PROTEIN DESIGN LABS, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1999
1. Summary of Significant Accounting Policies
Organization and Business
Since our founding in 1986, a primary focus of our operations has been
research and development. Achievement of successful research and
development and commercialization of products derived from our efforts
is subject to high levels of risk and significant resource commitments.
Our expenses have generally exceeded revenues. As of December 31, 1999,
we had an accumulated deficit of approximately $79.2 million. We believe
that our losses may 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 new research
areas and improve and expand our manufacturing capabilities. Since we or
our collaborative partners or licensees may not be able to successfully
develop additional products, obtain required regulatory approvals,
manufacture products at an acceptable cost and with appropriate quality,
or successfully market such products with desired margins, we may never
achieve profitable operations. The amount of net losses and the time
required to reach sustained profitability are highly uncertain. We
cannot assure you that we will be able to achieve or sustain
profitability.
Our commitment of resources to the development of Zenapax and the
humanized anti-IL-4 antibody, two humanized antibodies with respect to
which we recently obtained development rights, taken together with the
continued development of our existing products, will require significant
additional funds for development. These operating expenses may also
increase as some of our earlier stage potential products move into later
stage clinical development, as additional potential products are
selected as clinical candidates for further development, as we invest in
additional manufacturing capacity, as we defend or prosecute our patents
and patent applications, and as we invest in research or acquire
additional technologies, product candidates or businesses.
In the absence of substantial revenues from new corporate collaborations
or patent licensing or humanization agreements, significant royalties on
sales of products licensed under our intellectual property rights,
product sales or other uncertain sources of revenue, we will incur
substantial operating losses.
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 payable to
us due to credits for prior payments to us, the timing of royalty
reports, some of which are required quarterly and others semi-annually,
our method of accounting for royalty revenues from our licensees and our
ability to successfully defend and enforce our patents. Other revenue
may also be unpredictable and may fluctuate due to the timing of
payments of non-recurring licensing and signing fees and payments for
manufacturing services and achievement of milestones under new and
existing collaborative, humanization, and patent licensing agreements.
Revenue historically recognized under our prior agreements may not be an
indicator of revenue from any future collaborations.
In addition, our expenses may be unpredictable and may fluctuate from
quarter to quarter due to the timing of expenses, which may include
payments owed by us under licensing arrangements and due to our policy
of recording expenses under certain collaborative agreements during the
quarter in which such expenses are reported to us.
Principles of Consolidation
During the third quarter of 1999, we formed two wholly owned
subsidiaries to facilitate the purchase of the Company's Fremont,
California facilities. The consolidated financial statements include the
accounts of Protein Design labs, Inc. and its wholly-owned subsidiaries,
Fremont Holding L.L.C. and Fremont Management, Inc., after elimination
of inter-company accounts and transactions.
Cash Equivalents, Investments and Concentration of Credit Risk
We consider all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents. The
"Other" adjustments line item in the Statements of Cash Flows represents
the accretion of the book value of certain debt securities. We place our
cash, short-term and long-term investments with high-credit-quality
financial institutions and in securities of the U.S. government and U.S.
government agencies and, by policy, limit the amount of credit exposure
in any one financial instrument. To date, we have not experienced credit
losses on investments in these instruments.
Revenue Recognition
Contract revenues from research and development arrangements are
recorded as earned based on the performance requirements of the
contracts. Revenues from achievement of milestone events are recognized
when the funding party agrees that the scientific or clinical results
stipulated in the agreement have been met. Deferred revenue arises
principally due to timing of cash payments received under research and
development contracts.
Our collaborative, humanization and patent licensing agreements with
third parties provide for the payment of royalties to us based on net
sales of the licensed product under the agreement. The agreements
generally provide for royalty payments to us following completion of
each calendar quarter or semi-annual period and royalty revenue is
recognized when royalty reports are received from the third party. Non-
refundable signing and licensing fees under collaborative and
humanization agreements are recognized over the period in which
performance obligations are achieved. Non-refundable signing and
licensing fees under patent licensing agreements are recognized as
revenue when there are no future performance obligations remaining with
respect to such fees.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" (SAB 101). We are evaluating the effects, if any, that SAB
101 and the adoption of SAB 101 in the second quarter of 2000, may have
on the results of our operations or our financial position.
Net Loss Per Share
In accordance with Financial Accounting Standards Board Statement No.
128, "Earnings Per Share" (FAS 128), net loss per share is calculated
using the weighted average number of shares of common stock outstanding
during the period. Common stock equivalents from outstanding stock
options are not included as their effect is antidilutive.Had we been in
a net income position, diluted earnings per share for 1999, 1998, and
1997 would have included an additional 615,000, 527,000, and 1,052,000
shares, respectively, related to our outstanding stock options.
Comprehensive Loss
In accordance with Financial Accounting Standards Statement No. 130,
"Reporting Comprehensive Income" (FAS 130), we are required to display
comprehensive loss and its components as part of our complete set of
financial statements. The measurement and presentation of net loss did
not change. Comprehensive loss is comprised of net loss and other
comprehensive loss. Other comprehensive loss includes certain changes in
equity that are excluded from our net loss, Specifically FAS 130
requires unrealized gains and losses on our holdings of available-for-
sale securities. Comprehensive loss for the years ended December 31,
1999, 1998 and 1997 is reflected in the Statements of Stockholders'
Equity.
Segment Disclosure
In accordance with Financial Accounting Standards Statement No. 131,
"Disclosure about Segments of an Enterprise and Related Information"
(FAS 131), we are required to report operating segments and related
disclosures about our products, services, geographic areas and major
customers. We have no significant product revenue and have only one
segment with facilities solely within the United States. As a result,
the adoption of FAS 131 had no impact on our reporting.
Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
(FAS 133). FAS 133 provides a comprehensive and consistent standard for
the recognition and measurement of derivatives and hedging activites. In
July 1999, the Financial Accounting Standards Board announced the delay
of the effective date of FAS 133 for one year, to the first quarter of
2001. However, we have reviewed FAS 133 and because we do not use
derivatives, the adoption of FAS 133 is not expected to have an effect
on our results of operations or our financial position.
Management Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires the use of
management's estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. For example, we have
a policy of recording expenses for clinical trials based upon pro rating
estimated total costs of a clinical trial over the estimated length of
the clinical trial and the number of patients anticipated to be enrolled
in the trial. Expenses related to each patient are recognized ratably
beginning upon entry into the trial and over the course of the trial. In
the event of early termination of a clinical trial, management accrues
an amount based on its estimate of the remaining non-cancellable
obligations associated with the winding down of the clinical trial. Our
estimates and assumptions could differ significantly from the amounts
which may actually be realized.
Property and Equipment
Land, property and equipment are stated at cost less accumulated
straight-line depreciation and amortization and consist of the
following:
(In thousands)
December 31,
---------------------
1999 1998
---------- ----------
Land $6,790 --
Building and improvements 21,720 --
Leasehold improvements 4,322 16,967
Laboratory and manufacturing equipment 18,057 16,468
Computer and office equipment 4,785 4,625
Furniture and fixtures 1,294 1,015
---------- ----------
56,968 39,075
Less accumulated depreciation (18,921) (16,059)
---------- ----------
$38,047 $23,016
========== ==========
Depreciation is computed using the straight-line method over the
following estimated useful lives:
Buildings and improvements 15 to 30 years
Leasehold improvements Term of lease
Laboratory and manufacturing equipment 7 years
Computer and office equipment 3 years
Furniture and fixtures 7 years
2. Collaborative, Humanization and Patent Licensing Arrangements
Roche
We have entered into product licensing agreements with Hoffmann-La Roche
Inc. and its affiliates (Roche) for Zenapax, a humanized antibody
created by us. Since 1998, we have received royalties from the sales of
Zenapax by Roche. Royalties payable to us are subject to certain offsets
for milestones, patent expenses, third party license fees and royalties
paid by Roche under the agreements. The product licensing agreements may
be terminated by Roche upon 90 days notice, in which event rights
licensed to Roche will revert back to us.
In October 1999, we entered into agreements with Roche to accelerate the
development of Zenapax for the potential treatment of autoimmune
diseases. We assumed worldwide responsibility for the clinical
development of Zenapax in autoimmune diseases at our cost. Roche is to
supply, at no cost to us, certain quantities of Zenapax for use in
clinical testing; we may, but are under no obligation to, purchase
additional quantities.
In return for undertaking clinical development in autoimmune
indications, we will receive a significant share of Zenapax revenues
from sales for autoimmune indications in the form of revenue sharing
with Roche. We will receive the majority of net sales for all
autoimmune indications in the United States and Canada.
SmithKline
In September 1999, we entered into agreements with SmithKline Beecham
(SB) relating to two humanized antibodies discovered by SB for the
potential treatment of asthma. Under the terms of the agreements, we
obtained a license to SB's humanized antibody to interleukin-4 (anti-IL-
4). We granted an exclusive license under our antibody humanization
patents to SB for our humanized antibody to interleukin-5 (anti-IL-5).
Under the arrangement, we will be entitled to exclusive, worldwide
development, marketing and sales rights to the anti-IL-4 antibody unless
SB pays an opt-in fee at the end of Phase II clinical development. If
SB elects to participate, the two companies will share future
development costs and profits at a pre-agreed ratio. We may also
receive certain co-promotion rights in the U.S.
We granted SB a worldwide, exclusive license to humanized antibodies
directed to IL-5 under our humanization patents. SB paid us a licensing
fee and will pay maintenance fees and royalties on future sales, if any.
We also granted SB an option to three licenses under our humanization
patents for which SB will make additional payments to us upon exercise.
Scil Biomedicals GmbH
In March 1999, we entered into an agreement with Scil Biomedicals GmbH
(Scil) for rights to develop and market our SMARTTM (humanized) Anti-L-
Selectin Antibody in Europe. Scil paid us a $3.0 million non-refundable,
non-creditable signing and licensing fee for rights to the SMART Anti-L-
Selectin Antibody in the territory, and we will be entitled to royalties
on sales, if any. The agreement provides for us to make milestone
payments to Scil, at our election, upon the achievement of specified
clinical and regulatory goals.
Lilly
In December 1997, we entered into a research, development and licensing
agreement with Eli Lilly & Company (Lilly). We received a non-refundable
licensing and signing fee under the agreement of $3.0 million in 1997,
of which we recognized $1.35 million in 1997. We recognized $2.4 million
and $1.8 million in research and development funding under the agreement
in 1999 and 1998, respectively. Related costs under the agreement are
anticipated to approximate the related research and development funding
revenue and the costs incurred are included in research and development
expenses in the accompanying financial statements. The agreement further
provides for additional annual research funding of $2.4 million for the
third through fifth years if the agreement is not earlier terminated. In
addition, under this agreement we can earn milestones, receive royalty
payments on net sales of licensed products and negotiate co-promotion
rights in the U.S. and Canada. The agreement may be terminated by Lilly
upon written notice ranging from 90-180 days upon the occurrence of
certain events, including the event that certain key personnel are no
longer associated with us or are unable to fulfill certain obligations
under the agreement with Lilly.
Humanization Agreements
We have entered into a number of antibody humanization agreements
pursuant to which we have performed antibody humanization services and
granted patent licenses to specified antibody targets. Generally, under
these agreements, we received a licensing and signing fee and the right
to receive milestone payments for achievement of certain specified
milestones, as well as royalties on product sales, if any. Under some
of these agreements, we received certain rights to co-promote the
product.
Patent Licensing Arrangements
In December 1999, we entered into a patent rights agreement with
Celltech Chiroscience plc (Celltech) covering certain intellectual
property in the field of humanized monoclonal antibodies. Under the
agreement, Celltech paid a $3.0 million non-creditable, non-refundable
up-front fees for rights to worldwide non-exclusive licenses under our
antibody humanization patents (generally referred to as the Queen et al.
patents) for up to three Celltech antibodies. Concurrently, we paid
Celltech a non-creditable, non-refundable up-front fee for rights to
worldwide non-exclusive licenses under Celltech's antibody humanization
patent (Adair patent) for up to three of our antibodies. Further, upon
exercise of a license for a particular antibody, we or Celltech will pay
an additional license fee to the other company. Each company will pay
royalties to the other on potential sales of licensed antibodies, if
any.
In 1998, we entered into an arrangement with Genentech, Inc. (Genentech)
pursuant to which either party may obtain a nonexclusive license to
certain intellectual property rights related to monoclonal antibodies
held by the other party. Under the arrangement, we received a $6.0
million non-refundable signing and licensing fee recognized as revenue
and paid $1.0 million in expenses in 1998. In 1998, Genentech exercised
its rights to obtain a license under the arrangement and entered into a
nonexclusive license agreement for Herceptin® pursuant to which we
recognized an additional $1.0 million in income. The license for
Herceptin also includes the payment of royalties to us based on product
sales.
We have entered into numerous patent licensing agreements relating to
antibodies humanized by other companies. Generally, under these
agreements, we granted a worldwide, nonexclusive or exclusive license
under our humanized antibody patents to the other company for an
antibody to a specific target antigen. In each case, we received a
licensing and signing fee and the right to receive royalties on net
sales of licensed products. Under some of these agreements, we could
also receive milestone payments.
3. Other Accrued Liabilities
At December 31, other accrued liabilities consisted of the following:
(In thousands)
December 31,
---------------------
1999 1998
---------- ----------
Employee stock purchase plan $477 $443
Clinical trials 712 1,293
Accrued rent 19 21
Construction payable -- 1,307
Contract payable 660 --
Other accrued liabilities 1,606 1,820
---------- ----------
$3,474 $4,884
========== ==========
We have a policy of recording expenses for clinical trials based upon
pro rating estimated total costs of a clinical trial over the estimated
length of the clinical trial and the number of patients anticipated to
be enrolled in the trial. Expenses related to each patient are
recognized ratably beginning upon entry into the trial and over the
course of the trial. In the event of early termination of a clinical
trial, management accrues an amount based on our estimate of the
remaining non-cancellable obligations associated with the winding down
of the clinical trial.
4. Commitments
We occupy or are responsible for leased facilities under agreements that
expire in 2000 and 2004. We also have leased certain office equipment
under operating leases. Rental expense under these arrangements totaled
approximately $2.7 million, $2.5 million, and $1.7 million for the years
ended December 31, 1999, 1998 and 1997, respectively. In December 1998,
the Company subleased its Mountain View, California facility to two
third parties. Under these subleases, the Company recognized rental
income of approximately $1.2 million and $0.1 million for the years
ended December 31, 1999 and 1998, respectively.
At December 31, 1999 the total future minimum non-cancelable payments
under these operating lease agreements are approximately as follows (in
thousands):
2000 $1,545
2001 525
2002 520
2003 495
2004 160
----------
Total $3,245
==========
Effective in June 1997, the Company entered into a Sponsored Research
Agreement with Stanford University (Stanford) to provide funding and
equipment support over a period of 3 years for the laboratory of Stanley
Falkow, Ph.D. In 1999 and 1998, the Company provided approximately $0.6
million in annual funding and equipment support under this commitment.
Dr. Falkow resigned as a member of the Board of Directors in September
1998. The funding arrangement provides us with certain exclusive rights
to intellectual property resulting from the research efforts in Dr.
Falkow's laboratory at Stanford during the funding period.
5. Short- and Long-Term Investments
We invest our excess cash balances primarily in short-term and long-term
marketable securities and U.S. government and government agency notes.
These securities are classified as available-for-sale. Available-for-
sale securities are carried at fair value, with the unrealized gains and
losses reported in accumulated other comprehensive loss in stockholders'
equity. The amortized cost of debt securities is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in interest income. The cost of securities sold
is based on the specific identification method, when applicable.
The following is a summary of available-for-sale securities. Estimated
fair value is based upon quoted market prices for these or similar
instruments.
Available-for-Sale Securities
-----------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- --------- ---------
December 31, 1999
Securities of the
U.S. Government and
its agencies $115,385 $ -- ($2,183) $113,202
U.S. corporate securities 9,808 138 -- 9,946
--------- --------- --------- ---------
Total debt securities $125,193 $138 ($2,183) $123,148
========= ========= ========= =========
December 31, 1998
Securities of the
U.S. Government and
its agencies $115,373 $232 ($99) $115,506
U.S. corporate securities 13,922 27 (1) 13,948
--------- --------- --------- ---------
Total debt securities $129,295 $259 ($100) $129,454
========= ========= ========= =========
During 1999 and 1998, there were no realized gains or losses on the sale
of available-for-sale securities, as all securities liquidated in each
of these years were held to maturity. The remaining contractual period
until maturity of short-term and long-term investments generally range
from 0 to 1 month, and 16 to 28 months, respectively.
6. Stockholders' Equity
1997 Public Offering
In March 1997, we completed a public offering in which we sold 2,275,000
shares of common stock at a price per share of $32.00. The net proceeds
of this offering were approximately $68.2 million.
1997 Private Placement
In October 1997, we entered into a Stock Purchase Agreement with
Toagosei pursuant to which we sold 44,568 shares of our Common Stock to
Toagosei at a price of $44.875. The net proceeds of this offering were
approximately $2.0 million.
1991 Stock Option Plan
In December 1991, the Board of Directors adopted the 1991 Stock Option
Plan (Option Plan). We reserved 4,000,000 shares of common stock for the
grant of options under the Option Plan. At December 31, 1999, 237,346
shares were available for grant.
At December 31, 1999, options to purchase 960,460 shares were
exercisable at prices ranging from $6.25 to $43.75. Options granted
under the Option Plan generally vest at the rate of 25 percent at the
end of the first year, with the remaining balance vesting monthly over
the next three years in the case of employees, and ratably over two or
five years in the case of advisors and consultants.
Outside Directors' Stock Option Plan
In February 1992 the Board of Directors adopted the Outside Directors'
Stock Option Plan (Directors' Plan). We reserved 200,000 shares of
common stock for the grant of options under the Directors' Plan. Through
December 31, 1999, the Company granted options to purchase 165,000
shares at exercise prices ranging from $7.25 to $38.75 per share, of
which 25,000 were canceled. At December 31, 1999 55,500 were
exercisable. Options granted pursuant to the Directors' Plan vest
ratably over five years. A total of 33,000 options were exercised
through December 31, 1999.
1993 Employee Stock Purchase Plan
In February 1993, the Board of Directors adopted the 1993 Employee Stock
Purchase Plan (Employee Purchase Plan). We reserved 300,000 shares of
common stock for the purchase of shares by employees under the Employee
Purchase Plan, At December 31, 1999, 65,304 shares remain available for
purchase. Eligibility to participate in the Employee Purchase Plan is
essentially limited to full time employees who own less than 5% of the
outstanding shares. Under the Employee Purchase Plan, eligible employees
can purchase shares of our common stock based on a percentage of their
compensation, up to certain limits. The purchase price per share must
equal at least the lower of 85% of the market value on the date offered
or on the date purchased. During 1999, an aggregate of 46,200 shares
were purchased by employees under the Employee Purchase Plan at prices
of $18.86 or $19.66 per share.
1999 Nonstatutory Stock Option Plan
In August 1999, the Board of Directors adopted the 1999 Nonstatutory
Stock Option Plan (the Nonstatutory Option Plan). We reserved 1,000,000
shares of common stock for the grant of options under the Nonstatutory
Option Plan. As of December 31, 1999, 721,883 shares were available for
grant.
At December 31, 1999, options to purchase 20,256 shares were exercisable
at a price of $26.56. Options granted under the Nonstatutory Option
Plan, pursuant to the standard form of option agreement for employees,
vest at the rate of 25 percent at the end of the first year, with the
remaining balance vesting monthly over the next three years.
In August 1999, we granted supplemental options under the Nonstatutory
Option Plan to employees (excluding officers and directors) who had
options with exercise prices greater than $29.00 under the 1991 Stock
Option Plan, the then current market price of our common stock. These
supplemental grants vest monthly over a two year period beginning
September 1999. The vesting on the corresponding original grants under
the 1991 Stock Option Plan was halted and will resume in September 2001.
1999 Stock Option Plan
In April 1999, the Board of Directors adopted the 1999 Stock Option Plan
(the 1999 Option Plan) subject to approval by our stockholders, which
approval occurred in June 1999. We reserved 925,000 shares of common
stock for the grant of options under the 1999 Option Plan. As of
December 31, 1999, 784,958 shares were available for grant.
At December 31, 1999, options to purchase 17,673 shares were exercisable
at a price of $26.56. Options granted under the 1999 Option Plan,
pursuant to the standard form of option agreement for employees, vest at
the rate of 25 percent at the end of the first year, with the remaining
balance vesting monthly over the next three years.
In August 1999, we granted supplemental options under the 1999 Option
Plan to officers and directors (but excluding employee directors) who
had options with exercise prices greater than $29.00 under the 1991
Stock Option Plan, the then current market price of our common stock.
These supplemental grants vest monthly over a two year period beginning
September 1999. The vesting on the corresponding original grants under
the 1991 Stock Option Plan was halted and will resume in September 2001.
Stock Option Activity
Included in other current assets at December 31, 1999 is an aggregate
receivable from third parties of $2.5 million related to stock option
exercises.
Accounting for Stock-Based Compensation
We have elected to follow Accounting Principles Board Opinion No. 25,
"Accounting of Stock Issued to Employees" (APB 25) and related
interpretations, in accounting for stock-based awards to employees,
consultants and directors under the Option Plan, Directors' Plan, the
1999 Nonstatutory Option Plan and the 1999 Option Plan because, as
discussed below, the alternative fair value accounting provided for
under Financial Accounting Standard 123, "Accounting for Stock-Based
Compensation" (FAS 123) requires use of option valuation models that
were not developed for use in valuing employee stock-based awards.
Under APB 25, because the exercise price of our stock options equals the
market price of the underlying stock on the date of grant, no
compensation expense is recognized. Pro forma information regarding net
income and earnings per share in 1999, 1998 and 1997 has been determined
as if we had accounted for our stock-based awards under the fair value
method prescribed by FAS 123. The resulting effect on pro forma net
income and earnings per share on a pro forma basis disclosed for 1999,
1998 and 1997 is not likely to be representative of the effects on net
income and earnings per share on a pro forma basis in future years,
because subsequent years will include additional years of vesting. The
1997 pro forma net loss excludes the $11.9 million non-cash special
charge related to the extension of all stock options granted prior to
February 1995 except stock options granted to one non-employee director
(See Note 9). The special charge represents the intrinsic value of the
modified options calculated in accordance with APB 25. Under FAS 123,
only the additional compensation cost related to the time value of the
modified options is included in pro forma net losses.
(In thousands, except per share data)
Year Ended December 31,
-----------------------------
1999 1998 1997
--------- --------- ---------
Net loss:
As reported ($10,333) ($9,502) ($23,875)
Pro forma ($17,435) ($17,626) ($17,727)
Loss per share:
As reported ($0.55) ($0.51) ($1.35)
Pro forma ($0.93) ($0.95) ($1.00)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options pricing model with the following
weighted-average assumptions used for grants in each of 1999, 1998 and
1997, respectively: (a) no dividends; (b) expected volatility of 72% for
1999, 75% for 1998 and 55% for prior years; (c) weighted-average risk-
free interest rates of 5.39%, 5.45% and 6.22%; and (d) expected lives of
5 years.
A summary of the status of our stock option plans at December 31, 1999,
1998 and 1997, and changes during the years ending those dates is
presented below.
(In thousands, except exercise price data)
1999 1998 1997
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- --------- --------- ---------
Outstanding at beginning of year 2,487 $25.90 2,100 $22.25 1,941 $18.44
Granted 1,095 22.05 803 32.70 448 36.25
Exercised (639) 21.65 (215) 15.06 (237) 17.16
Forfeited (265) 26.78 (200) 26.48 (52) 23.66
--------- --------- ---------
Outstanding at end of year 2,678 25.17 2,488 25.90 2,100 22.25
========= ========= =========
Weighted average fair value of
options granted during the year $13.92 $21.23 $21.33
========= ========= =========
Exercisable at end of year 1,054 1,200 998
========= ========= =========
The following information applies to all stock options outstanding under
our stock option plans at December 31, 1999:
(In thousands, except exercise prices and remaining contractual life
data)
Options Outstanding Options Exercisable
--------------------------------- ----------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (years) Price Exercisable Price
- ------------------ ----------- ----------- --------- ----------- ----------
$6.25 to $10.50 57 2.41 $7.69 57 $7.69
$12.13 to $18.13 916 6.92 $16.37 428 $15.36
$19.06 to $29.25 970 8.38 $24.18 325 $24.37
$31.50 to $48.00 735 8.12 $38.70 244 $38.10
----------- -----------
2,678 $25.17 1,054 $23.11
=========== ===========
7. Income Taxes
As of December 31, 1999, we have federal and California state net
operating loss carryforwards of approximately $69,900,000 and
$4,800,000, respectively. We also have federal and California state
research and other tax credit carryforwards of approximately $4,200,000
and $2,100,000, respectively. The federal net operating loss and credit
carryforwards will expire at various dates beginning in the year 2002
through 2019, if not utilized. The California state net operating
losses will expire at various dates beginning in 2000 through 2004, if
not utilized.
Utilization of the federal and California state net operating loss and
credit carryforwards may be subject to a substantial annual limitation
due to the "change in ownership" provisions of the Internal Revenue Code
of 1986. The annual limitation may result in the expiration of net
operating losses and credits before utilization.
Significant components of our deferred tax assets for federal and state
income taxes as of December 31 are as follows:
(In thousands)
1999 1998
--------- ---------
Deferred tax assets:
Net operating loss carryforwards $24,000 $18,800
Research and other credits 6,300 5,600
Deferred revenue 900 900
Capitalized research and development 2,100 3,800
Other 1,900 (100)
--------- ---------
Total deferred tax assets 35,200 29,000
Valuation allowance for deferred tax asset (35,200) (29,000)
--------- ---------
Net deferred tax assets $ -- $ --
========= =========
Because of our lack of earnings history, the deferred tax assets have
been fully offset by a valuation allowance. The valuation allowance
increased by $900,000 and $11,000,000 during the years ended December
31, 1998 and 1997, respectively.
Approximately $5,000,000 of the valuation allowance for deferred tax
assets relates to benefits of stock option deductions which, when
recognized, will be allocated directly to contributed capital.
8. Legal Proceedings
PDL is involved in administrative opposition proceedings being conducted
by the European Patent Office (EPO) with respect to our first European
patent relating to humanized antibodies. 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, which cited references and made arguments not
considered by the EPO before grant of the patent. We expect a decision
from the EPO at an oral hearing currently scheduled to take place in
March 2000. A non-binding, preliminary view from the EPO received in May
1999 raised significant questions regarding the validity of the first
European patent, which, if not satisfactorily responded to by us in the
oral hearing, could result in revocation of certain claims or the entire
European patent. At the oral hearing, we expect that the EPO will either
maintain the patent in full, maintain the patent in an amended version
in which the scope of the patent's coverage is narrowed, or revoke the
patent. Any of the parties to the opposition, including PDL, may appeal
this decision to a board of appeals within the EPO, and any appeal could
be pending for several years.
Until the uncertainty regarding our first European patent 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 patent. An unfavorable result could also jeopardize our
royalty payments and potential license arrangements and could encourage
challenges of related patents in other jurisdictions, including the U.S.
In addition, an unfavorable result may lead some of our licensees to
stop making royalty payments, which would require us to initiate formal
legal actions to enforce our rights under our various humanization
patents, including the European patent. In addition, if we were to
commence an infringement action against a company that is not a party to
the opposition proceedings, it is possible that that company would be
permitted to become a party in the opposition proceedings. We have no
assurance that we will successfully enforce our rights under our
European or related U.S. and Japanese patents. The nine month opposition
period for our second European antibody humanization patent ends in May
2000, and we expect that a significant number of notices of opposition
will be filed with respect to this patent. We have also been advised
that three opposition statements have been filed with the Japanese
Patent Office with respect to our humanization patent issued in Japan in
late 1998.
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 the outcome of the European or Japanese opposition
proceedings or any litigation involving our antibody humanization
patents were to be unfavorable, our ability to collect royalties on
existing licensed products and to license our patents relating to
humanized antibodies may be materially harmed. In addition, these
proceedings or any other litigation to protect our intellectual property
rights or defend against infringement claims by others, could result in
substantial costs and diversion of management's time and attention,
which could materially harm our business and financial condition.
9. Special Charge
In 1997, we incurred a non-cash special charge of approximately $11.9
million related to the extension of the term of all our stock options
held by employees, officers, directors and consultants that were granted
prior to February 1995, with the single exception of stock options
granted to one non-employee director. The non-cash special charge
conforms the term of previously granted stock options, which was six
years, to those granted since February 1995, ten years. The special
charge resulted in an increase in additional paid-in capital of
approximately $11.9 million, although no proceeds were received by us.
10. Long-Term Debt
In September 1999, Fremont Holding L.L.C. (a wholly owned subsidiary of
Protein Design Labs, Inc.) obtained a $10.2 million term loan to
purchase our Fremont, California facilities. The loan bears interest at
the rate of 7.64% per year amortized over 15 years with principal and
interest payable monthly. The loan is secured by our Fremont, California
facilities and is subject to the terms and covenants of the loan
agreement.
At December 31, 1999 the total future minimum non-cancelable principal
payments under this term loan are approximately as follows (in
thousands):
2000 $368
2001 400
2002 432
2003 466
2004 502
Thereafter 7,924
----------
Total $3,245
==========
11. Subsequent Events
In February 2000, we issued 5.50% Convertible Subordinated Notes due
February 15, 2007 with a principal amount of $150 million (the
Convertible Notes). The Convertible Notes are convertible into our
common stock at a conversion price of $151.00 per share, subject to
adjustment in certain events and at the holders' option. Interest on the
Convertible Notes is payable semiannually in arrears on February 15 and
August 15 of each year. The Convertible Notes are unsecured and are
subordinated to all our existing and future Senior Indebtedness (as
defined in the indenture relating to the Convertible Notes). The
Convertible Notes may be redeemed at our option, in whole or in part,
beginning on February 15, 2003 at the redemption prices set forth in the
Convertible Notes indenture. We plan to file a shelf registration
statement covering resales of the Convertible Notes and the common stock
issuable upon conversion of the Convertible Notes.
At an oral hearing in March 2000, the Opposition Division (OD) of the
EPO decided to revoke the broad claims in our first European patent
based on formal matters of European patent law, specifically that there
had been an impermissible addition of subject matter after the filing of
the original European patent application, but did not provide the
rationale behind its decision. The decision upheld claims that protect
Zenapax. The OD did not otherwise announce a decision on the issue of
whether the claims in our patent are inventive in light of the prior art
or other issues of patentability. We plan to appeal the OD's decision to
the Technical Board of Appeals at the EPO. The Technical Board of
Appeals will consider all issues anew. The appeal suspends the decision
of the OD during the appeals process, which is likely to take several
years.
Until our appeal regarding our first European patent 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 OD's decision could encourage challenges of
our related patents in other jurisdictions, including the U.S. The OD's
decision may lead some of our licensees to stop making royalty payments
or lead potential licensees not to take a license, which might result in
us initiating formal legal actions to enforce our rights under our
various 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 EPO. We have no assurance that we will
successfully enforce our rights under our European or related U.S. and
Japanese patents. The nine month opposition period for our second
European antibody humanization patent ends in May 2000, and we expect
that a significant number of notices of opposition will be filed with
respect to this patent. We have also been advised that three opposition
statements have been filed with the Japanese Patent Office with respect
to our humanization patent issued in Japan in late 1998.
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 materially harm our business and financial
condition.
