PROTEIN DESIGN LABS, INC.

2002 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

Protein Design Labs, Nuvion and SMART are registered U.S. trademarks and the PDL logo, HuZAF and Zamyl are trademarks of Protein Design Labs, Inc. Zenapax is a registered U.S. trademark of Roche. All other company names and trademarks included in this Annual Report are trademarks, registered trademarks or trade names of their respective owners.

We are a recognized leader in the discovery and development of humanized monoclonal antibodies for the treatment of disease. Our key areas of disease focus include oncology and inflammatory and autoimmune diseases. We have several humanized antibodies in clinical development for inflammatory bowel disease, psoriasis and asthma. We are fully integrated from research through clinical development. We conduct multiple activities in support of the clinical development program, including pre-clinical studies, process development, and antibody manufacturing. We have significant research activities aimed at the discovery of new antibodies that may be useful for the treatment of certain cancers and autoimmune and inflammatory diseases.

Based on the strength of our proprietary platform, the number of antibody programs in development and the flexibility provided by our financial position, our goal is to launch our first proprietary product into the North American market by the end of calendar year 2007. We currently derive revenue primarily from an active out-licensing effort aimed at licensing rights under our fundamental antibody humanization patents to developers of antibody- based therapeutics. To date, we have entered into numerous patent agreements, and the resulting fees and royalty revenues from these licenses have led to a reduced cash burn. We receive royalties on four antibody products launched during the past five years.

Our objective is to leverage our product pipeline and patent portfolio in the field of antibodies to become a fully integrated, profitable, research-based biopharmaceutical company with the aim of marketing our own proprietary drug in North America by 2007. Currently, we derive revenues from three major sources:

With new management leadership and direction in effect from late 2002, we have undertaken to further improve our capabilities in three areas, in support of our longer range objective of marketing a proprietary drug by 2007. First, in research, we have efforts underway to increase productivity from ongoing discovery efforts, and to identify additional antibody targets, to derive a steady flow of preclinical and clinical antibody candidates. Second, in clinical development, we are defining a clear set of product requirements for each step of the development process, with larger and more experienced teams managing these efforts. Third, we are actively exploring near term commercial opportunities, principally in the antibody area, which might be synergistic with our ongoing development efforts.

The following table summarizes the potential therapeutic applications and development status for our priority clinical product candidates. Not all clinical trials being conducted are listed. The development and commercialization of our product candidates are subject to numerous risks and uncertainties.

Daclizumab. The FDA approved daclizumab (Zenapax) in December 1997 for the prevention of kidney transplant rejection. It has since been approved in Europe and a number of other countries. Zenapax was the first humanized antibody to be approved anywhere in the world. The Zenapax approvals are based on two Phase III clinical trials, both of which demonstrated that Zenapax-treated patients had a statistically significant reduction in acute rejection episodes compared to patients who did not receive Zenapax. Also, Zenapax treatment was not associated with any observed side effects in addition to those typically seen in the transplant setting. Our licensee Roche sells Zenapax in the U.S., Europe and other territories for the renal transplant indication and we receive royalties on Zenapax sales.

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 immune response that occurs 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.

In 1999, we reacquired from Roche specific development and marketing rights to daclizumab for autoimmune diseases. We are funding costs of clinical trials for daclizumab in autoimmune diseases and asthma. In return, we have the right to market daclizumab for approved autoimmune and asthma indications in the U.S. and Canada, and will receive a major portion of the revenues from sales for these diseases. Unless otherwise agreed, Roche will continue to manufacture daclizumab and pay for the cost of goods from its share of the revenues. In Europe and certain other countries, Roche can elect to market daclizumab for approved autoimmune indications or to allow us to market it, and revenues will be shared.

Daclizumab is currently being investigated in a PDL- sponsored Phase II trial in asthma. A Phase II trial of daclizumab to maintain remission following cyclosporine induction in psoriasis was completed in 2002, but did not meet the primary endpoint of the trial. Daclizumab is also under investigation in investigator-sponsored trials for ulcerative colitis, uveitis, multiple sclerosis, type I diabetes, aplastic anemia and the ocular manifestations of Behcet's disease. In the early stage clinical trial for uveitis, an autoimmune disease of the eye, daclizumab was safely administered to patients for one year and was active in controlling the disease in most patients, some of whom have continued to receive the drug for over four years. During 2003, we hope to initiate two Phase II company-sponsored trials, the first in ulcerative colitis and the second in multiple sclerosis. The trials are targeted to begin in the second and fourth quarter respectively.

Nuvion (visiluzumab). We are developing this humanized antibody for the treatment of graft-versus-host disease and ulcerative colitis. It binds to the CD3 antigen, a key receptor for stimulating T cells. Nuvion has completed a Phase I trial for steroid-refractory graft-versus-host disease, in which the response rate was 100%. We are conducting a Phase II trial in steroid-refractory graft-versus-host disease and a Phase I trial in primary graft-versus-host disease. The latter trial has experienced slow enrollment, and primary graft-versus-host disease will not be pursued as a registration strategy. In late 2002, we initiated a Phase I trial investigating Nuvion in severe refractory ulcerative colitis, and hope to complete this trial during 2003.

We conducted a Phase I/II trial of Nuvion in psoriasis. Many patients in this trial experienced adverse events consistent with the cytokine release syndrome, causing flu-like symptoms often associated with certain cytokine-related drugs, that prevented escalation of the dose to a level likely to be consistently effective. Based on these results, we have discontinued development of Nuvion in psoriasis at this time. We have retained worldwide rights to Nuvion, and we plan to seek a partner for development and commercialization outside the U.S. and Canada.

HuZAF (Anti-Gamma Interferon Antibody). This humanized antibody 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 have also completed a Phase I/II trial in patients with Crohn's disease, a form of inflammatory bowel disease. Data from the single dose portion of this trial showed a trend toward a higher rate of response and a greater number of remissions as the dose was increased, although there was a high rate of response in the placebo group. Based on results from this study, we are currently conducting a U.S.-based 175 patient Phase II trial of anti-gamma interferon in Crohn's disease patients examining the same doses as were used in the Phase I/II trial. In addition, we expect to initiate a second Phase II trial in Crohn's disease patients in 2003, which will examine a higher dose as well as a slightly modified treatment protocol, and be conducted in Europe. We currently expect to complete and analyze results from both trials by the end of the first quarter of 2004.

We are also conducting a Phase I/II trial in psoriasis, which will be concluded prior to the end of 2003. In the future, we may initiate clinical trials in other autoimmune diseases, as gamma interferon is implicated in a range of autoimmune diseases including systemic lupus and rheumatoid arthritis. We have retained worldwide rights to HuZAF, although we are now actively seeking a partner for development and commercialization for rights outside the U.S. and Canada.

Anti-IL-4 Antibody. We licensed this humanized antibody, for the potential treatment of asthma and allergy, from SmithKline Beecham, now GlaxoSmithKline plc (GSK), in 1999. The anti-IL-4 antibody blocks the effects of interleukin-4, which is believed to play a key role in initiating the series of biological processes that lead to allergy and asthma. GSK began a Phase I trial of the antibody, which we completed. We have also completed a Phase I/II multiple dose study. We completed patient accrual in a Phase II trial in moderate to severe asthma patients in late 2002 and plan to report data from this trial in May 2003.

Under the agreement with GSK, we conducted and paid for initial clinical trials of the anti-IL-4 antibody. GSK made a milestone payment to us upon the initiation of the ongoing U.S. Phase II trial. At the completion of a specified, larger confirmatory Phase II trial to be conducted by PDL, GSK may choose to pay us an "opt-in" fee to re-acquire marketing rights to this antibody. In that case, we and GSK will share future development costs and profits from any product sales. If GSK elects not to pay this fee, we will have the right to develop and market the antibody in exchange for paying certain milestones and royalties on net sales to GSK.

Other Programs. During 2002 we reported data from a Phase III trial of Zamyl in patients with relapsed or refractory acute myeloid leukemia. The data showed that the antibody was well tolerated but did not meet the primary efficacy endpoint of the trial. Also in 2002, we increased the dose of Remitogen in our ongoing Phase II trial in patients with non-Hodgkin's lymphoma. No responses were observed at the higher dosing level. Based on these data, we have discontinued further development of these antibodies and are seeking out-license partners. We have also decided to conduct additional preclinical studies with our anti-IL-12 antibody before considering further clinical development. Recent scientific investigations have suggested that the putative role of IL-12 in autoimmune disease may actually be mediated by a structurally related cytokine, IL-23.

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 aberrant 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, or murine, antibodies have been developed as potential therapeutics to inhibit immune function, destroy cancer cells or neutralize viruses.

Although murine monoclonal antibodies are relatively easy to generate, they have significant drawbacks as therapeutics. Murine antibodies have a relatively short half-life in human patients, requiring them to be administered frequently. In addition, murine antibodies are not adapted to work effectively with the human immune system and therefore often have limited ability to destroy the target, such as cancer cells. Most importantly, when injected into humans, a murine 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 murine antibody and renders it ineffective for further therapy. These problems have largely prevented murine antibodies from fulfilling their promise as therapeutics.

More recently, improved forms of antibodies, such as humanized, 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 murine antibodies and have led to a resurgence of interest in antibody therapeutics by the pharmaceutical and biotechnology industries. As a result of these advances, many monoclonal antibodies are now progressing into clinical trials. In particular, we are aware of approximately 50 humanized antibodies in clinical trials, including several antibodies addressing large markets. Ten human, humanized or chimeric antibodies have already been approved for marketing by the FDA.

Our patented SMART antibody platform technology has positioned us as a leader in the development of therapeutic antibodies that overcome many of the problems associated with murine antibodies. Our SMART antibodies are "humanized", human-like antibodies designed using structural information from promising murine antibodies to capture the benefits of such antibodies while overcoming many of their limitations in treating humans. Clinical trials and preclinical studies have shown that our humanized antibodies generally have the desired antibody characteristics, including low immunogenicity and a usefully long half-life.

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

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

We are engaged in research activities intended to provide antibody product candidates that we may enter into preclinical and clinical development. These research activities include efforts to discover new targets for antibodies in our core areas of therapeutic focus, namely oncology and autoimmune and inflammatory diseases. We use a variety of sophisticated methods to discover these targets. In May 2001, we entered into an agreement with Exelixis to discover and develop humanized antibodies for the diagnosis, prevention, and treatment of cancer. As a result of this agreement, Exelixis has provided a number of potential antibody targets in oncology that we and Exelixis are currently evaluating further. In addition, we have in-licensed rights to targets or antibodies from academic institutions or other biotechnology or pharmaceutical companies, and we may in-license rights to additional targets or antibodies in the future.

We also are 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 pre-clinical 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 man, with the aim of engineering antibodies with even more favorable biological characteristics.

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 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 manufacture antibodies for use as clinical trial material in a 74,000 square foot manufacturing facility in Plymouth, Minnesota, which we have leased since 1992. We have manufactured Nuvion, our anti-gamma interferon antibody, Remitogen, and other antibodies in that facility. We have recently renovated this facility to make it potentially able to be licensed as a commercial manufacturing facility. We expect to complete validation of the renovated facility and to resume manufacturing of antibodies in the first half of 2003. Daclizumab is currently manufactured by Roche and the anti-IL-4 antibody by GlaxoSmithKline. Under certain circumstances we have the right to manufacture daclizumab and we may acquire rights to manufacture the anti-IL4 antibody.

We have begun construction of a new commercial manufacturing facility in Brooklyn Park, Minnesota. Physical construction is expected to be completed in 2004, followed by validation and start up activities. We currently expect to be able to produce antibodies for commercial sale in this facility in 2007. Antibodies currently in our clinical-stage pipeline which may be made in this facility include Nuvion, anti-gamma interferon, daclizumab, and anti-IL-4. We intend to seek manufacturing rights for additional antibodies from collaborative or humanization partners.

Roche. In 1989, we entered into agreements with Roche to collaborate on the research and development of antibodies, which bind to the IL-2 receptor, including daclizumab (marketed for prevention of kidney transplant rejection as Zenapax). Under these agreements, Roche had exclusive, worldwide rights to manufacture, market and sell Zenapax. We began receiving royalties on sales of Zenapax in 1998. Our royalties are subject to offsets for milestones, third party license fees and royalties, and patent expenses paid by Roche.

In October 1999, we agreed with Roche to replace the 1989 agreements with new agreements under which we assumed worldwide responsibility for the clinical development of daclizumab for the potential treatment of autoimmune diseases, later amended to include asthma. Roche retained exclusive worldwide rights to Zenapax for non-autoimmune diseases and is continuing to market Zenapax for the prevention of kidney transplant rejection. In return for undertaking clinical development in autoimmune indications, we will receive a significant share of Zenapax revenues from sales for autoimmune indications, either from our own marketing efforts or from revenue sharing with Roche.

In the U.S. and Canada, we will have the right to market daclizumab in potential new autoimmune indications and will pay for these activities from our share of revenues. In Europe and certain other countries, Roche may choose to market daclizumab in autoimmune indications. In this case, we will receive a substantial portion of daclizumab revenue from these indications. For countries and indications for which Roche elects not to market, we will receive an exclusive license to market daclizumab and pay Roche a small royalty.

GlaxoSmithKline plc. In September 1999, we signed agreements with SmithKline Beecham, now GlaxoSmithKline, involving two humanized antibodies for the possible treatment of asthma. We obtained a license to GlaxoSmithKline's humanized anti-IL-4 antibody and granted an exclusive license under our antibody humanization patents to GlaxoSmithKline for its humanized anti-IL-5 antibody. We also granted GlaxoSmithKline options to obtain non-exclusive licenses under these patents for up to three additional antibodies. These arrangements with GlaxoSmithKline illustrate our ability to leverage our patent portfolio to obtain rights to a potentially important product.

We have completed Phase I and Phase I/II clinical trials for the humanized anti-IL-4 antibody and are conducting a Phase II trial in asthma patients. We will be entitled to exclusive, worldwide development, marketing and sales rights to the anti-IL-4 antibody unless GlaxoSmithKline pays a fee to acquire marketing rights at the end of a specified, larger Phase II trial. If GlaxoSmithKline decides to participate in the further development of the antibody, we will share future development costs and profits at a pre-agreed ratio. We also may receive co-promotion rights in the U.S.

Exelixis, Inc. In May 2001, we signed a collaborative agreement with Exelixis 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 for two or more years, and we purchased a $30.0 million five year note convertible at our option anytime after the first year of the collaboration into Exelixis common stock. We received an exclusive, worldwide license to develop antibodies against certain targets identified by Exelixis that are involved in cell growth, cell death and proliferation. Exelixis has the right to co-fund development of antibodies resulting from the collaboration. 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. We have notified Exelixis that we will not extend the research funding beyond the initial two year term.

Igeneon AG. In July 2002, we signed an agreement with Igeneon AG, a European biotechnology company focused on cancer immunotherapies, for exclusive worldwide rights to develop and market HuABL364, a humanized antibody against the Lewis Y antigen. We received a licensing fee and milestone payments and may receive additional milestone payments and royalties on any product sales generated by the antibody.

We have entered into patent license agreements with numerous other companies that are independently developing humanized antibodies, including Biogen, Celltech, Chugai, Elan Pharmaceuticals, Genentech, GSK, IDEC Pharmaceuticals, Medarex, MedImmune, Merck KGaA, Sankyo, 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 the right 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, GSK, MedImmune, Millennium Pharmaceuticals and Tanox. Under these agreements, licensees currently purchase a 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 and the right to receive additional payments upon the achievement of certain milestones and royalties on any product sales.

In February 2003, we announced the signing of a definitive merger agreement with Eos Biotechnology, Inc., a South San Francisco- based antibody discovery company, for approximately 4.3 million shares of our common stock. The acquisition is expected to close early in the second quarter of 2003. In conjunction with the merger, we expect to record a charge related to acquired in-process research and development. We will report the purchase accounting effects of the merger in our financial results for the period in which the transaction closes. Upon closing, this acquisition will expand our research personnel and add new capabilities in antibody target identification and validation, particularly in oncology. We will also obtain two pre-clinical antibody product candidates, one of which is expected to initiate clinical investigation for potential treatment of solid tumors in the first half of 2003, and the second, in early 2004.

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 22,000 square feet of general office space in Fremont, California, which lease term will expire on February 28, 2006. In October 2002, we leased 1,600 square feet of general office space in Menlo Park, California. The lease term will expire on March 31, 2005. We plan to obtain additional research and development and general office pace in the future and may lease or acquire additional space as required.

In Plymouth, Minnesota, we lease approximately 74,000 square feet of manufacturing, laboratory and office space. The lease term will expire on February 29, 2009, subject to our options to extend the lease for an additional five-year term. In March 2002, we purchased approximately 29 acres in Brooklyn Park, Minnesota and we have begun 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. 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 March 31, 2004.

Of the products that we currently have in clinical development, Roche is responsible for manufacturing Zenapax and GlaxoSmithKline is responsible for manufacturing the humanized anti-IL-4 antibody. We are responsible for manufacturing our other products for our own development. We intend to continue to manufacture potential products for use in preclinical and clinical trials using our manufacturing facilities in accordance with standard procedures that comply with appropriate regulatory standards.

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 which 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 have been issued patents in the U.S., Europe and Japan which we believe cover many or most humanized antibodies. Some of these patents also cover other aspects of our SMART antibody technology. We have filed similar patent applications in other countries.

Our two humanization patents issued by the European Patent Office apply in the United Kingdom, Germany, France, Italy and seventeen 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. 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 have appealed the Opposition Division's decision to the Technical Board of Appeal at the European Patent Office. The Technical Board of Appeal will consider all issues anew. The appeal suspends the decision of the Opposition Division during the appeals process.

The nine-month opposition period for our second European antibody humanization patent ended in May 2000. Eight notices of opposition have been filed with respect to this patent and we have filed our response with the European Patent Office. Oral hearings are scheduled to take place in October 2003. Also, three opposition statements have been filed with the Japanese Patent Office with respect to our humanization patent issued in Japan in late 1998. We received a decision from the Japanese Opposition Board in March 2001, supporting one aspect of the position of the opponents, and we filed a response in September 2001. In April 2002, the examiner issued a further Office Action maintaining the earlier decision of the Opposition Board, to which we filed an additional response in May 2002. We now await a final decision from the examiner.

We intend to vigorously defend the European patents and the Japanese patent in these proceedings; however, we may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If our appeal with respect to our first European patent is unsuccessful or if the outcome of the other 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.

The manufacturing, testing and marketing of our products are subject to regulation by numerous governmental authorities in the U.S. and other countries. In the U.S., pharmaceutical products are subject to rigorous FDA regulation. Additionally, other federal, state and local regulations govern the manufacture, testing, clinical and nonclinical 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 U.S., 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 U.S., we and our collaborative partners are subject to foreign regulatory requirements and, if the particular product is manufactured in the U.S., 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.

Both before and after approval is obtained, a biological pharmaceutical product, its manufacturer and the holder of the Biologics License Application (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.

Potential competitors have developed and are developing murine, chimeric, 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 SMART antibody technology. 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.

As of December 31, 2002, we had 397 full-time employees. Of the total, 108 employees were engaged in research and process development, 54 in quality assurance and compliance, 90 in clinical and regulatory, 71 in manufacturing and 74 in general and administrative functions. 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.

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.

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 Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read or 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 any other reports or filings we have filed with the SEC, by contacting the Corporate Communications Department at our corporate offices by calling (510) 574-1406 or by sending an e-mail message to cc@pdl.com. You can direct requests for literature to our Corporate Communications Department or on our website.

In general, our expenses have exceeded revenues. As of December 31, 2002, we had an accumulated deficit of approximately $90.5 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 invest in additional manufacturing capacity
• 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.

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 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 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
• 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 could 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 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 shares of Signature convertible preferred stock. Since the shares we received are not publicly traded, the value of the shares is difficult to estimate. As of December 31, 2002, we estimated that the fair value of our shares owned and to be received in early 2003 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 value as determined by our management and our original cost basis in the shares. If we deem the estimated fair value of the shares of Signature further impaired at the end of any future period, we may incur an additional impairment charge with respect to these shares.

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 value of the Exelixis stock in our financial statements. Such a requirement could cause changes in the Exelixis stock price to contribute to fluctuation of our operating results from quarter to quarter.

Most of our current revenues are related to our humanization patents. 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 have appealed this decision. Until our appeal 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 our appeal is unsuccessful, 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 U.S. 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 appeals 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 appeal 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 have been filed with respect to our second European antibody humanization patent and we have filed our response with the European Patent Office. Oral hearings are scheduled to take place in October 2003. Also, three opposition statements were filed with the Japanese Patent Office with respect to our humanization patent issued in Japan in late 1998. We received a decision from the Japanese Opposition Board in March 2001, supporting one aspect of the position of the opponents, and we filed a response in September 2001. In April 2002, the examiner issued a further Office Action maintaining the earlier decision of the Opposition Board, to which we filed an additional response in May 2002. We now await a final decision from the examiner. If the examiner maintains her earlier decision, we will have the opportunity to appeal to the Tokyo High Court. 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; however, we may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If our appeal with respect to our first European patent is unsuccessful or if the outcome of the other 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.

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.

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 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.

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 has appealed that decision. Also, 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 will be able to successfully appeal the decision of the Opposition Division with respect to their first European patent or 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. 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. Nevertheless, if our humanized antibodies were covered by Celltech's European or U.S. patents and if we were to need more than the three licenses under those patents currently available to us under the agreement, 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 recently 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 Biotherapy, Inc., however, do not cover treatment of either Crohn's disease or psoriasis, the two indications currently being investigated in our SMART Anti- Gamma Interferon Antibody clinical trials. However, a European patent issued to Genentech in 1998 does have claims to the use of anti-gamma interferon inhibitors, including antibodies, for treatment of inflammatory bowel disease, including Crohn's disease. Additional examples include an issued U.S. patent to Schering Corporation that may cover our humanized anti-IL-4 antibody, issued U.S. and European patents to Genetics Institute (now a wholly-owned subsidiary of Wyeth) that may cover our SMART Anti-IL-12 Antibody, and a recently issued U.S. patent to Genentech claiming humanized antibodies with certain framework region substitutions that may cover some of our antibodies in development. 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.

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.

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.

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 a relatively large number of potential products in clinical development. We may not be able to successfully commence and complete all of our planned clinical trials without significant additional resources and expertise. 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.

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 a Phase I trial, Remitogen produced partial clinical responses in several B-cell lymphoma patients. Partial, preliminary results in a Phase II trial of Remitogen, however, did not show a similar response rate. Consequently, the dosing regimen was amended in that trial to attempt to determine an effective dosing regimen. However, enrollment with this dosing regimen was progressing slowly. Therefore, in November 2002, we decided to terminate this study and we currently do not intend to conduct further clinical trials in this indication.

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 has 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 currently is suspended and our current plan is not to continue this trial and not to further develop Nuvion for psoriasis.

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.

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
• 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.

We have agreements with pharmaceutical and other companies to develop, manufacture and market certain of our potential products. In some cases, we are relying on our partners to manufacture such products, to conduct clinical trials, to compile and analyze the data received from these trials, to obtain regulatory approvals and, if approved, to market these licensed products. As a result, we may have little or no control over the manufacturing, development and marketing of these potential products and little or no opportunity to review clinical data prior to or following public announcement.

Our agreements can generally be terminated by our partners on short notice. A partner may terminate its agreement with us or separately pursue alternative products, therapeutic approaches or technologies as a means of developing treatments for the diseases targeted by us or our collaborative effort. Even if a partner continues to contribute to the arrangement, it may nevertheless determine not to actively pursue the development or commercialization of any resulting products. In these circumstances, our ability to pursue potential products could be severely limited.

Continued funding and participation by partners will depend on the timely achievement of our research and development objectives, the retention of key personnel performing work under those agreements and on each partner's own financial, competitive, marketing and strategic considerations. Such considerations include:

• the commitment of each partner's management to the continued development of the licensed products or technology
• the relationships among the individuals responsible for the implementation and maintenance of the development efforts, and
• the relative advantages of alternative products or technology being marketed or developed by each partner or by others, including their relative patent and proprietary technology positions, and their ability to manufacture potential products successfully.

Our ability to enter into new relationships and the willingness of our existing partners to continue development of our potential products depends upon, among other things, our patent position with respect to such products. If we are unable to successfully maintain our patents we may be unable to collect royalties on existing licensed products or enter into additional agreements.

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 either establish a marketing group and direct sales force or obtain the assistance of another company. We may not be able to establish marketing, sales and distribution capabilities 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.

To be successful we must retain our qualified clinical, manufacturing, scientific and management personnel. We are currently conducting a search for a Chief Financial Officer. If we are unsuccessful in filling this position or retaining qualified personnel, our business could be impaired.

Of the products that we currently have in clinical development, Hoffmann-La Roche Inc. and its affiliates (Roche) are responsible for manufacturing Zenapax and GlaxoSmithKline is responsible for manufacturing the humanized anti-IL-4 antibody. We are responsible for manufacturing our other products for our own development. 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. We and our collaborative partners 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. For example, in December 1999, Roche received a warning letter from the FDA regarding deficiencies in the manufacture of various products. Although the letter primarily related to products other than Zenapax, Roche has also experienced difficulties in the manufacture of Zenapax leading to interruptions in supply. If future manufacturing difficulties arise and are not corrected in a timely manner, Zenapax supplies could be interrupted, which could cause a delay or termination of our clinical trials of Zenapax in autoimmune disease and could force Roche to withdraw Zenapax from the market temporarily or permanently, resulting in loss of revenue to us. These occurrences could impair our competitive position.

We do not have experience in manufacturing commercial supplies of our potential products, nor do we currently have sufficient facilities to manufacture 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 are currently improving our existing manufacturing plant in order to manufacture initial commercial supplies of certain products. 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 improve 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 have begun construction of 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.

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 SMART antibody technology. 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 the 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. For example, Novartis, which has a significant marketing and sales force directed to the transplantation market, has received approval to market Simulect, a product competitive with Zenapax, in the U.S. and Europe. In May 2001, Novartis acquired a significant interest in Roche. We cannot predict the impact, if any, that this relationship may have on Roche's efforts to market Zenapax.

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 U.S. and other countries. In the U.S., 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 U.S., 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 U.S., we and our collaborative partners are subject to foreign regulatory requirements and, if the particular product is manufactured in the U.S., 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.

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 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. This 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, 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 could result in delays in development or regulatory approvals or in reduction or interruption of commercial sales and could impair our competitive position.

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 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 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 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.

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 U.S., 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 U.S. 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.

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
• 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.

Future changes in financial accounting standards may cause adverse, unexpected revenue fluctuations and affect our reported results of operations. New 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 Stock 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.

Early in the second quarter of 2003, we expect to complete 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 will issue 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 has or would 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.

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 22,000 square feet of general office space in Fremont, California. Our lease term will expire on February 28, 2006. In October 2002, we leased approximately 1,600 square feet of general office space in Menlo Park, California. 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.

In Plymouth, Minnesota, we lease approximately 74,000 square feet of manufacturing, laboratory and office space. Our lease term will expire on February 29, 2009, subject to our option to extend the leases for an additional five year term. In March 2002, we purchased approximately 29 acres in Brooklyn Park, Minnesota and we have begun 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 March 31, 2004.

We own substantially all of the equipment used in our facilities. See Note 4 to the financial statements.

PDL is 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 patent. We have appealed this decision. Until our appeal 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 our appeal is unsuccessful, 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 U.S. 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 appeals 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 appeal 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 have been filed with respect to our second European antibody humanization patent and we have filed our response to the European Patent Office. Oral hearings are scheduled to take place in October 2003. Also, three opposition statements have been filed with the Japanese Patent Office with respect to our humanization patent issued in Japan in late 1998. We received a decision from the Japanese Opposition Board in March 2001, supporting one aspect of the position of the opponents, and we filed a response in September 2001. In April 2002, the examiner issued a further Office Action maintaining the earlier decision of the Opposition Board, to which we filed an additional response in May 2002. We now await a final decision from the examiner. If the examiner maintains her earlier decision, we will have the opportunity to appeal to the Tokyo High Court. 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; however, we may not prevail in the opposition proceedings or any litigation contesting the validity of these patents. If our appeal with respect to our first European patent is unsuccessful or if the outcome of the other 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.

Not applicable.

PART II

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, adjusted for the stock split described below. We have never paid any cash dividends on our capital stock and we do not anticipate paying any cash dividends in the foreseeable future. On October 9, 2001, we effected a two-for- one stock split of our common stock in the form of a dividend of one share of Protein Design Labs, Inc. common stock for each share held at the close of business on September 18, 2001. Our stock began trading on a split-adjusted basis as of October 10, 2001.

As of December 31, 2002, we had approximately 134 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. The market for our securities is volatile. See "Risk Factors."

(In thousands, except per share data)

                                                                   Years Ended December 31,
                                                    -----------------------------------------------------
                                                      2002       2001       2000       1999       1998
                                                    ---------  ---------  ---------  ---------  ---------
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:

Revenues:
  Royalties....................................... $  40,421  $  30,604  $  19,189  $  11,378  $     822
  License and other...............................     5,952     13,796     21,220     16,762     20,748
                                                    ---------  ---------  ---------  ---------  ---------
     Total revenues...............................    46,373     44,400     40,409     28,140     21,570
                                                    ---------  ---------  ---------  ---------  ---------
Costs and expenses:
  Research and development........................    57,978     52,163     42,330     36,090     31,645
  General and administrative......................    19,093     15,724     12,109      9,842      8,685
                                                    ---------  ---------  ---------  ---------  ---------
     Total costs and expenses.....................    77,071     67,887     54,439     45,932     40,330
                                                    ---------  ---------  ---------  ---------  ---------
Operating loss....................................   (30,698)   (23,487)   (14,030)   (17,792)   (18,760)

  Interest income.................................    25,978     35,135     22,647      7,614      9,258
  Interest expense................................    (8,426)    (8,989)    (7,965)      (155)        --
  Impairment loss on investment (1)...............    (1,366)        --         --         --         --
                                                    ---------  ---------  ---------  ---------  ---------
Income (loss) before income taxes.................   (14,512)     2,659        652    (10,333)    (9,502)
Provision for income taxes........................        42         12          5         --         --
                                                    ---------  ---------  ---------  ---------  ---------
Net income (loss)................................. $ (14,554) $   2,647  $     647  $ (10,333) $  (9,502)
                                                    =========  =========  =========  =========  =========
Net income (loss) per share:
       Basic ..................................... $   (0.16) $    0.03  $    0.01  $   (0.14) $   (0.13)
                                                    =========  =========  =========  =========  =========
       Diluted.................................... $   (0.16) $    0.03  $    0.01  $   (0.14) $   (0.13)
                                                    =========  =========  =========  =========  =========
Shares used in computation of net income
   (loss) per share:
       Basic......................................    88,865     87,624     80,904     74,792     74,100
                                                    =========  =========  =========  =========  =========
       Diluted....................................    88,865     92,889     88,562     74,792     74,100
                                                    =========  =========  =========  =========  =========

                                                                          December 31,
                                                    -----------------------------------------------------
                                                      2002       2001       2000       1999       1998
                                                    ---------  ---------  ---------  ---------  ---------
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and investments............ $ 606,410  $ 650,315  $ 661,173  $ 137,237  $ 143,439
Working capital...................................   599,215    641,896    651,641     22,669     82,394
Total assets......................................   717,818    729,898    704,980    182,551    171,850
Long-term debt obligations, less current portion..   158,426    158,892    159,324      9,724         --
Accumulated deficit...............................   (90,477)   (75,923)   (78,570)   (79,217)   (68,884)
Total stockholders' equity                           544,766    558,443    534,144    164,743    162,496

                                     Years Ended December 31,     Annual Percent Change
                                 ------------------------------- ------------------------
                                   2002       2001       2000     2002/2001    2001/2000
                                 ---------  ---------  --------- -----------  -----------
Total Revenues................. $  46,373  $  44,400  $  40,409           4 %         10 %

                                     Years Ended December 31,     Annual Percent Change
                                 ------------------------------- ------------------------
                                   2002       2001       2000     2002/2001    2001/2000
                                 ---------  ---------  --------- -----------  -----------
Royalties...................... $  40,421  $  30,604  $  19,189          32 %         59 %
License and other..............     5,952     13,796     21,220         (57)%        (35)%

                                     Years Ended December 31,     Annual Percent Change
                                 ------------------------------- ------------------------
                                   2002       2001       2000     2002/2001    2001/2000
                                 ---------  ---------  --------- -----------  -----------
Research and development....... $  57,978  $  52,163  $  42,330          11 %         23 %
General and administrative.....    19,093     15,724     12,109          21 %         30 %
                                 ---------  ---------  ---------
Total cost and exepnses........    77,071     67,887     54,439          14 %         25 %
                                 =========  =========  =========

                                                                                                              Research and Development
                                                                                                              Costs for the Year Ended
                                                                                               Estimated          December 31,
                                                                 Phase of                      Completion   --------------------------
Product              Description/Indication                    Development    Collaborator      of Phase       2002     2001     2000
- -------------------- ----------------------------------------- ------------ ---------------- -------------- -------- -------- --------
                                                                                                                 (In thousands)
Humanized Anti-IL-4  Asthma                                    Phase IIa    GlaxoSmithKline       2003     $  2,791 $  2,961 $  4,854

SMART Anti-IL-12     Autoimmune Diseases                       Phase I             --        Completed (1)    2,526    5,058      538

HuZAF                                                                              --                        14,047    6,934    2,839
                     Crohn's Disease                           Phase II                           2004
                     Psoriasis                                 Phase I/II                         2003

Nuvion                                                                             --                         4,001    4,658    3,189
                     Steroid Refractory Graft Vs. Host Disease Phase II                           2004
                     Ulcerative Colitis                        Phase I                            2003

Remitogen                                                                          --                         2,766    3,532    5,704
                     Non-Hodgkin's B-Cell Lymphoma             Phase II                      Completed (2)
                     Solid Tumors                              Phase I                            2003

Zamyl                Acute Myeloid Leukemia                    Phase III           --        Completed (3)    3,981    5,036    6,261

Daclizumab           Asthma                                    Phase II     Roche                 2004        7,778    8,329    2,064

HuMV833              Solid Tumors                              Phase I      Toagosei         Completed (4)       22      383    5,246

Other (5)                                                                          --                        20,066   15,272   11,635
                                                                                                            -------- -------- --------
                     Total Research and Development Costs                                                    57,978   52,163   42,330
                                                                                                            ======== ======== ========

                                     Years Ended December 31,     Annual Percent Change
                                 ------------------------------- ------------------------
                                   2002       2001       2000     2002/2001    2001/2000
                                 ---------  ---------  --------- -----------  -----------
Interest income................ $  25,978  $  35,135  $  22,647         (26)%         55 %
Interest expense...............    (8,426)    (8,989)    (7,965)         (6)%         13 %
Impairment loss on investment..    (1,366)        --         --         100 %         -- %

                                                  Payments Due By Period
                                    -----------------------------------------------------
(In thousands)                      Less Than                          After
CONTRACTUAL OBLIGATIONS (1)          1 Year    1-3 Years  4-5 Years   5 Years     Total
                                    ---------  ---------  ---------  ---------  ---------
Operating leases.................. $   1,462  $   2,285  $   1,583  $     891  $   6,221
Long-term debt....................     1,139      2,278      2,278      7,783     13,478
Convertible debentures ...........     8,250     16,500    162,375         --    187,125
Research funding..................     1,000         --         --         --      1,000
Construction contracts............    81,293     31,934         --         --    113,227
                                    ---------  ---------  ---------  ---------  ---------
Total contractual cash obligations $  93,144  $  52,997  $ 166,236  $   8,674  $ 321,051
                                    =========  =========  =========  =========  =========

                                                                                                Fair
Liabilities (000's)        2003     2004     2005     2006      2007    Therafter    Total      Value
- ------------------------  -------  -------  -------  -------  --------  ---------  ---------  ---------
Long-term debt,
including current
portion
   Fixed Rate........... $   466  $   502  $   543  $   587  $    635  $   6,159  $   8,892  $   9,700 *
   Avg. Interest Rate...    7.64%    7.64%    7.64%    7.64%     7.64%      7.64%      7.64%
Convertible
subordinated notes
   Fixed Rate........... $    --  $    --  $    --  $    --  $150,000  $      --  $ 150,000  $ 123,000
   Avg. Interest Rate...    5.50%    5.50%    5.50%    5.50%     5.50%      5.50%      5.50%      5.50%

                                                        December 31,
                                                    ----------------------
                                                       2002        2001
                                                    ----------  ----------
ASSETS
Current assets:
    Cash and cash equivalents..................... $  287,730  $  120,268
    Marketable securities.........................    318,680     530,047
    Other current assets..........................      7,432       4,144
                                                    ----------  ----------
    Total current assets..........................    613,842     654,459

Land, property and equipment, net.................     70,802      42,111
Other assets......................................      3,174       3,328
Convertible note receivable.......................     30,000      30,000
                                                    ----------  ----------
    Total assets.................................. $  717,818  $  729,898
                                                    ==========  ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable.............................. $    1,628  $    1,249
    Accrued compensation..........................      2,520       2,000
    Accrued clinical trial costs..................      2,327       2,588
    Accrued interest..............................      3,071       3,071
    Other accrued liabilities.....................      4,576       3,123
    Deferred revenue..............................         38         100
    Current portion of long-term debt.............        466         432
                                                    ----------  ----------
    Total current liabilities.....................     14,626      12,563

Convertible subordinated notes....................    150,000     150,000
Long-term debt....................................      8,426       8,892
                                                    ----------  ----------
Total liabilities.................................    173,052     171,455
                                                    ----------  ----------
Commitments and Contingencies

Stockholders' equity:
    Preferred stock, par value $0.01 per
      share, 10,000 shares authorized; no
      shares issued and outstanding...............         --          --
    Common stock, par value $0.01 per share,
      250,000 shares authorized; 89,179 and
      88,499 issued and outstanding at
      December 31, 2002 and December 31, 2001,
      respectively................................        892         885
    Additional paid-in capital....................    628,292     624,094
    Accumulated deficit...........................    (90,477)    (75,923)
    Accumulated other comprehensive income........      6,059       9,387
                                                    ----------  ----------
    Total stockholders' equity....................    544,766     558,443
                                                    ----------  ----------
      Total liabilities and stockholders' equity.. $  717,818  $  729,898
                                                    ==========  ==========

                                                   Years Ended December 31,
                                               -------------------------------
                                                 2002       2001       2000
                                               ---------  ---------  ---------
Revenues:
    Royalties................................ $  40,421  $  30,604  $  19,189
    License and other........................     5,952     13,796     21,220
                                               ---------  ---------  ---------
      Total revenues.........................    46,373     44,400     40,409
                                               ---------  ---------  ---------
Costs and expenses:
    Research and development.................    57,978     52,163     42,330
    General and administrative...............    19,093     15,724     12,109
                                               ---------  ---------  ---------
      Total costs and expenses...............    77,071     67,887     54,439
                                               ---------  ---------  ---------
Operating loss...............................   (30,698)   (23,487)   (14,030)

Interest income..............................    25,978     35,135     22,647
Interest expense.............................    (8,426)    (8,989)    (7,965)
Impairment loss on investment................    (1,366)        --         --
                                               ---------  ---------  ---------
Income (loss) before income taxes............   (14,512)     2,659        652
Provision for income taxes...................        42         12          5
                                               ---------  ---------  ---------
Net income (loss)............................ $ (14,554) $   2,647  $     647
                                               =========  =========  =========
Net income (loss) per share:
    Basic ................................... $   (0.16) $    0.03  $    0.01
                                               =========  =========  =========
    Diluted.................................. $   (0.16) $    0.03  $    0.01
                                               =========  =========  =========
Shares used in computation of net
      income (loss) per share:
    Basic ...................................    88,865     87,624     80,904
                                               =========  =========  =========
    Diluted .................................    88,865     92,889     88,562
                                               =========  =========  =========

                                                                                              Accumulated
                                                                                                 Other
                                                 Common Stock       Additional                Comprehensive   Total
                                             ---------------------    Paid-in    Accumulated    Income     Stockholders'
                                               Shares      Amount     Capital      Deficit      (Loss)        Equity
                                             -----------  --------  -----------  -----------  -----------  ------------
Balance at December 31, 1999................ 77,127,036  $    772  $   245,233  $   (79,217) $    (2,045) $    164,743

Follow-on public offering of common stock
  at $59.2187 per share (net of
  underwriters discount of $18,103 and
  offering expenses of approximately $500)..  6,116,000        61      343,517           --           --       343,578

Issuance of common stock under
  employee benefit plans....................  3,910,264        39       22,504           --           --        22,543
Comprehensive income:
Net income..................................         --        --           --          647           --           647
Unrealized gain on securities...............         --        --           --           --        2,633         2,633
                                                                                                           ------------
Total comprehensive income..................                                                                     3,280
                                             -----------  --------  -----------  -----------  -----------  ------------
Balance at December 31, 2000................ 87,153,300       872      611,254      (78,570)         588       534,144

Issuance of common stock under
  employee benefit plans....................  1,346,001        13       12,840           --           --        12,853
Comprehensive income:
Net income..................................         --        --           --        2,647           --         2,647
Unrealized gain on securities...............         --        --           --           --        8,799         8,799
                                                                                                           ------------
Total comprehensive income..................                                                                    11,446
                                             -----------  --------  -----------  -----------  -----------  ------------
Balance at December 31, 2001                 88,499,301       885      624,094      (75,923)       9,387       558,443
Issuance of common stock under
  employee benefit plans....................    679,566         7        4,198           --           --         4,205
Comprehensive loss:
Net loss....................................         --        --           --      (14,554)          --       (14,554)
Unrealized loss on securities...............         --        --           --           --       (3,328)       (3,328)
                                                                                                           ------------
Total comprehensive loss....................                                                                   (17,882)
                                             -----------  --------  -----------  -----------  -----------  ------------
Balance at December 31, 2002................ 89,178,867  $    892  $   628,292  $   (90,477) $     6,059  $    544,766
                                             ===========  ========  ===========  ===========  ===========  ============

                                                            Years Ended December 31,
                                                       ----------------------------------
                                                          2002        2001        2000
                                                       ----------  ----------  ----------
Cash flows from operating activities:
Net income (loss).................................... $  (14,554) $    2,647  $      647
Adjustments to reconcile net income (loss) to net
  cash provided by (used in) operating activities:
   Depreciation and amortization.....................      5,441       4,782       3,570
   Amortization of convertible notes offering costs..        721         721         628
   Impairment loss on investment.....................      1,366          --          --
   Changes in assets and liabilities:
     Interest receivable.............................      3,904      (4,522)     (1,920)
     Other current assets............................     (3,336)     (2,164)      4,739
     Other assets....................................       (643)        105      (4,233)
     Accounts payable................................        379         187         185
     Accrued liabilities.............................      1,713       2,187       4,031
     Deferred revenue................................        (62)     (1,355)       (820)
                                                       ----------  ----------  ----------
        Total adjustments............................      9,483         (59)      6,180
                                                       ----------  ----------  ----------
Net cash provided by (used in) operating activities..     (5,071)      2,588       6,827

Cash flows from investing activities:
Purchases of marketable securities...................    (79,954)   (485,483)   (129,821)
Maturities of marketable securities..................    283,500     207,885      15,000
Purchases of convertible note........................         --     (30,000)         --
Purchase of land, property and equipment.............    (34,786)     (8,716)     (3,355)
                                                       ----------  ----------  ----------
Net cash provided by (used in) investing activities..    168,760    (316,314)   (118,176)

Cash flows from financing activities:
Proceeds from issuance of capital stock, net
   of issuance costs.................................      4,205      12,853     366,121
Proceeds from issuance of convertible notes..........         --          --     150,000
Payments on long-term debt...........................       (432)       (400)       (369)
                                                       ----------  ----------  ----------
Net cash provided by financing activities............      3,773      12,453     515,752
                                                       ----------  ----------  ----------
Net increase (decrease) in cash and cash equivalents.    167,462    (301,273)    404,403
Cash and cash equivalents at beginning of year.......    120,268     421,541      17,138
                                                       ----------  ----------  ----------
Cash and cash equivalents at end of year............. $  287,730  $  120,268  $  421,541
                                                       ==========  ==========  ==========
Supplemental cash flow data:
Cash paid during the year for interest............... $    8,957  $    8,989  $    4,894
                                                       ==========  ==========  ==========
Non-cash activities:
Exchange of assets for third party preferred stock... $    1,290  $       --  $       --
                                                       ==========  ==========  ==========

                                                   Years Ended December 31,
                                               -------------------------------
                                                 2002       2001       2000
                                               ---------  ---------  ---------
Numerator:
  Net income (loss).......................... $ (14,554) $   2,647  $     647
                                               =========  =========  =========

Denominator:
  Basic net income (loss) per share -
    Weighted-average shares..................    88,865     87,624     80,904

  Dilutive potential common shares -
    Stock options............................        --      5,265      7,658
                                               ---------  ---------  ---------
  Denominator for diluted net income
    (loss) per share.........................    88,865     92,889     88,562
                                               =========  =========  =========

Basic net income (loss) per share............ $   (0.16) $    0.03  $    0.01
                                               =========  =========  =========

Diluted net income (loss) per share.......... $   (0.16) $    0.03  $    0.01
                                               =========  =========  =========

                                                       Years Ended December 31,
                                                   -------------------------------
(In thousands, except per share data)                2002       2001       2000
                                                   ---------  ---------  ---------
Numerator:
  Net income (loss).............................. $ (14,554) $   2,647  $     647


Net income (loss), as reported
Deduct:  Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects.......   (11,842)   (38,939)   (13,300)
                                                   ---------  ---------  ---------
Pro forma net (loss)............................. $ (26,396) $ (36,292) $ (12,653)
                                                   =========  =========  =========
Net income (loss) per share:
   Basic-as reported............................. $   (0.16) $    0.03  $    0.01
                                                   =========  =========  =========

   Basic-pro forma............................... $   (0.30) $   (0.41) $   (0.16)
                                                   =========  =========  =========

   Diluted-as reported........................... $   (0.16) $    0.03  $    0.01
                                                   =========  =========  =========

   Diluted-pro forma............................. $   (0.30) $   (0.41) $   (0.16)
                                                   =========  =========  =========

                                                         December 31,
                                                     ----------------------
                                                        2002        2001
                                                     ----------  ----------
Land............................................... $   10,743  $    6,790
Buildings and improvements.........................     22,198      22,001
Leasehold improvements.............................      6,691       3,181
Laboratory and manufacturing equipment.............     20,604      19,866
Construction in-process............................     26,754       5,910
Computer and office equipment......................      6,621       4,465
Furniture and fixtures.............................      2,058       1,633
                                                     ----------  ----------
                                                        95,669      63,846
Less accumulated depreciation and amortization.....    (24,867)    (21,735)
                                                     ----------  ----------
                                                    $   70,802  $   42,111
                                                     ==========  ==========

                                                         December 31,
                                                     ----------------------
                                                        2002        2001
                                                     ----------  ----------
Royalty expense.................................... $      385  $       98
Patent legal expense...............................        230         176
Construction in-process............................      1,893         313
Other..............................................      2,068       2,536
                                                     ----------  ----------
                                                    $    4,576  $    3,123
                                                     ==========  ==========

Year Ending December 31,
2003                                                $    1,462
2004                                                     1,335
2005                                                       950
2006                                                       835
2007                                                       748
Thereafter                                                 891
                                                     ----------
Total                                               $    6,221
                                                     ==========

                                                Available-for-Sale-Securities
                                      ----------------------------------------------
                                                    Gross       Gross     Estimated
                                                  Unrealized  Unrealized     Fair
                                         Cost       Gains       Losses      Value
                                      ----------  ----------  ----------  ----------
December 31, 2002
 Securities of the U.S. Government
   and its agencies
     maturing:
       within 1 year................ $   50,935  $      556  $       --  $   51,491
       between 1-3 years............    121,257       1,933          --     123,190
U.S. corporate debt securities
      maturing:
       within 1 year................    110,116       2,444          --     112,560
       between 1-3 years............     30,313       1,126          --      31,439
                                      ----------  ----------  ----------  ----------
Total marketable debt
     securities..................... $  312,621  $    6,059  $       --  $  318,680
                                      ==========  ==========  ==========  ==========

December 31, 2001
 Securities of the U.S. Government
   and its agencies
     maturing:
       within 1 year................ $   10,051  $      320  $       --  $   10,371
       between 1-3 years............    364,359       4,648        (421)    368,586
U.S. corporate debt securities
      maturing:
       within 1 year................      5,112          99          --       5,211
       between 1-3 years............    141,138       4,741          --     145,879
                                      ----------  ----------  ----------  ----------
Total marketable debt
     securities..................... $  520,660  $    9,808  $     (421) $  530,047
                                      ==========  ==========  ==========  ==========

  (In thousands)

All stock option plans..................... $   20,650
Employee Stock Purchase Plan...............      1,183
Convertible debt...........................      3,974
                                             ----------
        Total..............................     25,807
                                             ==========

                                            2002                 2001                 2000
                                    -------------------- -------------------- --------------------
                                               Weighted             Weighted             Weighted
                                               Average              Average              Average
                                               Exercise             Exercise             Exercise
                                     Shares      Price    Shares      Price    Shares      Price
                                    ---------  --------- ---------  --------- ---------  ---------
Outstanding at beginning of year...   10,528  $   18.40     9,575  $   13.90    10,712  $    5.89
Granted............................    3,427      13.46     3,142      28.41     3,413      28.14
Exercised..........................     (516)      5.63    (1,274)      8.29    (3,768)      5.69
Forfeited..........................   (1,129)     22.45      (915)     20.18      (782)     11.87
                                    ---------            ---------            ---------
Outstanding at end of year.........   12,310      17.18    10,528      18.40     9,575      13.90
                                    =========            =========            =========
Exercisable at end of year.........    5,975                3,799                2,612
                                    =========            =========            =========
Weighted average fair value of
  options granted during the year..           $   10.72            $   21.55            $   26.63
                                               =========            =========            =========

                                  Weighted
                                   Average
                                  Remaining   Weighted                Weighted
                                 Contractual  Average                 Average
Range of Exercise      Number       Life      Exercise    Number      Exercise
Prices               Outstanding   (years)      Price   Exercisable     Price
- -------------------- ----------- -----------  --------- -----------  -----------

$  3.41 - $  4.25         1,394        5.02  $    4.18       1,279  $      4.17
$  4.28 - $  8.30         2,226        7.13       7.12       1,160         6.18
$  8.55 - $ 10.62         1,750        6.98       9.35         757         9.60
$ 10.94 - $ 18.90         1,861        8.76      16.83         327        14.08
$ 19.97 - $ 23.24         1,904        7.54      21.16       1,058        21.05
$ 23.46 - $ 27.50         1,748        8.36      27.19         713        27.25
$ 27.83 - $ 38.56           705        8.13      32.57         318        32.95
$ 38.78 - $ 56.84           722        7.95      43.53         363        44.12
                     -----------                        -----------
Totals                   12,310              $   17.18       5,975  $     15.50
                     ===========                        ===========

                                                   Years Ended December 31,
                                               -------------------------------
                                                 2002       2001       2000
                                               ---------  ---------  ---------
Current:
     Federal................................. $      --  $      --  $      --
     State...................................        12         12          5
     Foreign.................................        30         --         --
                                               ---------  ---------  ---------
Total Current................................ $      42  $      12  $       5
                                               =========  =========  =========

                                                   Years Ended December 31,
                                               -------------------------------
                                                 2002       2001       2000
                                               ---------  ---------  ---------

Computed at U.S. statutory rate
  At statutory rate.......................... $  (5,079) $     930  $     228
  Unutilized (utilized) net operating losses.     5,079       (930)      (228)
  State taxes................................        12         12          5
  Foreign taxes..............................        30         --         --
                                               ---------  ---------  ---------
Total........................................ $      42  $      12  $       5
                                               =========  =========  =========

                                                 2002       2001
                                               ---------  ---------
Deferred tax assets:
  Net operating loss carryforwards........... $  89,410  $  86,430
  Research and other credits.................    11,910     11,390
  Deferred revenue...........................        20         40
  Capitalized research and development.......     8,090      6,960
  Other......................................       730      1,760
                                               ---------  ---------
Total deferred tax assets....................   110,160    106,580
Valuation allowance for deferred tax asset...  (107,740)  (103,390)
                                               ---------  ---------
Total deferred tax assets....................     2,420      3,190

Deferred Tax Liabilities
  Unrealized gains on investments............     2,420      3,190
                                               ---------  ---------
  Total deferred tax liabilities.............     2,420      3,190
                                               ---------  ---------
Net Deferred Tax Assets...................... $      --  $      --
                                               =========  =========

Year Ending December 31,
2003                                          $     466
2004                                                502
2005                                                543
2006                                                587
2007                                                635
Thereafter                                        6,159
                                               ---------
Total                                         $   8,892
                                               =========

                                                    2002 Quarter Ended
                                   ---------------------------------------------------
                                   December 31,   September 30,   June 30,   March 31,
                                   -------------  -------------  ----------  ---------
Revenues:
  Royalties...................... $       7,263  $       5,991  $   13,491  $  13,676
  License and other..............         3,450            551       1,300        651
                                   -------------  -------------  ----------  ---------
    Total revenues...............        10,713          6,542      14,791     14,327

Costs and expenses:
  Research and development.......        15,733         14,306      14,760     13,178
  General and administrative.....         5,416          4,735       4,787      4,155
                                   -------------  -------------  ----------  ---------
    Total costs and expenses.....        21,149         19,041      19,547     17,333
                                   -------------  -------------  ----------  ---------
 Operating loss..................       (10,436)       (12,499)     (4,756)    (3,006)

  Interest income................         5,843          6,542       6,455      7,138
  Interest expense...............        (1,910)        (2,034)     (2,242)    (2,240)
  Impairment loss on investment..        (1,366)            --          --         --
                                   -------------  -------------  ----------  ---------
  Loss before income taxes.......        (7,869)        (7,991)       (543)     1,892
  Provision for income taxes.....            15             --          16         11
                                   -------------  -------------  ----------  ---------
Net income (loss)................ $      (7,884) $      (7,991) $     (559) $   1,881
                                   =============  =============  ==========  =========

Net income (loss) per share:
   Basic......................... $       (0.09) $       (0.09) $    (0.01) $    0.02
                                   =============  =============  ==========  =========

   Diluted....................... $       (0.09) $       (0.09) $    (0.01) $    0.02
                                   =============  =============  ==========  =========
Shares used in computation of
  net income (loss) per share:
   Basic.........................        89,063         88,999      88,751     88,645
                                   =============  =============  ==========  =========

   Diluted.......................        89,063         88,999      88,751     91,750
                                   =============  =============  ==========  =========

                                                    2001 Quarter Ended
                                   ---------------------------------------------------
                                   December 31,   September 30,   June 30,   March 31,
                                   -------------  -------------  ----------  ---------
Revenues:
  Royalties...................... $       5,631  $       4,905  $   10,462  $   9,606
  License and other..............         1,300          3,150       2,221      7,125
                                   -------------  -------------  ----------  ---------
    Total revenues...............         6,931          8,055      12,683     16,731

Costs and expenses:
  Research and development.......        13,831         12,459      12,207     13,665
  General and administrative.....         4,318          3,735       4,052      3,619
                                   -------------  -------------  ----------  ---------
    Total costs and expenses.....        18,149         16,194      16,259     17,284
                                   -------------  -------------  ----------  ---------
 Operating loss..................       (11,218)        (8,139)     (3,576)      (553)

  Interest income................         8,115          8,616       8,966      9,439
  Interest expense...............        (2,245)        (2,248)     (2,250)    (2,248)
                                   -------------  -------------  ----------  ---------
  Income (loss) before income tax        (5,348)        (1,771)      3,140      6,638
  Provision for income taxes.....            --              5          --          7
                                   -------------  -------------  ----------  ---------
Net income (loss)................ $      (5,348) $      (1,776) $    3,140  $   6,631
                                   =============  =============  ==========  =========

Net income (loss) per share:
   Basic......................... $       (0.06) $       (0.02) $     0.04  $    0.08
                                   =============  =============  ==========  =========

   Diluted....................... $       (0.06) $       (0.02) $     0.03  $    0.07
                                   =============  =============  ==========  =========
Shares used in computation of
  net income (loss) per share:
   Basic.........................        88,103         87,718      87,444     87,230
                                   =============  =============  ==========  =========

   Diluted.......................        88,103         87,718      93,184     92,564
                                   =============  =============  ==========  =========