treated in the Phase II portion.

        Because these severely ill patients have limited treatment options, we believe that the Phase I and Phase I/II studies may serve as the basis for discussions with regulatory agencies regarding the design of trials that may be appropriate for submission in support of a Biologics License Application (BLA) filing. We anticipate that such registrational trials could begin in the first half of 2005 and that the filing of a regulatory submission could occur by the end of 2006. The timing of such trials and regulatory filing are subject to significant uncertainties. We also plan to investigate other potential uses for Nuvion if we make additional progress in ulcerative colitis.

        In June 2003, we discontinued our studies aimed at the treatment of steroid-refractory graft-versus-host disease (GvHD) following bone marrow transplantation as a potential indication for visilizumab. Accrual to a multi-institution Phase II trial, previously acknowledged as slow in accruing, was stopped. While most patients had improvement in symptoms of GvHD, the treatment with visilizumab was not, on average, associated with a significant prolongation of survival compared to historic controls.

        HuZAF (fontolizumab, anti-gamma interferon).    This humanized antibody has enrolled two Phase II studies in a total of approximately 300 patients with Crohn's disease, a form of inflammatory bowel disease. Fontolizumab targets gamma interferon, a protein that stimulates several types of white blood cells and that has been shown by academic researchers to play a role in certain autoimmune diseases. We have completed two Phase I trials of anti-gamma interferon in normal volunteers, which indicated that the antibody is well tolerated and has biological activity. We also completed a Phase I/II trial in patients with Crohn's disease. Data from the single-dose portion of this trial was difficult to interpret due to a high rate of response in the placebo group.

        These two randomized, placebo-controlled, double blind Phase II trials are designed to better define the activity of this antibody in Crohn's disease. The first trial enrolled 201 patients and explores an initial intravenous dose of fontolizumab given as 1 mg/kg or 4 mg/kg, followed by additional lower subcutaneous doses. In the second trial, patients received up to two intravenous doses of fontolizumab given at 4 mg/kg or 10 mg/kg. A total of 133 patients have entered the study. We expect to report results from both Phase II trials of fontolizumab in Crohn's disease in May 2004 during the Digestive Disease Week meeting.

        Results of a Phase I/II trial of subcutaneous administration of fontolizumab in psoriasis were reported in November 2003. We do not currently plan to pursue fontolizumab for a registration in psoriasis, but continue to perform exploratory studies that may be helpful in optimizing dosing regimens in other diseases.

        In the future, we may initiate clinical trials of fontolizumab in other autoimmune diseases, including systemic lupus and rheumatoid arthritis.

        M200 (anti-a5b1 integrin antibody).    We obtained the anti-a5b1 integrin antibody program in connection with our April 2003 acquisition of Eos Biotechnology, Inc. (Eos). This chimeric antibody is in Phase I clinical studies for advanced solid tumors. M200 is a direct anti-endothelial cell antibody that inhibits angiogenesis. Agents that inhibit angiogenesis are intended to block formation of blood vessels in tumors, thereby leading to slower tumor growth, cell death or inhibition of metastasis. M200 targets

6

the activated subset of endothelial cells. These activated cells are found in the lining of blood vessels undergoing angiogenesis, and by inhibiting the binding of fibronectin to a5b1 integrin receptors, angiogenesis is inhibited. In vitro studies have shown that the antibody inhibits angiogenesis, including vessel formation induced by vascular endothelial growth factor (VEGF), basic fibroblast growth factor (bFGF), as well as other pro-angiogenic growth factors. As a result, the antibody may prove effective in treating tumors in which one or more growth factors contribute to angiogenesis.

        We are currently conducting a Phase I clinical trial of M200, initiated in May 2003, in patients with advanced solid tumors for whom there is no standard treatment. The primary study objective is to define the safety profiles associated with the antibody. The Phase I trial is expected to be completed by mid-2004, and Phase II trials are anticipated to begin by the end of 2004, again in patients with advanced solid tumors, including pancreatic or kidney cancers.

PDL PRODUCTS IN PRECLINICAL STAGE DEVELOPMENT

        F200 (anti-a5b1 integrin antibody fragment).    F200 is an anti-a5b1 integrin antibody fragment currently in preclinical development for certain ocular indications, including age-related macular degeneration. We currently anticipate that an Investigative New Drug application (IND) could be filed for this antibody in early 2005. However, we believe that it will facilitate the development and possible commercialization of this molecule if we obtain a committed and experienced ophthalmic development and marketing partner. Development progress may be affected by potential partnering discussions or commitment of resources to more advanced programs.

        Other Preclinical Programs.    We are evaluating a number of additional therapeutic antibody candidates, at earlier stages of development, that may be useful for the treatment of autoimmune diseases and cancer. These include antibodies to targets such as the chemokine IP10, that may be involved in inflammatory bowel diseases; Pr1, an antibody-drug conjugate that may be useful for the treatment of prostate cancer; numerous additional targets that may lead to therapeutics for the treatment of diseases such as ulcerative colitis, Crohn's disease, rheumatoid arthritis, breast cancer, ovarian cancer and lung cancer.

RECENTLY TERMINATED CLINICAL PROGRAMS

        Anti-IL-4 Antibody.    We licensed the anti-IL-4 humanized antibody, for the potential treatment of asthma and allergy, from SmithKline Beecham, now GlaxoSmithKline plc (GSK), in 1999. We reported data in May 2003 from a Phase IIa clinical trial of the humanized anti-IL-4 antibody in steroid-naïve, mild/moderate asthma patients. The antibody was well tolerated, but did not demonstrate clinical benefit compared to placebo at either of the dose levels tested. Upon our decision to not conduct additional clinical studies of the humanized anti-IL-4 antibody, we returned the program to GSK.

        Anti-IL-12 Antibody.    Interleukin-12 (IL-12) is a cytokine with potential as a target in the treatment of a number of autoimmune diseases. Our Phase I trial in normal volunteers was completed; however, new data on the emerging role of IL-23 in MS led to a decision to cease further development of our antibody. In December 2003, we entered into a licensing agreement with Abbott Laboratories, Inc. (Abbott) that provides Abbott certain exclusive rights to intellectual property related to antibodies capable of binding to IL-12 or its receptor. The licensed rights are not related to our humanization technology. The Abbott antibody licensed under this arrangement is currently in Phase I/II clinical development. We received an upfront licensing fee, and may receive development milestone payments and royalties on future sales of antibodies developed by Abbott against IL-12. We initially licensed certain intellectual property related to anti-IL-12 therapy from Roche and will share with Roche a portion of all amounts received.

7

CURRENT SOURCES OF REVENUES

        Royalties.    We license our patents covering numerous humanized antibodies in return for license fees, annual maintenance payments and royalties on product sales. Seven of the eight humanized antibodies currently approved by the FDA are licensed under our patents and five of these licensed products generated royalties to PDL that were recognized in 2003: Genentech's Herceptin and Xolair; MedImmune's Synagis; Wyeth's Mylotarg; and Roche's Zenapax. Combined worldwide sales of these products exceeded $1.3 billion in 2003. Additionally, Genentech has exercised licenses for its Raptiva™ and Avastin™ antibody products, which were approved by the FDA in October 2003 and February 2004, respectively. As royalty revenue is recognized one quarter following the quarter in which sales occurred, we will receive royalties on sales of Raptiva beginning in the first quarter of 2004 and on sales of Avastin in the second quarter of 2004.

        Patent licensing, humanization agreements and outlicensing.    We have patent license or patent rights agreements with numerous other companies for humanized antibodies they are developing, and we will seek to enter into additional agreements on an ongoing basis.

        We humanize antibodies for other companies in return for upfront fees, milestone payments and royalties on any product sales. In some cases, we also receive the right to co-promote these products in designated territories.

        In addition, we are seeking to out-license marketing rights for certain antibodies in some geographical areas to other biotechnology or pharmaceutical companies, and may receive upfront fees, milestone payments and/or other types of funding, in addition to possible royalties or other profit-sharing arrangements on any product sales by our licensees.

OUR TECHNOLOGY

Antibody Background Information

        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, or due to an irregular autoimmune response. B cells produce millions of different kinds of antibodies, which have slightly different shapes that enable them to bind and, as a result, inactivate different targets. Antibodies that have 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 range of targets, including targets to which the human body does not normally produce antibodies. Specifically, many mouse antibodies have been developed as potential therapeutics to inhibit immune function, destroy cancer cells or neutralize viruses.

        Although mouse monoclonal antibodies are relatively easy to generate, they have significant drawbacks as therapeutics. Mouse antibodies have a relatively short half-life in human patients, requiring them to be administered frequently. In addition, mouse 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 humans, a mouse antibody is usually recognized by the body's immune system as foreign. The immune system therefore responds with a human anti-mouse antibody, or HAMA, response, which rapidly neutralizes the mouse antibody and renders it ineffective for further therapy. These problems have largely prevented mouse antibodies from fulfilling their promise as therapeutics.

        More recently, improved forms of antibodies, such as humanized, human and chimeric antibodies, have been developed using recombinant DNA and other technologies. These new antibodies can minimize or avoid many of the problems associated with mouse antibodies and have led to a

8

resurgence of interest in antibody therapeutics by the pharmaceutical and biotechnology industries. As a result of these advances, many monoclonal antibodies are now progressing into clinical trials. In particular, we are aware of approximately 40 humanized antibodies in clinical trials, including several antibodies addressing large markets. Fourteen human, humanized or chimeric antibodies have already been approved for marketing by the FDA, of which seven are humanized and licensed under our patents.

Our Antibody Technology Platform

        Our proprietary antibody technology platform has positioned us as a leader in the development of therapeutic antibodies that overcome many of the problems associated with mouse antibodies. Using our patented approach, "humanized" antibodies are designed to retain biological activity of mouse antibodies while incorporating human-like traits, which enhance the utility of such antibodies for human therapeutic use. Clinical trials and preclinical studies have shown that our humanized antibodies have the desired human-like antibody characteristics, low immunogenicity and a usefully long half-life, coupled with the important target-binding activity of a mouse-derived antibody.

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

        Our antibody technology platform creates a humanized antibody designed by using our proprietary software to guide the choice of substitutions of amino acids from the original mouse antibody into the human antibody framework, based on structural information derived from the original mouse antibody. The construction of a humanized antibody starts with the identification of a mouse antibody that has demonstrated favorable results in laboratory, animal or human studies. A model of the mouse 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 key amino acids in the framework most responsible for maintaining the shape of CDRs. Software we developed as well as the experience of our computational chemists is important in this analysis. These key mouse amino acids are substituted into the human antibody framework along with mouse CDRs in order to maintain their ability to bind well to the target. The resulting humanized antibody retains most or all of the binding ability of the mouse antibody, but typically is between 85% and 95% human.

OUR RESEARCH

        Our research efforts are focused on creating and developing humanized antibodies for the treatment of autoimmune diseases, inflammatory conditions and cancer. Following our acquisition of Eos in April 2003, we significantly restructured and redefined our research to combine the target and biology expertise of Eos with the advanced protein engineering skills of PDL, with the aim of generating an average of one new antibody IND candidate per year after 2004. We have significant research activities aimed at the discovery of new antibodies and utilize various state-of-the-art research tools intended to optimize the efficiency of antibodies that may be useful for the treatment of certain diseases. These activities are intended to provide antibody product candidates for further preclinical

9

and clinical development in our core disease areas. We use a variety of sophisticated methods to discover these targets. In addition, we have obtained or in-licensed targets, or rights to targets or antibodies, through collaborative research agreements, from academic institutions or other biotechnology or pharmaceutical companies. We may in-license rights to additional targets or antibodies in the future.

        We are also engaged in efforts to validate targets that result from our own discovery efforts, our collaborations and in-licensing, which include evaluating antibodies against these targets in a number of different in vitro and in vivo assays. The purpose of these validation activities is to determine which antibodies have sufficiently potent biological activities for us to humanize them using our proprietary technology and subsequently enter them into preclinical testing and clinical development.

        We conduct additional research activities intended to improve the general characteristics of antibodies that are used as human therapeutics. As examples, we are examining factors which influence the interaction of antibodies with other components of the human immune system and factors which influence the duration of circulation of antibodies in humans, with the aim of engineering antibodies with even more favorable biological characteristics.

OUR ANTIBODY MANUFACTURING

        Antibodies for use as human therapeutics are generally manufactured through the culture of mammalian cell lines, which produce the antibodies. We maintain facilities and personnel in California and Minnesota for the production and characterization of such cell lines. We also engage in process development activities intended to improve the productivity and other characteristics of such cell lines. We believe our knowledge and capabilities in this area provide a significant degree of competitive advantage over those companies that currently lack such fully integrated operations. In particular, we have over a decade of manufacturing experience based upon a serum-free and protein-free production process, and we believe that this approach is a significant competitive advantage.

        We manufacture antibodies for use as clinical trial material in an approximately 90,000 square-foot manufacturing facility in Plymouth, Minnesota, which we have leased since 1992. We currently manufacture visilizumab, fontolizumab and other preclinical antibodies in that facility. We renovated this facility in late 2002 and early 2003 to make it potentially licensable by regulatory agencies in the United States and other countries for supply of commercial antibodies. We completed initial validation of the renovated facility and resumed manufacturing of antibodies in the first half of 2003.

        We are constructing a new commercial manufacturing facility in Brooklyn Park, Minnesota, approximately nine miles from our Plymouth location. Physical construction is expected to be completed late in 2004, which will be followed by validation and start-up activities. We currently expect to be able to produce antibodies for clinical use from this facility by 2006 and for commercial sale from this facility in 2007. Antibodies currently in our clinical-stage pipeline that may be made in this facility include visilizumab, fontolizumab, daclizumab, and the anti-a5b1 integrin antibody.

HUMANIZATION AND PATENT LICENSING RIGHTS AGREEMENTS

        We have entered into patent license agreements with numerous companies that are independently developing humanized antibodies, including Abbott Laboratories, Biogen Idec, Celltech, Chugai, Elan Pharmaceuticals, Genentech, Medarex, MedImmune, Merck KGaA, Sankyo, Seattle Genetics, and Wyeth. In each license agreement, we granted a worldwide, exclusive or nonexclusive license under our patents to the other company for antibodies to a specific target antigen. In general, we received an upfront licensing fee, and rights to receive annual maintenance fees and royalties on any product sales. Under some of these agreements, we also may receive milestone payments. In addition, we have entered into patent rights agreements with Celltech, Genentech, GlaxoSmithKline (GSK), MedImmune, Millennium Pharmaceuticals and Tanox. Under these agreements, licensees currently purchase a

10

research license, in exchange for an upfront fee, and a right to obtain, in exchange for consideration separate from the upfront fee, patent licenses for commercial purposes for a specified number of target antigens. Our patent rights agreements with Celltech and Genentech also give us rights to purchase licenses under certain of their patents. We have also entered into agreements to use our technology to humanize antibodies for other companies, including Ajinomoto, Fujisawa Pharmaceuticals, Eli Lilly, InterMune Pharmaceuticals, Mochida Pharmaceutical, Progenics Pharmaceuticals, Teijin, Wyeth and Yamanouchi Pharmaceutical. In general, we received an upfront licensing fee, and rights to receive additional payments upon the achievement of certain milestones and royalties on any product sales.

        We continue to pursue discussions with companies involved in antibody research and development and may enter into additional patent license, patent rights and humanization agreements from time to time.

        In August 2003, we reported that Genentech had advised us that it had determined that the Xolair antibody product was not covered under the claims of our relevant antibody humanization patents. The companies subsequently conducted confidential discussions in an effort to resolve this issue and later expanded the scope of these discussions to include Genentech's Raptiva and Avastin antibody products. In December 2003, Genentech and we announced that the companies had concluded a definitive agreement which resolved a dispute relating to our existing patent licensing master agreement, in particular with respect to our antibody humanization patents and certain of Genentech's humanized antibodies. Under the terms of the agreement, Genentech exercised licenses under the patent licensing master agreement between the parties for Genentech's Xolair and Raptiva antibody products. These exercises resulted in payment of license exercise fees in excess of $2 million to us, which we recognized as license revenue in the fourth quarter of 2003. We recognized royalty revenue from 2003 sales of Xolair beginning in the fourth quarter of 2003, and we will commence recognition of royalty revenue from Raptiva product sales in the first quarter of 2004.

        In consideration of approximately $1.1 million, Genentech exercised a license for its Avastin antibody product, which was approved by the FDA in February 2004. As a result, we will recognize license exercise fees of approximately $1.1 million in the first quarter of 2004 and commence recognition of royalty revenue from Avastin product sales in the second quarter of 2004.

        In connection with the December 2003 definitive agreement, we agreed to certain royalty reductions for significant levels of annual aggregate sales of Genentech products licensed under the master agreement. The revised royalty rate structure would apply reciprocally to any of our products licensed under the master agreement. The agreement resolves and settles both companies' disputes regarding infringement of the Xolair, Raptiva and Avastin products and the validity and enforceability of our patents. We also obtained additional rights to obtain non-exclusive, royalty-bearing licenses under certain of Genentech's antibody patents.

ACQUISITION OF EOS

        In April 2003, we completed the acquisition of Eos, an antibody discovery company, for approximately 4.2 million shares of our common stock. In conjunction with the merger, we recorded a charge of $37.8 million related to acquired in-process research and development. This acquisition expanded our research and development personnel by approximately 41 people, and added new capabilities in antibody target identification and validation, particularly in oncology, as well as adding M200 and F200, a clinical and a preclinical program, respectively.

MANUFACTURING AND FACILITIES

        We manufacture our products for clinical development, other than M200. M200 is currently supplied by ICOS Corporation as part of a manufacturing agreement related to our acquisition of Eos. However, we intend to change over from ICOS supply to our own supply as soon as is reasonably practicable, subject to regulatory and physical constraints.

11

        We intend to continue to manufacture our potential products for use in preclinical and clinical trials, and to manufacture products for commercial use by 2007. We expect to use our manufacturing facilities in accordance with standard procedures that comply with appropriate regulatory standards.

        We own two buildings comprising approximately 92,000 square feet of research and development and general office space in Fremont, California. We have an approximately $8.5 million mortgage on these facilities. In addition, we lease approximately 72,000 square feet of adjacent research and development and general office space in Fremont, California. Our lease terms for these facilities will expire on February 28, 2006 and December 31, 2006.

        In Plymouth, Minnesota, we lease approximately 90,000 square feet of manufacturing, laboratory and office space. The lease term will expire on February 28, 2009, subject to our option to extend the lease for an additional five-year term. In March 2002, we purchased approximately 29 acres in Brooklyn Park, Minnesota and we are building a new commercial manufacturing plant on this property that is currently pending completion and validation.

        In Somerville, New Jersey, we lease approximately 6,000 square feet of general office space. The lease term will expire on October 31, 2005.

        In Paris, France, we lease approximately 1,000 square feet of general office space. The lease term will expire on September 30, 2004.

        In Menlo Park, California, we lease approximately 1,600 square feet of general office space. The lease term will expire on March 31, 2005.

        We may obtain additional research and development and general office space in the future and may lease or acquire additional space as required.

PATENTS AND PROPRIETARY TECHNOLOGY

        We have been issued patents in the United States, Europe and Japan, which we believe cover many or most humanized antibodies. Some of these patents also cover other aspects of our antibody technology platform. We have filed similar patent applications in other countries. Our U.S. humanization patents, known generally as the Queen, et. al. patents, expire in 2013.

        Our two humanization patents issued by the European Patent Office apply in the United Kingdom, Germany, France, Italy and 17 other European countries. The European Patent Office procedures provide for an opposition period in which other parties may submit arguments as to why a patent was incorrectly granted and should be withdrawn or limited. Eighteen notices of opposition to our first European patent were filed during the opposition period for the patent, including oppositions by major pharmaceutical and biotechnology companies. Five opponents, including Genentech, have withdrawn from the opposition proceedings.

        At an oral hearing in March 2000, the Opposition Division of the European Patent Office decided to revoke the broad claims in our first European patent. We subsequently appealed the Opposition Division's decision to the Technical Board of Appeal at the European Patent Office. In November 2003, the Technical Board of Appeal upheld our appeal and set aside the Opposition Division's initial decision. The Board of Appeal ordered that certain claims be remitted to the Opposition Division for further prosecution and consideration of issues of patentability (novelty, enablement and inventive step). Regardless of the Opposition Division's decision on these claims, such decision could be subject to further appeals. The claims remitted by the Board of Appeal cover the production of humanized antibody light chains that contain amino acid substitutions made under our antibody humanization technology. We believe that such claims, if upheld by the Opposition Division, would cover the production of many humanized antibodies.

12

        The nine-month opposition period for our second European antibody humanization patent ended in May 2000. Eight notices of opposition were filed with respect to this patent and we have filed our response with the European Patent Office. Oral hearings scheduled to take place in October 2003 were postponed and a subsequent hearing date has not yet been established.

        Three opposition statements were filed with the Japanese Patent Office with respect to our Japanese humanization patent. The Japanese Opposition Board's subsequent decision supported one aspect of the position of the opponents, to which we filed two responses. Ultimately, we received a final determination from the Japanese Patent Office examiner affirming the Opposition Board's earlier decision. We have appealed this decision to the Tokyo High Court. A hearing was held in April 2003. The patent will remain valid and enforceable during this appeal process. If this appeal is unsuccessful, we will then have an opportunity to appeal to the Japanese Supreme Court.

        We intend to vigorously defend the European patents and the Japanese patent in these proceedings. We may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If the outcome of the European or Japanese opposition proceedings or any litigation involving our antibody humanization patents were to be unfavorable, our ability to collect royalties on existing licensed products and to license our patents relating to humanized antibodies may be materially harmed.

        In addition to seeking the protection of patents and licenses, we also rely upon trade secrets, know-how and continuing technological innovation, which we seek to protect, in part, by confidentiality agreements with employees, consultants, suppliers and licensees. If these agreements are not honored, we might not have adequate remedies for any breach. Additionally, our trade secrets might otherwise become known or patented by our competitors.

        Our success depends significantly on our ability to obtain and maintain patent protection for our products and technologies, to preserve our trade secrets and to operate without infringing on the proprietary rights of third parties. While we file and prosecute patent applications to protect our inventions, our pending patent applications may not result in the issuance of valid patents or our issued patents may not provide competitive advantages. Also, our patent protection may not prevent others from developing competitive products using related or other technology.

        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 our programs. Some of these applications or patents may be competitive with our applications or contain material that could prevent the issuance of patents to us or result in a significant reduction in the scope of our issued patents. Additionally, other companies, universities and research institutions may obtain patents that could limit our ability to use, import, manufacture, market or sell our products or impair our competitive position. As a result, we might be required to obtain licenses from others before we could continue using, importing, manufacturing, marketing, or selling our products. We may not be able to obtain required licenses on terms acceptable to us, if at all. If we do not obtain required licenses, we may encounter significant delays in product development while we redesign potentially infringing products or methods or may not be able to market our products at all.

        The scope, enforceability and effective term of patents issued to companies, universities and research institutions can be highly uncertain and often involve complex legal and factual questions. No consistent policy has emerged regarding the breadth of claims in biotechnology patents, so that even issued patents may later be modified or revoked by the relevant patent authorities or 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 we are unable to predict the extent of patent protection in any country. We cannot assure you that the patents we obtain or the unpatented proprietary technology we hold will afford us significant commercial protection.

13

GOVERNMENT REGULATION

        The manufacturing, testing and marketing of our products are subject to regulation by numerous governmental authorities in the United States and other countries. In the United States, pharmaceutical products are subject to rigorous FDA regulation. Additionally, other federal, state and local regulations govern the manufacture, testing, clinical and non-clinical studies to assess safety and efficacy, approval, advertising and promotion of pharmaceutical products. The process of obtaining approval for a new pharmaceutical product or for additional therapeutic indications within this regulatory framework requires a number of years and the expenditure of substantial resources. Companies in the pharmaceutical and biotechnology industries, including us, have suffered significant setbacks in various stages of clinical trials, even in advanced clinical trials after promising results had been obtained in earlier trials.

        As part of the regulatory approval process, we must demonstrate the ability to manufacture the pharmaceutical product. Accordingly, the manufacturing and quality control procedures must conform to rigorous guidelines 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 United States, foreign manufacturing establishments must comply with these FDA-approved guidelines. These foreign manufacturing establishments are subject to periodic inspection by the FDA or by corresponding regulatory agencies in these countries under reciprocal agreements with the FDA. Moreover, pharmaceutical product manufacturing facilities may also be regulated by state, local and other authorities.

        For the marketing of pharmaceutical products outside the United States, our collaborative partners and we are subject to foreign regulatory requirements and, if the particular product is manufactured in the United States, FDA and other U.S. export provisions. 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 us or our licensees or marketing partners in our respective efforts to secure necessary governmental approvals. This could delay or prevent us, our licensees or our marketing partners from marketing potential pharmaceutical products. In addition, as we build our commercial infrastructure to market our products in North America, our promotional materials and activities will also be governed by FDA regulations and guidelines.

        Both before and after approval is obtained, a biological pharmaceutical product, its manufacturer and the holder of the BLA for the pharmaceutical product are subject to comprehensive regulatory oversight. The FDA may deny approval to a BLA if applicable regulatory criteria are not satisfied. 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, marketing approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems with the pharmaceutical product occur following approval. 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, which may include, among other adverse actions, withdrawal of the previously approved pharmaceutical product or marketing approvals and/or the imposition of criminal penalties against the manufacturer and/or BLA holder.

COMPETITION

        Potential competitors have developed and are developing mouse, chimeric, human and humanized antibodies or other compounds for treating autoimmune and inflammatory diseases, transplantation,

14

asthma and cancers. In addition, a number of academic and commercial organizations are actively pursuing similar technologies, and several companies have developed or may develop technologies that may compete with our antibody technology platform. Competitors may succeed in more rapidly developing and marketing technologies and products that are more effective than our products or that would render our products or technology obsolete or noncompetitive. Our collaborative partners may also independently develop products that are competitive with products that we have licensed to them. This could reduce our revenues under our agreements with these partners.

        Any product that we or our collaborative partners succeed in developing and for which regulatory approval is obtained must then compete for market acceptance and market share. The relative speed with which we and our collaborative partners can develop products, complete clinical testing and approval processes, and supply commercial quantities of the products to the market compared to competitive companies will affect market success. In addition, the amount of marketing and sales resources, and the effectiveness of the marketing used with respect to a product will affect its marketing success.

        Other competitive factors include:

•

the capabilities of our 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 our products relative to their cost;



•

method of and frequency of administration of our products;



•

price of our products; and



•

patent protection of our products.

HUMAN RESOURCES

        As of December 31, 2003, we had 549 full-time employees. Of the total, 157 employees were engaged in research and process development, 126 in clinical and regulatory, 112 in manufacturing, 83 in general and administrative functions, and 71 in quality assurance and compliance. Our scientific staff members have diversified experience and expertise in molecular and cell biology, biochemistry, immunology, protein chemistry, computational chemistry and computer modeling. Our success will depend in large part on our ability to attract and retain skilled and experienced employees. None of our employees are covered by a collective bargaining agreement, and we consider our relations with our employees to be good.

ENVIRONMENT

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

AVAILABLE INFORMATION

        We file electronically with the Securities and Exchange Commission (or SEC) our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to

15

Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

        You may obtain a free copy of our most recent annual report on Form 10-K, quarterly report on Form 10-Q and proxy statement on our website on the World Wide Web at http://www.pdl.com. Additionally, you may obtain a free copy of these filings, as well as our current reports on Form 8-K and any other reports or filings we have filed with the SEC, including any amendment to those reports we have filed with, or furnished to, the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as practicable after we have electronically filed such material with, or furnished it to, the SEC, by contacting the Corporate Communications Department at our corporate offices by calling (510) 574-1406.

RISK FACTORS

        You should carefully consider and evaluate all of the information included and incorporated by reference in this Annual Report on Form 10-K, including the risk factors listed below. Any of these risks could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of our common stock.

        Keep these risk factors in mind when you read forward-looking statements contained in this Annual Report on Form 10-K and the documents incorporated by reference herein. These statements relate to our expectations about future events and time periods. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "intends," "plans," "believes," "anticipates," "expects," "estimates," "predicts," "potential," "continue" or "opportunity," the negative of these words or words of similar import. Similarly, statements that describe our reserves and our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward-looking statements. Forward-looking statements involve risks and uncertainties, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements.

We have a history of operating losses and may not achieve sustained profitability.

        In general, our expenses have exceeded revenues. As of December 31, 2003, we had an accumulated deficit of approximately $220.3 million. We expect our expenses to increase because of the extensive resource commitments required to achieve regulatory approval and commercial success for any individual product. For example, over the next several years, we will incur substantial additional expenses as we continue to develop and manufacture our potential products, invest in research and improve and expand our manufacturing, marketing and sales capabilities. Since we or our partners or licensees may not be able to successfully develop additional products, obtain required regulatory approvals, manufacture products at an acceptable cost and with appropriate quality, or successfully market such products with desired margins, we may never achieve sustained profitable operations. The amount of net losses and the time required to reach sustained profitability are highly uncertain. We may be unable to achieve sustained profitability.

        Our commitment of resources to the continued development of our products will require significant additional funds for development. Our operating expenses may also increase as:

•

some of our earlier stage potential products move into later stage clinical development;



•

additional potential products are selected as clinical candidates for further development;



•

we pursue clinical development of our potential products in new indications;

16

•

we invest in additional manufacturing capacity;



•

we build commercial infrastructure to market our products in North America;



•

we defend or prosecute our patents and patent applications; and



•

we invest in research or acquire additional technologies, product candidates or businesses.

        In the absence of substantial revenues from new agreements with third-party business partners, significant royalties on sales of products licensed under our intellectual property rights, product sales or other uncertain sources of revenue, we will incur substantial operating losses.

We have substantial outstanding indebtedness, which could adversely affect our financial condition and prevent us from fulfilling our obligations under our 2.75% $250 million convertible notes.

        In connection with our sale of the 2.75% convertible notes, referred to as the Notes, in July 2003, we incurred $250.0 million of indebtedness, set to mature in August 2023, although callable as early as 2010. Our total consolidated long-term debt as of December 31, 2003 was $258.5 million and constituted approximately 37% of our total pro forma capitalization as of such date. The indenture relating to the Notes does not restrict our ability to incur additional indebtedness, including debt that is senior to the Notes.

        The degree to which we are leveraged could have important consequences, because:

•

it could affect our ability to satisfy our obligations under the Notes;



•

a substantial portion of our cash flow from operations will be required to be dedicated to interest and principal payments and may not be available for operations, working capital, capital expenditures, expansion, acquisition or general corporate or other purposes;



•

our ability to obtain additional financing in the future may be impaired;



•

we may be more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;



•

our flexibility in planning for, or reacting to, changes in our business and industry may be limited; and



•

it may make us more vulnerable in the event of a downturn in our business, our industry or the economy in general.

        Our ability to make payments on and, if necessary, to refinance our debt, including the Notes, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, business, financial, competitive, legislative, regulatory and other factors that are beyond our control.

        We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to pay our debt, including the Notes, or to fund our other liquidity needs. We may need to refinance all or a portion of our debt, including the Notes, on or before maturity. We cannot assure you that we would be able to refinance any of our debt, including the Notes, on commercially reasonable terms or at all.

Our revenues, expenses and operating results will likely fluctuate in future periods.

        Our revenues have varied in the past and will likely continue to fluctuate considerably from quarter to quarter and from year to year. As a result, our revenues in any period may not be predictive

17

of revenues in any subsequent period. Our royalty revenues may be unpredictable and may fluctuate since they depend upon:

•

the seasonality of sales of licensed products;



•

the existence of competing products;



•

the market launch of recently licensed products;



•

the marketing efforts of our licensees;



•

potential reductions in royalties receivable due to credits for prior payments to us;



•

the timing of royalty reports, some of which are required quarterly and others semi-annually; and



•

our ability to successfully defend and enforce our patents.

        We receive royalty revenues on sales of the product Synagis. This product has higher sales in the fall and winter, which to date have resulted in much higher royalties paid to us in our first and second quarters than in other quarters. The seasonality of Synagis sales will contribute to fluctuation of our revenues from quarter to quarter.

        License and other revenue may also be unpredictable and may fluctuate due to the timing of payments of non-recurring licensing and signing fees, payments for manufacturing and clinical development services, and payments for the achievement of milestones under new and existing agreements with third-party business partners. Revenue historically recognized under our prior agreements may not be an indicator of non-royalty revenue from any future collaborations.

        Our expenses may be unpredictable and may fluctuate from quarter to quarter due to the timing of expenses, including clinical trial expenses as well as payments owed by us and to us under collaborative agreements for reimbursement of expenses and which are recorded under our policy during the quarter in which such expenses are reported to us or to our partners and agreed to by us or our partners.

        In addition, our expenses or other operating results may fluctuate due to the accounting treatment of securities we own or may purchase or securities we have issued or may issue. In May 2002, we entered into an agreement with our Chairman of the Board under which vesting of his stock options may accelerate in certain events, and such acceleration would trigger an accounting expense. In addition, we hold a $30.0 million five-year convertible note receivable we purchased from Exelixis, Inc. in May 2001. Accounting rules require the conversion feature of some convertible notes to be separated from the debt agreement in which the conversion feature is contained and accounted for as a derivative instrument, and therefore reflected in the note purchaser's financial statements based upon the fair market value of the stock into which the note is convertible. Due in part to the number of shares into which this note receivable would currently convert and the average daily trading volume of Exelixis stock, the Exelixis note is not currently considered a derivative instrument and, therefore, changes in the market value of Exelixis stock are not required to be recorded in our financial statements. However, a significant increase in the average daily trading volume of Exelixis stock, or new accounting pronouncements or regulatory rulings could require us to report the change in the value of the Exelixis stock in our financial statements such that changes in the Exelixis stock price contribute to fluctuations of our operating results from quarter to quarter.

18

Our humanization patents are being opposed and a successful challenge or refusal to take a license could limit our future revenues.

        Most of our current revenues are related to our humanization patents and the related licenses that third parties enter into with us for rights to those patents. If our rights are successfully challenged or third parties decline to take licenses for the patents, our future revenues would be adversely affected.

        At an oral hearing in March 2000, the Opposition Division of the European Patent Office decided to revoke the broad claims of our first European humanization patent. We appealed this decision. In November 2003, the Technical Board of Appeal of the European Patent Office decided to uphold our appeal and to set aside the Opposition Division's decision. The Board of Appeal ordered that certain claims be remitted to the Opposition Division for further prosecution and consideration of issues of patentability (novelty, enablement and inventive step). The claims remitted by the Board of Appeal cover the production of humanized antibody light chains that contain amino acid substitutions made under our antibody humanization technology. Regardless of the Opposition Division's decision on these claims, such decision could be subject to further appeals. Until the opposition is resolved, we may be limited in our ability to collect royalties or to negotiate future licensing or collaborative research and development arrangements based on this and our other humanization patents. Moreover, if the opposition is successful, our ability to collect royalties on European sales of antibodies humanized by others would depend on the scope and validity of our second European patent, whether the antibodies are manufactured in a country outside of Europe where they are covered by one of our patents, and in that case the terms of our license agreements with respect to that situation. Also, the Opposition Division's decision could encourage challenges of our related patents in other jurisdictions, including the United States. This decision may lead some of our licensees to stop making royalty payments or lead potential licensees not to take a license, either of which might result in us initiating formal legal actions to enforce our rights under our humanization patents. In such a situation, a likely defensive strategy to our action would be to challenge our patents in that jurisdiction. During the opposition process with respect to our first European patent, if we were to commence an infringement action to enforce that patent, such an action would likely be stayed until the opposition is decided by the European Patent Office. As a result, we may not be able to successfully enforce our rights under our European or related U.S. and Japanese patents.

        Eight notices of opposition were filed with respect to our second European antibody humanization patent and we have filed our response with the European Patent Office. Oral hearings, originally scheduled to take place in October 2003, have been postponed by the European Patent Office. No new date has been set for the hearings.

        Also, three opposition statements were filed with the Japanese Patent Office with respect to our Japanese humanization patent. The Japanese Opposition Board's subsequent decision supported one aspect of the position of the opponents, to which we filed two responses. Ultimately, we received a final determination from the Japanese Patent Office examiner affirming the Opposition Board's earlier decision. We have appealed this decision to the Tokyo High Court. A hearing was held in April 2003. The patent will remain valid and enforceable during this appeal process. If this appeal is unsuccessful, we will then have an opportunity to appeal to the Japanese Supreme Court.

        We intend to vigorously defend the European patents and the Japanese patent in these proceedings. We may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If the outcome of the European or Japanese opposition proceedings or any litigation involving our antibody humanization patents were to be unfavorable, our ability to collect royalties on existing licensed products and to license our patents relating to humanized antibodies may be materially harmed. In addition, these proceedings or any other litigation to protect our intellectual property rights or defend against infringement claims by others could result in substantial costs and diversion of management's time and attention, which could harm our business and financial condition.

19

        Our ability to maintain and increase our revenues from licensing is dependent upon third parties entering into new patent licensing arrangements, exercising rights under existing patent rights agreements, and paying royalties under existing patent licenses with us. To date, we have been successful in obtaining such licensing arrangements, and in receiving royalties on product sales, from parties whose products may be covered by our patents. However, we have experienced challenges in our licensing efforts, including the disagreement we had with Genentech in 2003 over whether its Xolair antibody product was covered under our humanization patents. There can be no assurance that we will continue to be successful in our licensing efforts in the future. Additionally, although we have reached an amicable settlement with Genentech that is intended to resolve such disagreements, Genentech or other companies may, in the future, seek to challenge our U.S. patents through litigation or patent office proceedings, such as re-examinations or interferences. If we experience difficulty in enforcing our patent rights through licenses, or if our licensees, or prospective licensees, challenge our antibody humanization patents, our revenues and financial condition could be adversely affected, and we could be required to undertake additional actions, including litigation to enforce our rights. Such efforts would increase our expenses and could be unsuccessful.

If we are unable to protect our patents and proprietary technology, we may not be able to compete successfully.

        Our pending patent applications may not result in the issuance of valid patents or our issued patents may not provide competitive advantages. Also, our patent protection may not prevent others from developing competitive products using related or other technology. 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 our programs. Some of these applications or patents may be competitive with our applications or contain material that could prevent the issuance of patents to us or result in a significant reduction in the scope of our issued patents. For example, BTG International Limited (successor in interest to the Medical Research Council) recently has been issued a U.S. patent, to which we have a license, with claims that might be construed to overlap with our issued humanization patents. While the significance of this new U.S. patent is unclear, if it conflicts with our U.S. patents or patent applications, we may become involved in patent office or legal proceedings to determine which company was the first to invent the technology and processes contained in the conflicting patents. These proceedings could be expensive, last several years and either prevent issuance of additional patents to us relating to humanization of antibodies or result in a significant reduction in the scope or invalidation of our patents. Any limitation would reduce our ability to negotiate or collect royalties or to negotiate future collaborative research and development agreements based on these patents.

        The scope, enforceability and effective term of patents can be highly uncertain and often involve complex legal and factual questions. No consistent policy has emerged regarding the breadth of claims in biotechnology patents, so that even issued patents may later be modified or revoked by the relevant patent authorities or 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 we are unable to predict the extent of patent protection in any country. In addition to seeking the protection of patents and licenses, we also rely upon trade secrets, know-how and continuing technological innovation that we seek to protect, in part, by confidentiality agreements with employees, consultants, suppliers and licensees. If these agreements are not honored, we might not have adequate remedies for any breach. Additionally, our trade secrets might otherwise become known or patented by our competitors.

20

We may require additional patent licenses in order to manufacture or sell our potential products.

        Other companies, universities and research institutions may obtain patents that could limit our ability to use, import, manufacture, market or sell our products or impair our competitive position. As a result, we might be required to obtain licenses from others before we could continue using, importing, manufacturing, marketing, or selling our products. We may not be able to obtain required licenses on terms acceptable to us, if at all. If we do not obtain required licenses, we may encounter significant delays in product development while we redesign potentially infringing products or methods or may not be able to market our products at all.

        Celltech has been granted a European patent covering humanized antibodies, which we have opposed. At an oral hearing in September 2000, the Opposition Division of the European Patent Office decided to revoke this patent. Celltech appealed that decision, but the Technical Board of Appeal recently rejected the appeal. As a result, the decision revoking the patent is final; no further appeals are available. However, Celltech has a second issued divisional patent in Europe, which has claims that may be broader in scope than its first European patent, and which we have opposed. In addition, Celltech has a third divisional application currently drafted with broad claims directed towards humanized antibodies. We cannot predict whether Celltech's second European patent will be modified or revoked in any future opposition proceedings, or whether it will be able to obtain the grant of a patent from the pending divisional application with claims broad enough to generally cover humanized antibodies. Celltech has also been issued a corresponding U.S. patent that contains claims that may be considered broader in scope than their first European patent. In addition, Celltech was recently issued a second U.S. patent with claims that may be considered broader than its first U.S. patent. We have entered into an agreement with Celltech providing each company with the right to obtain nonexclusive licenses for up to three antibody targets under the other company's humanization patents. This agreement expires in December 2004. Notwithstanding this agreement, if our humanized antibodies were covered by Celltech's European or U.S. patents and if we need more than the three licenses under those patents currently available to us under the agreement, or we are unable to negotiate an extension of this agreement beyond December 2004 on terms that are acceptable to us, we would be required to negotiate additional licenses under those patents or to significantly alter our processes or products. We might not be able to successfully alter our processes or products to avoid conflict with these patents or to obtain the required additional licenses on commercially reasonable terms, if at all.

        In addition, if the Celltech U.S. patent or any related patent applications conflict with our U.S. patents or patent applications, we may become involved in proceedings to determine which company was the first to invent the products or processes contained in the conflicting patents. These proceedings could be expensive, last several years and either prevent issuance of additional patents to us relating to humanization of antibodies or result in a significant reduction in the scope or invalidation of our patents. Any limitation would reduce our ability to negotiate or collect royalties or to negotiate future collaborative research and development agreements based on these patents.

        Lonza Biologics, Inc. has a patent issued in Europe to which we do not have a license that may cover a process that we use to produce our potential products. In addition, we do not have a license to an issued U.S. patent assigned to Stanford University and Columbia University, which may cover a process we use to produce our potential products. We have been advised that an exclusive license has been previously granted to a third party, Centocor, Inc., under this patent. If our processes were found to be covered by either of these patents, we might be required to obtain licenses or to significantly alter our processes or products. We might not be able to successfully alter our processes or products to avoid conflicts with these patents or to obtain licenses on acceptable terms.

        We are also aware of issued patents that could apply to one or more of our specific products. For example, a U.S. patent issued to Advanced Biotherapy, Inc. has claims to the use of anti-gamma interferon antibodies to treat certain autoimmune diseases. The claims issued to Advanced

21

Biotherapy, Inc., however, do not cover treatment of Crohn's disease, the indication currently being investigated in our HuZAF (fontolizumab, anti-gamma interferon antibody) clinical trials. However, a European patent issued to Genentech in 1998 and a U.S. patent issued in 2003 do have claims to the use of anti-gamma interferon inhibitors, including antibodies, for treatment of inflammatory bowel disease, including Crohn's disease. As a result, we might be required to obtain licenses from others. We may not be able to obtain required licenses on terms acceptable to us, if at all. If we do not obtain required licenses, we may encounter significant delays in product development while we redesign potentially infringing products or methods or we may not be able to market our products at all.

If our research efforts are not successful, we may not be able to effectively develop new products.

        We are engaged in research activities intended to identify antibody product candidates that we may enter into clinical development. These research activities include efforts to discover and validate new targets for antibodies in our areas of therapeutic focus. We obtain new targets through our own drug discovery efforts and through in-licensing targets from institutions or other biotechnology or pharmaceutical companies. Our success in identifying new antibody product candidates depends upon our ability to discover and validate new targets, either through our own research efforts, or through in-licensing or collaborative arrangements. In order to increase the possibilities of identifying antibodies with a reasonable chance for success in clinical studies, part of our business strategy is to identify a number of potential targets. If we are unsuccessful in our research efforts to identify and obtain rights to new targets, our ability to develop new products could be harmed.

Clinical development is inherently uncertain and expense levels may fluctuate unexpectedly because we cannot accurately predict the timing and level of such expenses.

        Our future success depends in large part upon the results of clinical trials designed to assess the safety and efficacy of our potential products, and the majority of our expenses are to support these activities. The completion of clinical trials often depends significantly upon the rate of patient enrollment, and our expense levels will vary depending upon the rate of enrollment. In addition, the length of time necessary to complete clinical trials and submit an application for marketing and manufacturing approvals varies significantly and is difficult to predict. The expenses associated with each phase of development depend upon the design of the trial. The design of each phase of trials depends in part upon results of prior phases, and additional trials may be needed at each phase. As a result the expense associated with future phases can not predicted in advance. Further, we may decide to terminate or suspend ongoing trials. Failure to comply with extensive FDA regulations may result in unanticipated delay, suspension or cancellation of a trial or the FDA's refusal to accept test results. The FDA may also suspend our clinical trials at any time if it concludes that the participants are being exposed to unacceptable risks. As a result of these factors, we cannot predict the actual expenses that we will incur with respect to trials for any of our potential products, and we expect that our expense levels will fluctuate unexpectedly in the future.

If we cannot successfully complete our clinical trials, we will be unable to obtain regulatory approvals required to market our products.

        To obtain regulatory approval for the commercial sale of any of our potential products or to promote these products for expanded indications, we must demonstrate through preclinical testing and clinical trials that each product is safe and effective for use in indications for which approval is requested. We have had, and may in the future have, clinical setbacks that prevent us from obtaining regulatory approval for our potential products. Most recently, in May 2003, we announced that we have discontinued additional clinical studies of the humanized anti-IL-4 antibody after data from a Phase IIa clinical trial of the antibody in steroid-naïve, mild/moderate asthma indicated that the anti-IL-4 antibody did not demonstrate clinical benefit compared to placebo at either of the dose levels tested.

22

Earlier clinical trials such as Phase I and II trials generally are designed to gather information to determine whether further trials are appropriate and, if so, how such trials should be designed. As a result, data gathered in these trials may indicate that the endpoints selected for these trials are not the most relevant for purposes of assessing the product or the design of future trials. Moreover, success or failure in meeting such early clinical trial endpoints may not be dispositive of whether further trials are appropriate and, if so, how such trials should be designed.

        Larger or later stage clinical trials may not produce the same results as earlier trials. Many companies in the pharmaceutical and biotechnology industries, including our company, have suffered significant setbacks in clinical trials, including advanced clinical trials, even after promising results had been obtained in earlier trials. As an example, in June 2003 we announced the discontinuance of studies aimed at the treatment of steroid-refractory graft-versus-host-disease following bone marrow transplantation with Nuvion after partial, preliminary results in a Phase II trial showed that Nuvion was not, on average, associated with a significant prolongation of survival relative to historic controls.

        Even when a drug candidate shows evidence of efficacy in a clinical trial, it may be impossible to further develop or receive regulatory approval for the drug if it causes an unacceptable incidence or severity of side effects, or further development may be slowed down by the need to find dosing regimens that do not cause such side effects. For example, while Nuvion had shown biological activity in some patients in a Phase I/II trial for psoriasis, it has also caused a level of side effects that would be unacceptable in this patient population. Enrollment in this trial has been terminated and our current plan is not to further develop Nuvion for psoriasis. Development for Nuvion in severe steroid-refractory ulcerative colitis is ongoing.

        In addition, we may not be able to successfully commence and complete all of our planned clinical trials without significant additional resources and expertise because we have a relatively large number of potential products in clinical development. Additionally, regulatory review of our clinical trial protocols may cause us in some cases to delay or abandon our planned clinical trials. Our potential inability to commence or continue clinical trials, to complete the clinical trials on a timely basis or to demonstrate the safety and efficacy of our potential products, further adds to the uncertainty of regulatory approval for our potential products.

Our clinical trial strategy may increase the risk of clinical trial difficulties.

        Research, preclinical testing and clinical trials may take many years to complete and the time required can vary depending on the indication being pursued and the nature of the product. We may at times elect to use aggressive clinical strategies in order to advance potential products through clinical development as rapidly as possible. For example, we may commence clinical trials without conducting preclinical animal efficacy testing where an appropriate animal efficacy testing model does not exist, or we may conduct later stage trials based on limited early stage data. We anticipate that only some of our potential products may show safety and efficacy in clinical trials and some may encounter difficulties or delays during clinical development.

We may be unable to enroll sufficient patients in a timely manner in order to complete our clinical trials.

        The rate of completion of our clinical trials, and those of our collaborators, is significantly dependent upon the rate of patient enrollment. Patient enrollment is a function of many factors, including:

•

the size of the patient population;



•

perceived risks and benefits of the drug under study;



•

availability of competing therapies, including those in clinical development;

23

•

availability of clinical drug supply;



•

availability of clinical trial sites;



•

design of the protocol;



•

proximity of and access by patients to clinical sites;



•

patient referral practices of physicians;



•

eligibility criteria for the study in question; and



•

efforts of the sponsor of and clinical sites involved in the trial to facilitate timely enrollment.

        We may have difficulty obtaining sufficient patient enrollment or clinician support to conduct our clinical trials as planned, and we may need to expend substantial additional funds to obtain access to resources or delay or modify our plans significantly. These considerations may lead us to consider the termination of ongoing clinical trials or development of a product for a particular indication.

Our revenues from licensed technologies depend on the efforts and successes of our licensees.

        In those instances where we have licensed rights to our technologies, the product development and marketing efforts and successes of our licensees will determine the amount and timing of royalties we may receive, if any. We have no assurance that any licensee will successfully complete the product development, regulatory and marketing efforts required to sell products. The success of products sold by licensees will be affected by competitive products, including potential competing therapies that are marketed by the licensee or others.

Our lack of experience in sales, marketing and distribution may hamper market introduction and acceptance of our products.

        We intend to market and sell a number of our products either directly or through sales and marketing partnership arrangements with partners. To market products directly, we must establish an internal marketing and sales group, contract for these services, or obtain the assistance of another company. Pursuant to the terms of our revised collaboration agreement with Hoffmann-La Roche Inc. (Roche), we have a reversion right, exercisable in 2006, but effective in 2007, to repurchase all rights, including marketing rights, in transplant indications, unless earlier elected by Roche. If we elect to exercise this right, or Roche elects to transfer such rights to us, we will be responsible for the marketing and commercialization of Zenapax in all indications worldwide. While Roche must notify us at least six months prior to a transfer of Zenapax to us, there can be no assurance that we will be able to establish marketing, sales and distribution capabilities for Zenapax in a timely manner. Further, we may not be able to establish such capabilities for our other products or succeed in gaining market acceptance for our products. If we were to enter into co-promotion or other marketing arrangements with pharmaceutical or biotechnology companies, our revenues would be subject to the payment provisions of these arrangements and could largely depend on these partners' marketing and promotion efforts.

If we do not attract and retain key employees, our business could be impaired.

        To be successful we must retain our qualified clinical, manufacturing, scientific and management personnel. If we are unsuccessful in retaining qualified personnel, our business could be impaired.

Manufacturing difficulties could delay commercialization of our products.

        Of the products that we currently have in clinical development, Roche and its affiliates are responsible for manufacturing Zenapax. In connection with the restructuring of our collaboration

24

agreement with Roche, we obtained the rights to manufacture Zenapax. We are responsible for manufacturing our other products for our own development, and will begin manufacturing clinical supplies of Zenapax following a transition period that we expect will extend to 2005. Our ability to successfully market and develop Zenapax, in particular in transplantation, depends upon our success in manufacturing Zenapax at commercial scale. We have not manufactured this product in the past and we will need to show comparability with material used by Roche. There can be no assurance that we will successfully and in a timely manner be capable of manufacturing Zenapax following the transfer of Zenapax to us by Roche.

        We intend to continue to manufacture potential products for use in preclinical and clinical trials using our manufacturing facility in accordance with standard procedures that comply with appropriate regulatory standards. The manufacture of sufficient quantities of antibody products that comply with these standards is an expensive, time-consuming and complex process and is subject to a number of risks that could result in delays and/or the inability to produce sufficient quantities of such products in a commercially viable manner. Our collaborative partners and we have experienced some manufacturing difficulties. Product supply interruptions could significantly delay clinical development of our potential products, reduce third-party or clinical researcher interest and support of proposed clinical trials, and possibly delay commercialization and sales of these products. Manufacturing difficulties can even interrupt the supply of marketed products, thereby reducing revenues and risking loss of market share.

        We do not have experience in manufacturing commercial supplies of our potential products, nor do we currently have sufficient facilities to manufacture all of our potential products on a commercial scale. To obtain regulatory approvals and to create capacity to produce our products for commercial sale at an acceptable cost, we will need to improve and expand our existing manufacturing capabilities. We have recently completed improvements to our existing manufacturing plant in order to manufacture initial commercial supplies of certain products, including Nuvion and Zenapax. Our ability to file for, and to obtain, regulatory approvals for such products, as well as the timing of such filings, will depend on our ability to successfully operate our existing manufacturing plant. We may be unable to do so, or to obtain regulatory approval or to successfully produce commercial supplies on a timely basis. Failure to do so could delay commercialization of our products.

        In addition, we are constructing a new commercial manufacturing plant. As we implement these plans, we will incur substantial costs. Any construction or other delays could impair our ability to obtain necessary regulatory approvals and to produce adequate commercial supplies of our potential products on a timely basis. Failure to do so could delay commercialization of some of our products and could impair our competitive position.

Our revenue may be adversely affected by competition and rapid technological change.

        Potential competitors have developed and are developing human and humanized antibodies or other compounds for treating autoimmune and inflammatory diseases, transplantation, asthma and cancers. In addition, a number of academic and commercial organizations are actively pursuing similar technologies, and several companies have developed or may develop technologies that may compete with our antibody technology platform. Competitors may succeed in more rapidly developing and marketing technologies and products that are more effective than our products or that would render our products or technology obsolete or noncompetitive. Our collaborative partners may also independently develop products that are competitive with products that we have licensed to them. This could reduce our revenues under our agreements with these partners.

        Any product that our collaborative partners or we succeed in developing and for which regulatory approval is obtained must then compete for market acceptance and market share. The relative speed with which we and our collaborative partners can develop products, complete the clinical testing and

25

approval processes, and supply commercial quantities of the products to the market compared to competitive companies will affect market success. In addition, the amount of marketing and sales resources and the effectiveness of the marketing used with respect to a product will affect its marketing success. For example, Novartis, which has a significant marketing and sales force directed to the transplantation market, markets Simulect® (basiliximab), a product competitive with Zenapax, in the United States and Europe. Novartis has acquired a significant interest in Roche.

We may be unable to obtain or maintain regulatory approval for our products.

        All of our products in development are subject to risks associated with applicable government regulations. The manufacturing, testing and marketing of our products are subject to regulation by numerous governmental authorities in the United States and other countries. In the United States, pharmaceutical products are subject to rigorous FDA regulation. Additionally, other federal, state and local regulations govern the manufacture, testing, clinical and non-clinical studies to assess safety and efficacy, approval, advertising and promotion of pharmaceutical products. The process of obtaining approval for a new pharmaceutical product or for additional therapeutic indications within this regulatory framework requires a number of years and the expenditure of substantial resources. Companies in the pharmaceutical and biotechnology industries, including us, have suffered significant setbacks in various stages of clinical trials, even in advanced clinical trials after promising results had been obtained in earlier trials.

        As part of the regulatory approval process, we must demonstrate the ability to manufacture the pharmaceutical product. Accordingly, the manufacturing process and quality control procedures must conform to rigorous guidelines 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 United States, foreign manufacturing establishments must comply with these FDA approved guidelines. These foreign manufacturing establishments are subject to periodic inspection by the FDA or by corresponding regulatory agencies in these countries under reciprocal agreements with the FDA. Moreover, pharmaceutical product manufacturing facilities may also be regulated by state, local and other authorities.

        In addition, the FDA recently completed the transfer of regulatory responsibility, review and continuing oversight for many biologic therapeutic products, including antibody therapeutics, from the Center for Biologics Evaluation and Research (CBER) to the Center for Drug Evaluation and Research (CDER). This transfer of responsibility could result in new regulatory standards, which could result in delays in development or regulatory approvals for our potential products. In addition, when we assume responsibility for manufacturing Zenapax, we will be required to demonstrate that the material manufactured by Roche is comparable to the material we produce at our manufacturing facilities. New regulations resulting from the transfer of regulatory responsibility from CBER to CDER could make it more difficult for us to show comparability which could delay development and regulatory approval of Zenapax in new indications or reduce or interrupt commercial sales of Zenapax for the prevention of acute kidney transplant rejection.

        For the marketing of pharmaceutical products outside the United States, our collaborative partners and we are subject to foreign regulatory requirements and, if the particular product is manufactured in the United States, FDA and other U.S. export provisions. 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 us or our licensees or marketing partners in our respective efforts to secure necessary governmental approvals. This could delay or prevent us, our licensees or our marketing partners from marketing potential pharmaceutical products.

26

        Both before and after approval is obtained, a biologic pharmaceutical product, its manufacturer and the holder of the BLA for the pharmaceutical product are subject to comprehensive regulatory oversight. The FDA may deny approval to a BLA if applicable regulatory criteria are not satisfied. 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, regulatory approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems with the pharmaceutical product occur following approval. 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, which may include, among other adverse actions, withdrawal of the previously approved pharmaceutical product or regulatory approvals and/or the imposition of criminal penalties against the manufacturer and/or BLA holder.

Manufacturing changes may result in delays in obtaining regulatory approval or marketing for our products.

        Manufacturing of antibodies for use as therapeutics in compliance with regulatory requirements is complex, time-consuming and expensive. If we make changes in the manufacturing process, we may be required to demonstrate to the FDA and corresponding foreign authorities that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. Additionally, when we assume responsibility for manufacturing Zenapax, we will be required to demonstrate that the material manufactured by Roche does not differ significantly from the material we produce at our manufacturing facilities. Showing comparability between the material we produce before and after manufacturing changes, and in the case of Zenapax, between the material produced by Roche and the drug material produced by us, is particularly important if we want to rely on results of prior preclinical studies and clinical trials performed using the previously produced drug material. Depending upon the type and degree of differences between the newer and older drug material, and in the case of Zenapax, between the our material and the Roche material, we may be required to conduct additional animal studies or human clinical trials to demonstrate that the newly produced drug material is sufficiently similar to the previously produced drug material. We have made manufacturing changes and are likely to make additional manufacturing changes for the production of our products currently in clinical development. These manufacturing changes or an inability to immediately show comparability between the Roche material and our material could result in delays in development or regulatory approvals or in reduction or interruption of commercial sales and could impair our competitive position.

Our business may be harmed if we cannot obtain sufficient quantities of raw materials.

        We depend on outside vendors for the supply of raw materials used to produce our product candidates. Once a supplier's materials have been selected for use in our manufacturing process, the supplier in effect becomes a sole or limited source of that raw material due to regulatory compliance procedures. If the third-party suppliers were to cease production or otherwise fail to supply us with quality raw materials and we were unable to contract on acceptable terms for these services with alternative suppliers, our ability to produce our products and to conduct preclinical testing and clinical trials of product candidates would be adversely affected. This could impair our competitive position.

We may be subject to product liability claims, and our insurance coverage may not be adequate to cover these claims.

        We face 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

27

effects. This risk will exist even with respect to any products that receive regulatory approval for commercial sale. While we have obtained liability insurance for our products, it may not be sufficient to satisfy any liability that may arise. Also, adequate insurance coverage may not be available in the future at acceptable cost, if at all.

We may incur significant costs in order to comply with environmental regulations or to defend claims arising from accidents involving the use of hazardous materials.

        We are subject to federal, state and local laws and regulations governing the use, discharge, handling and disposal of materials and wastes used in our operations. As a result, we may be required to incur significant costs to comply with these laws and regulations. We cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for any resulting damages and incur liabilities which exceed our resources. In addition, we cannot predict the extent of the adverse effect on our business or the financial and other costs that might result from any new government requirements arising out of future legislative, administrative or judicial actions.

Changes in the U.S. and international health care industry could adversely affect our revenues.

        The U.S. and international health care industry is subject to changing political, economic and regulatory influences that may significantly affect the purchasing practices and pricing of pharmaceuticals. Cost containment measures, whether instituted by health care providers or imposed by government health administration regulators or new regulations, could result in greater selectivity in the purchase of drugs. As a result, third-party payors may challenge the price and cost effectiveness of our products. In addition, in many major markets outside the United States, pricing approval is required before sales can commence. As a result, significant uncertainty exists as to the reimbursement status of approved health care products.

        We may not be able to obtain or maintain our desired price for our products. Our products may not be considered cost effective relative to alternative therapies. As a result, adequate third-party reimbursement may not be available to enable us to maintain prices sufficient to realize an appropriate return on our investment in product development. Also, the trend towards managed health care in the United States and the concurrent growth of organizations such as health maintenance organizations, as well as legislative proposals to reform health care or reduce government insurance programs, may all result in lower prices, reduced reimbursement levels and diminished markets for our products. These factors will also affect the products that are marketed by our collaborative partners.

Our common stock price is volatile and an investment in our company could decline in value.

        Market prices for securities of biotechnology companies, including ourselves, have been highly volatile so that investment in our securities involves substantial risk. Additionally, 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. The following are some of the factors that may have a significant effect on the market price of our common stock:

•

developments or disputes as to patent or other proprietary rights;



•

disappointing sales of approved products;



•

approval or introduction of competing products and technologies;



•

results of clinical trials;



•

failures or unexpected delays in obtaining regulatory approvals or unfavorable FDA advisory panel recommendations;

28

•

delays in manufacturing or clinical trial plans;



•

fluctuations in our 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 us or our competitors;



•

initiation, termination or modification of agreements with our collaborative partners;



•

loss of key personnel;



•

litigation or the threat of litigation;



•

public concern as to the safety of drugs developed by us;



•

sales of our common stock held by collaborative partners or insiders;



•

comments and expectations of results made by securities analysts; and



•

general market conditions.

        If any of these factors causes us to fail to meet the expectations of securities analysts or investors, or if adverse conditions prevail or are perceived to prevail with respect to our business, the price of the common stock would likely drop significantly. A significant drop in the price of a company's common stock often leads to the filing of securities class action litigation against the company. This type of litigation against us could result in substantial costs and a diversion of management's attention and resources.

We may not have the ability to raise the funds to repurchase the 2.75% $250 million convertible notes on the repurchase date or to finance any repurchase offer required by the indenture.

        In August 2010, August 2013 and August 2018, respectively, holders of our $250 million convertible notes (the Notes) may require us to repurchase all or a portion of their notes at 100% of their principal amount, plus any accrued and unpaid interest to, but excluding, such date. For notes to be repurchased in August 2010, we must pay for the repurchase in cash, and we may pay for the repurchase of notes to be repurchased in August 2013 and August 2018, at our option, in cash, shares of our common stock or a combination of cash and shares of our common stock. In addition, if a repurchase event occurs (as defined in the indenture), each holder of the Notes may require us to repurchase all or a portion of the holder's notes. We cannot assure you that there will be sufficient funds available for any required repurchases of these securities. In addition, the terms of any agreements related to borrowing which we may enter into from time to time may prohibit or limit our repurchase of notes or make our repurchase of notes an event of default under certain circumstances. If a repurchase event occurs at a time when a credit agreement prohibits us from purchasing the Notes, we could seek the consent of the lender to purchase the Notes or could attempt to refinance the debt covered by the credit agreement. If we do not obtain a consent, we may not purchase the Notes. Our failure to purchase tendered notes would constitute an event of default under the indenture, which might also constitute a default under the terms of our other debt. In such circumstances, our financial condition and the value of our securities could be materially harmed.

Legislative actions, potential new accounting pronouncements and higher insurance costs are likely to impact our future financial position or results of operations.

        Future changes in financial accounting standards may cause adverse, unexpected fluctuations in the timing of revenue recognition and may affect our financial position or results of operations. New

29

pronouncements and varying interpretations of pronouncements have occurred with frequency and may occur in the future and we may make changes in our accounting policies in the future. Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules, are creating uncertainty for companies such as ours and insurance costs are increasing as a result of this uncertainty and other factors. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.

Prior and future acquisitions could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results.

        In April 2003, we completed the acquisition of a privately owned company, Eos Biotechnology, Inc. We expect to continue to review opportunities to acquire other businesses, products or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities. In our acquisition of Eos, we issued stock as all of the consideration, and we may be obligated to release additional shares from escrow. The issuance of stock in these and any future transactions will dilute stockholders' percentage ownership.

        Other risks associated with acquiring the operations of other companies include:

•

problems assimilating the purchased operations, technologies or products;



•

unanticipated costs associated with the acquisition;



•

diversion of management's attention from our existing business;



•

the potential loss of key collaborators of the acquired companies;



•

lack of synergy, or the inability to realize expected synergies, resulting from the acquisition;



•

adverse effects on existing relationships with other third-party business partners;



•

risks associated with entering markets in which we have no, or limited, prior experience; and



•

potential loss of key employees of acquired organizations.

        We cannot assure that we would be successful in overcoming problems encountered in connection with such acquisitions, and our inability to do so could significantly harm our business. In addition, to the extent that the economic benefits associated with such acquisitions diminish in the future, we may be required to record write downs of goodwill, intangible assets or other assets associated with such acquisitions.

ITEM 2. PROPERTIES

        We own two buildings comprising approximately 92,000 square feet of research and development and general office space in Fremont, California. In addition, we lease approximately 72,000 square feet of research and development and general office space in Fremont, California. Our lease terms will expire on February 28, 2006 and December 31, 2006.

        In Plymouth, Minnesota, we lease approximately 90,000 square feet of manufacturing, laboratory and office space. Our lease terms will expire on December 31, 2004 and February 28, 2009, subject to our option to extend the leases for an additional five-year term. In March 2002, we purchased

30

approximately 29 acres in Brooklyn Park, Minnesota and we continue to build a new commercial manufacturing plant on this property.

        In Somerville, New Jersey, we lease approximately 6,000 square feet of general office space. Our lease term will expire on October 31, 2005.

        In Paris, France, we lease approximately 1,000 square feet of general office space. Our lease term will expire on September 30, 2004.

        In Menlo Park, California, we lease approximately 1,600 square feet of general office space. Our lease term will expire on March 31, 2005.

        We plan to obtain additional research and development and general office space in the future and may lease or acquire additional space as required.

        We own substantially all of the equipment used in our facilities. (See Note 7 to the consolidated financial statements.)

ITEM 3. LEGAL PROCEEDINGS

        We are involved in administrative opposition proceedings being conducted by the European Patent Office with respect to our first European patent relating to humanized antibodies. At an oral hearing in March 2000, the Opposition Division of the European Patent Office decided to revoke the broad claims of our first European humanization patent. We appealed this decision. In November 2003, the Technical Board of Appeal of the European Patent Office decided to uphold our appeal and to set aside the Opposition Division's decision. The Board of Appeal ordered that certain claims be remitted to the Opposition Division for further prosecution and consideration of issues of patentability (novelty, enablement and inventive step). The claims remitted by the Board of Appeal cover the production of humanized antibody light chains that contain amino acid substitutions made under our antibody humanization technology. Regardless of the Opposition Division's decision on these claims, such decision could be subject to further appeals. Until the opposition is resolved, we may be limited in our ability to collect royalties or to negotiate future licensing or collaborative research and development arrangements based on this and our other humanization patents. Moreover, if the opposition is successful, our ability to collect royalties on European sales of antibodies humanized by others would depend on the scope and validity of our second European patent, whether the antibodies are manufactured in a country outside of Europe where they are covered by one of our patents, and in that case the terms of our license agreements with respect to that situation. Also, the Opposition Division's decision could encourage challenges of our related patents in other jurisdictions, including the United States. This decision may lead some of our licensees to stop making royalty payments or lead potential licensees not to take a license, either of which might result in us initiating formal legal actions to enforce our rights under our humanization patents. In such a situation, a likely defensive strategy to our action would be to challenge our patents in that jurisdiction. During the opposition process with respect to our first European patent, if we were to commence an infringement action to enforce that patent, such an action would likely be stayed until the opposition is decided by the European Patent Office. As a result, we may not be able to successfully enforce our rights under our European or related U.S. and Japanese patents.

        Eight notices of opposition were filed with respect to our second European antibody humanization patent and we have filed our response with the European Patent Office. Oral hearings, originally scheduled to take place in October 2003, have been postponed by the European Patent Office. No new date has been set for the hearings.

        Also, three opposition statements were filed with the Japanese Patent Office with respect to our Japanese humanization patent. The Japanese Opposition Board's subsequent decision supported one aspect of the position of the opponents, to which we filed two responses. Ultimately, we received a

31

final determination from the Japanese Patent Office examiner affirming the Opposition Board's earlier decision. We have appealed this decision to the Tokyo High Court. A hearing was held in April 2003. The patent will remain valid and enforceable during this appeal process. If this appeal is unsuccessful, we will then have an opportunity to appeal to the Japanese Supreme Court.

        We intend to vigorously defend the European patents and the Japanese patent in these proceedings. We may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If the outcome of the European or Japanese opposition proceedings or any litigation involving our antibody humanization patents were to be unfavorable, our ability to collect royalties on existing licensed products and to license our patents relating to humanized antibodies may be materially harmed. In addition, these proceedings or any other litigation to protect our intellectual property rights or defend against infringement claims by others could result in substantial costs and diversion of management's time and attention, which could harm our business and financial condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        Not applicable.

32

PART II

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

MARKET INFORMATION AND DIVIDEND POLICY

        Our common stock trades on the Nasdaq National Market under the symbol "PDLI." Prices indicated above are the high and low closing bid prices as reported by the Nasdaq National Market System for the periods indicated. We have never paid any cash dividends on our capital stock and we do not anticipate paying any cash dividends in the foreseeable future.

        As of December 31, 2003, we had approximately 242 common stockholders of record. Because many of these shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders but we believe that there are in excess of 300 holders.

33

ITEM 6. SELECTED FINANCIAL DATA

        Certain reclassifications of previously reported amounts have been made to conform to the presentation in the Consolidated Statement of Operations for the year ended December 31, 2003.

(1)

Represents acquired in-process research and development, which relates to the Eos acquisition and the purchase of certain technology from Roche that had not yet achieved technological feasibility. For a description of these charges, see Notes 2 and 4 to the Consolidated Financial Statements.

(2)

Includes charges associated with the early extinguishment of certain of our debt. For a description of these charges, see Note 12 to the Consolidated Financial Statements.

(3)

Represents non-cash charges related to the impairment of an equity investment. For a description of these charges, see Note 5 to the Consolidated Financial Statements.

34

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

        This report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are "forward looking statements" for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," estimates," "potential," or "continue" or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

OVERVIEW

        We are a recognized leader in the discovery and development of humanized monoclonal antibodies for the treatment of disease. All of our revenues are derived from licensing, humanization and royalty arrangements. As of December 31, 2003, we received royalties on five marketed products, with approximately 90% of our royalty revenues derived from the Herceptin antibody product marketed by Genentech and the Synagis antibody product marketed by MedImmune. We do not currently anticipate having proprietary marketed products prior to 2007. Accordingly, our revenues and related cash flows depend substantially on the success of our licensees and our ability to enter into new licensing and royalty arrangements.

Significant Risks

        In general, we have a history of operating losses and may not achieve sustained profitability. As of December 31, 2003, we had an accumulated deficit of approximately $220.3 million. Our expenses will increase over the next several years because of the extensive resource commitments required to identify and develop antibody candidates, including the ongoing operating costs associated with our acquisition of Eos Biotechnologies, Inc. (see Acquisition of Eos below), to achieve regulatory approval and to market potential products for commercial success for any individual product. Over the next several years, we expect to incur substantial additional expenses as we continue to identify, develop and manufacture our potential products, invest in research and improve and expand our development, manufacturing, marketing and sales capabilities. Since we or our collaborative partners or licensees may not be able to successfully develop additional products, obtain required regulatory approvals, manufacture products at an acceptable cost and with appropriate quality, or successfully market such products with desired margins, we may never achieve sustained profitable operations. The amount of net losses and the time required to reach sustained profitability are highly uncertain. Although we have had some profitable reporting periods, we do not expect to achieve sustained profitability until we are able to market and sell products. Since our goal is to launch our first product or products into the North American market by 2007, our ability to achieve this cash-flow positive position would not occur sooner than that, if we were successful.

35

        Our commitment of resources to research and the continued development of our products will require significant additional funds. Our operating expenses may also increase as some of our earlier stage potential products move into later stage clinical development, as additional potential products are selected as clinical candidates for further development, as we invest in additional manufacturing capacity, as we defend or prosecute our patents and patent applications, and as we invest in research or acquire additional technologies, product candidates or businesses.

        In the absence of substantial revenues from new corporate collaborations or patent rights or patent licensing or humanization agreements, significant royalties on sales of products licensed under our intellectual property rights, product sales or other uncertain sources of revenue, we will incur substantial operating losses.

Acquisition of Eos

        In April 2003, we completed the acquisition of Eos Biotechnology, Inc. (Eos), a privately held South San Francisco-based antibody discovery company, in exchange for approximately 4.2 million shares of our common stock. The Eos acquisition expanded our research personnel and added new capabilities in antibody target identification and validation, particularly in oncology. We also obtained two pre-clinical antibody product candidates; one of the antibody candidates (M200), which began clinical development in May 2003, targets potential treatment of solid tumors, and the second (F200) targets potential treatment of certain ocular indications.

        The Eos acquisition was accounted for as an acquisition of assets rather than as a business combination as Eos was a development stage company that had not commenced its planned principal operations. Eos lacked the necessary elements of a business because it did not have completed products and, therefore, no ability to access customers. The Eos operating results have been included in our consolidated results of operations since April 5, 2003. In conjunction with this transaction, we recorded a charge of approximately $37.8 million related to acquired in-process research and development in the second quarter of 2003.

        The aggregate purchase price was $38.8 million, consisting of the shares issued to the Eos stockholders valued at $35.5 million (including the value of shares withheld to provide for tax liabilities of $1.3 million), transaction costs of $2.2 million and employee change of control costs of $1.1 million. The shares issued in connection with this acquisition were valued at $8.17 per share, which represented the average of the closing market price of our common stock a few days before and after the acquisition announcement date (February 4, 2003).

Acquisition of Daclizumab

        Effective October 2003, we entered into an amendment to our collaboration agreement with Roche, pursuant to which we now have exclusive worldwide rights to market, develop, manufacture and sell Zenapax® (daclizumab) in all disease indications other than transplantation. Roche is currently expected to continue to market Zenapax in transplantation indications until 2007, although an earlier transfer to us of rights in transplantation may occur upon six months' written notice at Roche's election.

        Under the new arrangement, we assumed worldwide responsibility for the development and, if successful, sales and marketing of daclizumab in all indications other than transplantation. We also have rights to manufacture daclizumab.

        In connection with the new arrangement, we paid Roche $80 million in cash for return of exclusive rights in indications other than transplantation, and we obtained an option to acquire rights in transplant indications (reversion right), exercisable by us in 2006, but effective in 2007 or as early as 2005 at the election of Roche. To effectuate the transfer of Zenapax in the transplantation indications,

36

we will pay an additional exercise fee to Roche based on the average annual gross sales of Zenapax during the period from January 1, 2004 through the calendar quarter prior to the date of notice of the exercise, or Roche's notice of its decision to transfer the rights to us prior to our exercise date. If we do not receive transplantation rights, we would pay modest royalties to Roche on any sales in all diseases other than transplantation, and would continue to receive royalties on sales of Zenapax in transplantation.

        Of the $80 million that we paid to Roche in October 2003, we recorded a charge to acquired in-process research and development totaling approximately $48.2 million. We capitalized the remaining amount of $31.8 million, which relates to core technology and the reversion right. We are amortizing the value of the core technology, $16.0 million, over the term of the patents underlying the acquired technology. We will reclassify the reversion right asset, $15.8 million, into core technology at the time when the rights to the technology revert back to us, which at our option will be no later than 2007, but could be as early as 2005 at the election of Roche. Upon reclassifying the reversion right asset to core technology, we will amortize the asset over the remaining term of the patents underlying the acquired technology.

CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES

        The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates. The items in our financial statements requiring significant estimates and judgments are as follows:

Revenue Recognition

        We currently recognize three types of revenues resulting from the licensing and use of our technology, and from services we sometimes perform in connection with the licensed technology. These revenues are typically derived from our proprietary patent portfolio covering the development, use, sale and importation of humanized antibodies.

        We enter into patent license and humanization agreements that may contain other elements, such as royalties and milestones related to the achievement of particular stages in product development. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes, and if so, how the aggregate contract value should be allocated among the deliverable elements and when to recognize revenue for each element. We recognize revenue for delivered elements only when the fair values of undelivered elements are known, when the associated earnings process is complete and, to the extent the milestone amount relates to our performance obligation, when our customer confirms that we have met the requirements under the terms of the agreement and when payment is reasonably assured. Changes in the allocation of the contract value between deliverable elements might impact the timing of revenue recognition, but in any event, would not change the total revenue recognized on the contract.

        Under our humanization agreements, the licensee typically pays an upfront fee for us to "humanize" an antibody. These upfront fees are recognized on a percent completion basis, as the humanization work is performed, which is typically over three to six months. We follow this method because we can reliably estimate the progress of each project based on information from our scientists. Due to our extensive experience in humanizing antibodies, coupled with the short-term nature of the humanization contracts, the likelihood that the actual progress is materially different than that reflected in our revenues at the end of any particular reporting period is low. Historically, revenues recognized have approximated actual progress under each humanization agreement.

37

Clinical Trial Expenses

        Our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with numerous clinical trial centers and clinical research organizations. In the normal course of business we contract with third parties to perform various clinical trial activities in the on-going development of potential drugs. The financial terms of these agreements are subject to negotiation and variation from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events or the successful accrual of patients or the completion of portions of the clinical trial or similar conditions. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. As such, direct expenses related to each patient enrolled in a clinical trial are recognized on an estimated cost-per-patient basis as services are performed. In addition to considering information from our clinical operations group regarding the status of our clinical trials, we rely on information from contract research organizations (CROs), such as estimated costs per-patient, to calculate our accrual for direct clinical expenses at the end of each reporting period. For indirect expenses, which relate to site and other administrative costs to manage our clinical trials, we rely on information provided by the CRO, including costs incurred by the CRO as of a particular reporting date, to calculate our indirect clinical expenses. In the event of early termination of a clinical trial, we accrue an amount based on our estimate of the remaining non-cancelable obligations associated with the winding down of the clinical trial, which we confirm directly with the CRO. Our estimates and assumptions could differ significantly from the amounts that may actually be incurred, however, our experience has been that our estimates at the end of any particular reporting period have been materially accurate.

Intangible Assets

        The valuation in connection with the initial purchase and the ongoing evaluation for impairment of intangible assets requires significant management estimates and judgment. The purchase price allocation process requires management estimates and judgment as to expectations for various products and business strategies. For example, we estimate future probability-adjusted cash flows and certain discount rates as well as assumed commercialization dates for future potential products. These estimations affect the allocation between charges to acquired in-process research and development and capitalization of intangible assets. If any of the significant assumptions differ from the estimates and judgments used in the purchase price allocation, this could result in different valuations for intangible assets.

        Once the values for intangible assets are established, we must test intangible assets with definite useful lives for impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." When we conduct our impairment tests for intangibles, factors that are considered important in determining whether impairment might exist include significant changes in our underlying business and product candidates or other factors specific to each asset being evaluated. Any changes in key assumptions about the business and its prospects, or changes in market conditions or other externalities, could result in an impairment charge and such a charge could have a material adverse effect on our consolidated results of operations.

38

RESULTS OF OPERATIONS

Years ended December 31, 2003, 2002 and 2001

Total Revenues

        Our total revenues for 2003 were $66.7 million, a 44% increase from 2002 due to higher royalties and license fees when compared to 2002. Total revenues for 2002 were $46.4 million, a 4% increase from 2001 due to higher royalties, partially offset by lower license and other revenues. These revenue changes are further discussed below.

Royalties

        Royalty revenues recognized under agreements with Roche, Genentech, MedImmune and Wyeth were $52.7 million in 2003 compared to $40.4 million in 2002, an increase of 30% compared to an increase of 32% in 2002 from 2001. In 2003, the increase was primarily due to increased Herceptin sales reported by Genentech and higher Synagis sales reported by MedImmune. Royalty payments from MedImmune and Genentech accounted for 47% and 46%, respectively, of our royalty revenues during 2003. The increase in royalty revenues in 2002 when compared to 2001 was primarily due to higher third-party sales of Synagis and Herceptin. In 2002, royalty revenues from MedImmune and Genentech accounted for 47% and 43% of our royalty revenues, respectively. In 2001, royalty revenues from MedImmune and Genentech accounted for 48% and 39% of our royalty revenues, respectively.

        We expect that in 2004, with the additional licensed products brought to market in late 2003 and the launch of Genentech's Avastin antibody product in 2004, we will continue to experience royalty revenue growth. We also continue to expect quarterly fluctuations in royalty revenues due to the seasonality of sales of Synagis.

License and Other Revenues

        License and other revenues were $14.0 million in 2003, an increase of 135% from 2002. License and other revenues were $6.0 million in 2002, a decrease of 57% from 2001. License and other

39

revenues recognized primarily consist of upfront patent licensing and patent rights fees, milestones, amortization of upfront fees associated with humanization agreements and license maintenance fees.

        The increase in license and other revenues in 2003 was primarily due to the fact that we entered into more patent licensing agreements in 2003 as compared with 2002 as well as higher milestone revenue in 2003 as compared with 2002. In 2003, we entered into six patent licensing agreements, compared to one patent rights and one patent licensing agreement in 2002. In addition, in 2003, we recognized $2.5 million in milestone revenues, with no such comparable revenues in 2002.

        The decrease in license and other revenues in 2002 from 2001 was primarily due to the fact that we entered into fewer patent licensing, patent rights and humanization agreements in 2002 as compared with 2001 and due to greater milestone and humanization revenues in 2001 as compared with 2002. In 2002, we entered into one patent rights and one patent licensing agreement, as compared with three patent rights agreements in 2001. In addition, in 2001, we recognized more than $7.0 million in milestone and humanization revenues, with no such comparable revenues in 2002.

        We expect quarterly fluctuations in license and other revenues depending on the number of new contract arrangements we enter into and milestones achieved by our licensees.

Costs and Expenses

Research and Development Expenses

        Research and development expenses in 2003 were $82.7 million, an increase of 43% from 2002. Research and development expenses in 2002 were $58.0 million, an increase of 11% from 2001. Research and development costs include costs of personnel to support our research and development activities, costs of preclinical studies, costs of conducting our clinical trials, such as clinical investigator fees, monitoring costs, data management and drug supply costs, research and development funding provided to third parties and an allocation of facility costs. The increase in 2003 was primarily due to an increase in personnel costs of approximately $16.3 million, in large part resulting from an increase of research and development personnel of approximately 143 employees as a result of the acquisition of Eos, and the hiring of additional employees to pursue our expanding research and development programs. Also contributing to the increase were additional clinical development activities for our major research and development projects of approximately $3.9 million and an increase in facility-related expenses of $5.0 million, resulting from the expansion of our facilities in 2003. These increases in costs were partially offset by lower research and development funding provided to Exelixis of $1.1 million.

        The increase in 2002 was primarily related to an increase in research and development personnel headcount of approximately 38 employees and associated increase in personnel costs of approximately $3.4 million, higher research and development funding provided to Exelixis of $1.7 million, reflecting a

40

full year of funding in 2002 compared to a partial year of funding in 2001, and higher preclinical studies' costs of $0.8 million.

        We expect our research and development expenses will continue to increase as we invest in manufacturing, advance our product candidates into later stages of development and add new product candidates. More specifically, the increase is expected to relate primarily to expanded clinical trial activity, including associated direct scale-up and manufacturing expenses, and the additional headcount required to execute our clinical trial programs as well as the further expansion of our research, preclinical, manufacturing and process development infrastructure.

        Below is a summary of products and the related stages of development for each product in clinical development, including the research and development expenses recognized in connection with each product.

(1)

Product is no longer being developed for this indication.

(2)

Product acquired from Eos in April 2003.

(3)

Product was returned to GlaxoSmithKline.

(4)

Target-related intellectual property outlicensed in December 2003.

(5)

Further development of these products by PDL is not currently expected; some of these candidates are available for out-license.

(6)

No single potential product included in "other" constitutes more than 5% of the total research and development expenses for the period presented.

        The information in the column labeled "Estimated Completion of Phase" is our current estimate of the timing of completion of product development phases. The actual timing of completion of those phases could differ materially from the estimates provided in the table. The clinical development portion of these programs may span as many as seven to ten years and any further estimation of completion dates or costs to complete would be highly speculative and subjective due to the numerous

41

risks and uncertainties associated with developing biopharmaceutical products, including significant and changing government regulation, the uncertainty of future preclinical and clinical study results and uncertainties associated with process development and manufacturing as well as marketing. For a discussion of the risks and uncertainties associated with the timing of completing a product development phase, see the "Clinical development is inherently uncertain and expense levels may fluctuate unexpectedly because we can not accurately predict the timing and level of such expenses," "If we cannot successfully complete our clinical trials, we will be unable to obtain regulatory approvals required to market our products," "Our clinical trial strategy may increase the risk of clinical trial difficulties," "If we do not attract and retain key employees, our business could be impaired," and "We may be unable to obtain or maintain regulatory approval for our products" sections of our Risk Factors.

General and Administrative Expenses

        General and administrative expenses in 2003 were $27.6 million, an increase of 50% from 2002. In 2002, general and administrative expenses were $18.4 million, an increase of 22% from 2001. General and administrative costs include costs of personnel, professional services, patent, consulting and other expenses related to our administrative functions and an allocation of facility costs. The increase in 2003 was primarily related to increased personnel and recruiting costs of $5.2 million, higher legal costs related to our intellectual property, licensing and other contractual matters of $1.7 million, increased facility-related costs of $0.7 million, and stock-based compensation expense associated with the issuance of stock options to non-employees in 2003 of approximately $0.3 million. The increase in 2002 was primarily related to increased personnel and recruiting costs of $1.9 million, legal costs related to our intellectual property, licensing and other contractual matters of $0.7 million and $0.2 million related to maintenance agreements for our document control software systems. We expect that general and administrative expenses will continue to increase as we build infrastructure and support for expanded research and development capabilities.

Acquired In-Process Research and Development

Eos Acquisition

        In connection with the April 2003 acquisition of Eos, we recorded charges for acquired in-process research and development of $37.8 million due to Eos' incomplete research and development programs that had not yet reached technological feasibility as of April 4, 2003 and had no alternative future use as of that date. A summary of these programs follows:

*

Development progress may be affected by potential partnering discussions or commitment of resources to more advanced programs.

42

Acquisition of Zenapax® Rights from Roche

        Effective October 2003, we entered into an amendment to our collaboration agreement with Roche, pursuant to which we now have exclusive worldwide rights to market, develop, manufacture and sell Zenapax (daclizumab) in all disease indications other than transplantation.

        In connection with the new arrangement, we paid Roche $80 million in cash for return of exclusive rights in indications other than transplantation, and we obtained an option to acquire rights in transplant indications (reversion right), exercisable by us in 2006, but effective in 2007 or as early as 2005 at the election of Roche.

        Of the $80 million that we paid to Roche in October 2003, we recorded a charge to acquired in-process research and development totaling approximately $48.2 million. This amount relates to the rights to autoimmune indications for daclizumab that are currently being developed and tested in clinical studies, specifically to treat ulcerative colitis and asthma.

        We are evaluating daclizumab in two Phase II clinical studies in patients with moderate-to-severe ulcerative colitis and asthma. These trials were fully enrolled by the end of December 2003, and we anticipate that results may be available in mid-year 2004.

Assumptions Underlying In-Process Research and Development Charges

        The values of the acquired in-process research and development from both the Eos acquisition and the Roche arrangement were determined by estimating the related future probability-adjusted net cash flows, which were then discounted to present values using a rate of 15%. This discount rate is a significant assumption and is based on our estimated weighted average cost of capital taking into account the risks associated with the projects acquired. The projected cash flows from such projects were based on estimates of revenues and operating profits related to such projects considering the stage of development of each potential product acquired, the time and resources needed to complete each product, the estimated life of each potential commercialized product and associated risks including the inherent difficulties and uncertainties in developing a drug compound including obtaining FDA and other regulatory approvals, and risks related to the viability of and potential alternative treatments in any future target markets. In determining the value of the acquired in-process research and development, the assumed commercialization dates used for the potential products ranged from 2008 to 2009 and 2007 to 2008 related to the Eos acquisition and the Roche arrangement, respectively.

        Numerous risks and uncertainties exist with timely completion of development, including the uncertainty and timing of commencing human clinical trials and patient enrollment, as well as uncertainties related to the results of such studies, including interpretation of the data and obtaining FDA and other regulatory body approvals. The nature of the remaining efforts for completion of the acquired in-process research and development projects primarily consist of initiating clinical trials and studies, the cost, length and success of which are extremely difficult to determine. Feedback from regulatory authorities or results from clinical studies might require modifications or delays in later stage clinical trials or additional studies to be performed. The acquired products under development may never be successfully commercialized due to the uncertainties associated with the pricing of new pharmaceuticals and the fact that the cost of sales to produce these products in a commercial setting has not been determined. If these programs cannot be completed on a timely basis, then our prospects for future revenue growth would be adversely impacted.

43

Interest and Other Income, Interest Expense and Impairment Loss on Investment

        Interest and other income, net was $9.8 million in 2003, a decrease of 62% from 2002. In 2002, interest and other income was $26.0 million, a decrease of 26% from 2001. In 2003, interest and other income, net consists of interest income of $16.3 million, partially offset by early debt extinguishment charges of approximately $6.5 million. Interest income decreased by $9.7 million in 2003 when compared to 2002 primarily due to declining interest rates on our marketable securities. Interest income in 2002 was $26.0 compared to $35.1 million in 2001. Also in 2002, the decrease in interest earned was due largely to the decreased interest earned on our marketable securities' balances primarily as a result of lower market interest rates.

        Interest expense in 2003, net of amounts capitalized, related to our 5.50% convertible subordinated notes that were redeemed in November 2003, our 2.75% convertible subordinated notes, a 7.64% term loan associated with the purchase our Fremont, California facilities, and notes payable assumed in our acquisition of Eos in the second quarter of 2003. Interest expense in 2002 related to our 5.50% convertible subordinated notes and a 7.64% term loan associated with the purchase our Fremont, California facilities. Interest expense in 2003 was $9.8 million, an increase of 7% from 2002. Interest expense in 2002 was $9.1 million, a decrease of 6% from 2001. Interest expense for 2003 increased slightly compared to the same period in 2002, due to increased interest expense resulting from the issuance of the 2.75% convertible notes in July 2003, including higher amortization of associated debt issuance costs, and the notes payable assumed from the Eos acquisition, partially offset by increased capitalized interest. Capitalized interest was $2.2 million and $0.5 million in 2003 and 2002, respectively, in connection with the renovation of our existing manufacturing facilities and the development activities for our future manufacturing facilities. The decrease in 2002 when compared to 2001 was the result of capitalizing $0.5 million of our interest cost in 2002 in connection with the renovation of our existing manufacturing facilities and the development and construction activities for our future manufacturing facilities. No interest was capitalized in 2001.

        In January 2002, we sold the assets of our small molecule group to Signature BioScience, Inc. (Signature), a privately held drug discovery company, in exchange for 523,952 shares of Signature convertible preferred stock. The stock received was recorded at the net book value of the assets sold plus transaction costs incurred, which approximated $1.3 million. In conjunction with this transaction, in December 2002, we accrued an additional $0.2 million payable to Signature in connection with cash retention bonuses to designated key employees still employed by Signature after one year. Pursuant to the terms of the agreement, in exchange for these bonus payments we received in early 2003 an additional 149,701 shares of Signature convertible preferred stock, which was recorded as an increase in the carrying value of the preferred stock. Since the shares we received are not publicly traded, the value of the shares is therefore difficult to estimate. As of December 31, 2002, we estimated that the value of our investment in Signature had declined to $150,000 and that an impairment of our investment had occurred and that such impairment was other then temporary. Accordingly, we recorded an impairment charge of $1.4 million in December 2002. The amount of the charge was based on the difference between the estimated fair value as determined by our management and our original cost basis in the shares of approximately $1.6 million. As of March 31, 2003, we estimated that our

44

investment in Signature had become fully impaired and that such impairment was other than temporary. Accordingly, we recorded an impairment charge of $150,000 in March 2003.

Income Taxes

        We have recorded a tax provision of approximately $73,000 for 2003 primarily related to income earned in our foreign operations and foreign withholding tax in connection with a license maintenance fee, compared to $42,000 for 2002. We do not expect to record any tax provision for federal income taxes during 2004 based upon our projected U.S. tax loss for 2004.

LIQUIDITY AND CAPITAL RESOURCES

        To date, we have financed our operations primarily through public and private placements of equity and debt securities, revenue under agreements with third parties and interest income on invested capital. At December 31, 2003, we had cash and cash equivalents, marketable securities and restricted investments in the aggregate of $505.0 million, compared to $606.4 million at December 31, 2002.

        Net cash used in our operating activities in 2003 was approximately $23.0 million compared with net cash used in operating activities of $5.1 million in 2002. In 2003, the change in cash used in operating activities as compared to 2002 related primarily to the funding of greater operating expenses, increases in other current assets and other assets resulting from the transaction costs associated with the issuance of our 2.75% convertible notes, partially offset by an increase in accounts payable and accrued liabilities resulting from the construction of our new commercial manufacturing facility in Brooklyn Park, Minnesota. Net cash used in our operating activities in 2002 was approximately $5.1 million compared with net cash provided by operating activities of $2.6 million in 2001. The change was primarily due to a net loss in 2002, partially offset by a decrease in interest receivable in 2002 versus an increase in interest receivable in 2001 and the non-cash impairment loss on our investment in Signature in 2002.

        In 2003, net cash used in our investing activities was $21.5 million, compared to cash provided by investing activities in 2002 of $168.8 million. The change in 2003 was primarily the result of purchases of marketable securities associated with the issuance of our 2.75% convertible notes, as well as the purchase of intangible assets and increased purchases of property and equipment. Purchases of property and equipment in 2003 was primarily related to the development and construction activities for our manufacturing facility in Brooklyn Park, Minnesota. The purchase of intangible assets related to an amendment to our collaboration agreement with Roche, pursuant to which we paid Roche $80 million in cash in return for exclusive worldwide rights to market, manufacture and sell daclizumab in all disease indications other than transplantation, resulting in a charge to in-process research and development of $48.2 million and intangible assets of $31.8 million. In 2002, purchases of land, property and equipment primarily consisted of land and equipment purchases in connection with the renovation of our existing Plymouth, Minnesota manufacturing facility as well as construction activities for our manufacturing facility in Brooklyn Park, Minnesota.

        Net cash provided by our investing activities in 2002 was $168.8 million compared to net cash used in our investing activities of $316.3 million in 2001. The change in 2002 was primarily the result of an increase in maturities of marketable securities and a decrease in purchases of marketable securities during the period as compared to our maturities and reinvestment activities associated with the purchases of short- and long-term investments in 2001, as a result of the investment of higher cash balances at the end of 2000 resulting from a follow-on offering in the third quarter of 2000. Also, the increase is attributable to higher capital expenditures in 2002, which primarily related to the renovation of our Plymouth, Minnesota manufacturing facility and development and construction activities and the purchase of land for our manufacturing facility in Brooklyn Park, Minnesota. Capital expenditures in

45

2001 primarily consisted of equipment purchases and renovation of our Plymouth, Minnesota manufacturing facility.

        Net cash provided by our financing activities in 2003 was $98.5 million compared to $3.8 million in 2002. The change in 2003 from 2002 was primarily the result of the proceeds totaling $250 million from the issuance of our 2.75% convertible notes in July 2003, partially offset by the redemption of our 5.50% convertible notes in November 2003 in the aggregate of approximately $154.1 million. The decrease in net cash provided by our financing activities in 2002 as compared to net cash provided by our financing activities of $12.5 million in 2001 was primarily the result of a decrease in the exercise of outstanding stock options.

        We estimate that our existing capital resources will be sufficient to fund our current level of operations for at least the next four years. Our future capital requirements will depend on numerous factors, including, among others, royalties from sales of products by third-party licensees, including Synagis, Herceptin, Xolair, Raptiva, Zenapax, Mylotarg and Avastin; our ability to enter into additional collaborative, humanization, patent license and patent rights agreements; interest income; progress of product candidates in clinical trials; the ability of our licensees to obtain regulatory approval and successfully manufacture and market products licensed under our patents; the continued or additional support by our collaborative partners or other third parties of research and development efforts and clinical trials; investment in existing and new research and development programs; time required to gain regulatory approvals; significant resources we will devote to constructing and qualifying our manufacturing facilities; our ability to obtain and retain funding from third parties under collaborative arrangements; our continued development of internal marketing and sales capabilities; the demand for our potential products, if and when approved; potential acquisitions of technology, product candidates or businesses by us; and the costs of defending or prosecuting any patent opposition or litigation necessary to protect our proprietary technology. In order to develop and commercialize our potential products we may need to raise substantial additional funds 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.

        In September 1999, Fremont Holding L.L.C. (our wholly owned subsidiary) obtained a $10.2 million term loan to purchase our Fremont, California facilities. The loan bears interest at the rate of 7.64% per year amortized over 15 years with principal and interest payable monthly. The loan is secured by our Fremont, California facilities and is subject to the terms and covenants of the loan agreement.

        In November 2003, we paid approximately $155.9 million in cash to redeem our 5.5% convertible notes due February 15, 2007, including accrued interest of $1.8 million and prepayment obligations of approximately $4.1 million in connection with the redemption. In addition to the $4.1 million in prepayment obligations for early extinguishment of these notes, we recorded a charge to write-off the unamortized balance of the original debt issuance costs of approximately $2.4 million; these charges, totaling $6.5 million, are included in interest and other income, net, in the Consolidated Statement of Operations.

        In May 2001, we signed a collaborative agreement with Exelixis, Inc. to discover and develop humanized antibodies for the diagnosis, prevention and treatment of cancer. We agreed to provide Exelixis with $4.0 million in annual research funding through June 1, 2003, and we purchased a $30.0 million five-year note, convertible at our option after the first year of the collaboration into Exelixis common stock. The research funding period ended in June 2003. During the funding period, Exelixis performed certain genetic screens and other research activities intended to identify and validate targets for antibody therapeutics in oncology. We received an exclusive, worldwide license to develop antibodies against certain targets identified by Exelixis that are involved in cell growth, cell death and

46

proliferation. Exelixis has the right to co-fund development of antibodies resulting from the collaboration. Therefore, we recognized the expense of research funding ratably over the periods for which it was performed. For antibody products we develop that Exelixis elects not to co-fund, we have agreed to make specified milestone payments and royalty payments on any product sales.

        In July 2003, we issued 2.75% convertible subordinated notes due August 16, 2023 in the aggregate with a principal amount of $250.0 million. The 2.75% convertible notes are convertible into our common stock at a conversion price of $20.14 per share, subject to adjustment in certain events and at the holders' option. Interest on the 2.75% convertible notes is payable semiannually in arrears on February 16 and August 16 of each year. The 2.75% convertible notes are unsecured and are subordinated to all our existing and future senior indebtedness and may be redeemed at our option, in whole or in part, beginning on August 16, 2008 at par value. In addition, in August 2010, August 2013 and August 2018, holders of our 2.75% convertible notes may require us to repurchase all or a portion of their notes at 100% of their principal amount, plus any accrued and unpaid interest to, but excluding, such date. For 2.75% convertible notes to be repurchased in August 2010, we must pay for the repurchase in cash, and we may pay for the repurchase of notes to be repurchased in August 2013 and August 2018, at our option, in cash, shares of our common stock or a combination of cash and shares of our common stock. In the third quarter of 2003, we filed a shelf registration statement with the Securities and Exchange Commission covering the resale of the 2.75% convertible notes and the common stock issuable upon conversion of the notes.

        We pledged a portfolio of U.S. government securities costing approximately $20.8 million as security for the 2.75% convertible notes. These securities, and the earnings thereon, will be sufficient to pay the first six scheduled interest payments due on the notes. The pledged amount of $20.8 million has been classified as restricted investments on our Consolidated Balance Sheet. The portion related to payments to be made within one year, $7.4 million, is reflected on the Consolidated Balance Sheet within marketable securities and the portion related to payments to be made thereafter, $13.4 million, is reflected on the Consolidated Balance Sheet as long-term restricted investments.

        In connection with the construction of our new commercial manufacturing facility in Brooklyn Park, Minnesota, we have entered into, and will continue to enter into, agreements with third parties for the construction and design of the facility. We have engaged Fluor Daniel (a division of Fluor Enterprises) to handle the engineering and certain procurement services for the new facility. In addition, we engaged Fluor Daniel to perform systems integration and assist in commissioning of the facility. As of December 31, 2003, under these arrangements, the aggregate contractual costs totaled approximately $29.4 million, of which approximately $5.5 million and $0.9 million is remaining to be paid in 2004 and 2005, respectively. The design and project management work under this agreement was substantially completed in 2003, the construction support and systems integration is scheduled to be completed by the end of 2004, and the commissioning work is scheduled to be completed by mid-2005. In addition, we have entered into various commitments related to the manufacturing equipment and validation services required for the new facility with aggregate contractual costs of approximately $36.0 million as of December 31, 2003, of which approximately $18.8 million and $3.1 million is remaining to be paid in 2004 and 2005, respectively. We have also signed agreements with McGough Construction for the construction management and certain construction services for the facility. Under those agreements as of December 31, 2003, the aggregate contractual costs totaled approximately $94.0 million, of which approximately $57.5 million remains to be paid in 2004. The facility construction is scheduled to be completed in late 2004.

47

        Our contractual obligations under lease, debt, construction and research funding agreements for the next five years and thereafter as of December 31, 2003 are as follows:

(1)

This table does not include (a) any milestone payments from us to third parties which may become payable under research collaborations or license agreements as the timing and likelihood of such payments are not known, or (b) any royalty payments from us to third parties as the amounts of such payments and / or likelihood of such payments are not known in any period presented above.

Recent Accounting Pronouncements

        In November 2002, the FASB issued Emerging Issues Task Force Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables" (Issue 00-21). Issue 00-21 addresses certain aspects of the accounting by a company for arrangements under which it will perform multiple revenue-generating activities. Issue 00-21 addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. Issue 00-21 also addresses the impact on the measurement and/or allocation of arrangement consideration of customer cancellation provisions and consideration that varies as a result of future actions of the customer or the company. The provisions of Issue 00-21 applied to our revenue arrangements entered into after June 30, 2003. Our adoption of Issue 00-21 did not have a material impact on our results of operations or financial position.

        In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities," (FIN 46). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. A variable interest entity is a corporation, partnership, trust, or any other legal structures used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities for interim periods ending after March 15, 2004. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. Our adoption of FIN 46 is not expected to have a material impact on our results of operations or financial position.

        In December 2003, the FASB revised FASB Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," (FAS 132) to improve financial statement disclosures for defined benefit plans. The standard requires that companies provide more details about their plan assets, benefit obligations, cash flows, benefit costs and other relevant information. For example, cash flow disclosures will include projections of future benefit payments and an estimate of contributions to be made in the next year to fund pension and other postretirement benefit plans. In addition to

48

expanded annual disclosures, companies are required to report the various elements of pension and other postretirement benefit costs on a quarterly basis. FAS 132 is effective for fiscal periods ending after December 15, 2003. Our adoption of FAS 132, as revised in December 2003, is reflected in Note 13 to the Consolidated Financial Statements.

Off-Balance Sheet Arrangements

        None.

ITEM 7a. MARKET RISKS

Interest Rate Risk

        We maintain a non-trading investment portfolio of investment grade, highly liquid debt securities, which limits the amount of credit exposure to any one issue, issuer or type of instrument. We do not use derivative financial instruments for speculative or trading purposes. We hold a $30.0 million five-year convertible note receivable purchased from Exelixis, Inc. in May 2001. Accounting rules require the conversion feature of some convertible notes to be separated from the debt agreement in which the conversion feature is contained and accounted for as a derivative instrument, and therefore reflected in the note purchaser's financial statements based upon the fair market value of the stock into which the note is convertible. Due in part to the number of shares into which this note receivable would currently convert and the average daily trading volume of Exelixis stock, the Exelixis note is not currently considered a derivative instrument and, therefore, changes in the market value of Exelixis stock are not required to be recorded in our financial statements. However, a significant increase in the average daily trading volume of Exelixis stock, or changes or interpretations in accounting principles could require us to report the value of the Exelixis stock in our financial statements. Such a requirement could cause us to include changes in the Exelixis stock price on a quarterly basis and would contribute to fluctuation in our operating results from quarter to quarter.

        The securities in our investment portfolio are not leveraged and are classified as available-for-sale and therefore are subject to interest rate risk. We do not currently hedge interest rate exposure. If market interest rates were to increase by 100 basis points from December 31, 2003 levels, the fair value of the portfolio would decline by approximately $2.5 million. The modeling technique used measures the change in fair values arising from an immediate hypothetical shift in market interest rates and assumes ending fair values include principal plus accrued interest.

        As of December 31, 2003, the aggregate fair values of our long-term debt and convertible subordinated notes were approximately $8.5 million and $290.0 million, respectively. The long-term debt bears interest at a fixed rate of 7.64% and the convertible subordinated notes bear interest at a fixed rate of 2.75%. These obligations are subject to interest rate risk because the fixed interest rates under these obligations may exceed current interest rates.

        The following table presents information about our material debt obligations that are sensitive to changes in interest rates. The table presents principal amounts and related weighted average interest

49

rates by year of expected maturity for our debt obligations. Our convertible notes may be converted to common stock prior to the maturity date.

*

The fair value of the remaining payments under our long-term obligations is estimated using discounted cash flow analyses, based on our current incremental borrowing rate for similar types of borrowing arrangements.

Foreign Currency Risk

        As we have operations outside of the United States, our financial results could be affected by changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we operate. To date, our foreign operations have not been significant to our results of operations and financial condition; therefore, our current foreign currency risk is minimal.

50

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PROTEIN DESIGN LABS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

See accompanying notes.

51

PROTEIN DESIGN LABS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)