Based on a cross-licensing patent agreement with Genentech Inc. related to humanized antibodies signed nearly five years ago, Protein Design Labs Inc. and company followers were happily eyeing certain Genentech product sales and the potential for more as other products received approval.

Word that Genentech is disputing the relevance of PDL patents to Genentech's recently marketed asthma product, Xolair - thereby throwing a royalty uncertainty over Genentech's late-stage products, Avastin and Raptiva - caused those observers to sell off PDL stock (NASDAQ:PDLI) Friday, as it dropped $3.65, or 25.2 percent, to close at $10.85.

For PDL, of Fremont, Calif., royalties in general make up "the lion's share of our current revenues," said James Goff, PDL's senior director, corporate communications - and stand as the gateway to quicker profitability.

Without Xolair royalties, PDL profitability is pushed further away, said Felicia Reed, analyst with Adams Harkness & Hill, of Boston.

The agreement, originally signed in September 1998, called for a $6 million up-front payment from Genentech and a $1 million payment from PDL, as the companies basically sidestepped any brewing patent infringement issues by allowing licensing options on each other's antibody products. It paved the way for Genentech to take a nonexclusive license for Herceptin under PDL's patents. The breast cancer product was approved in September 1998 and is one of four products PDL receives royalties from - the other three being MedImmune Inc.'s Synagis, Wyeth's Mylotarg and F. Hoffmann-La Roche Ltd.'s Zenapax.

PDL annually receives the most from Synagis, Goff told BioWorld Today. While hard numbers for the royalty rates have not been disclosed, Goff said the company's royalty agreements "have ranged from 3 percent to 3.75 percent, the older [agreements] being at the lower end of that range. Genentech is definitely an older agreement."

However, those agreements are set; the current disagreement "affects future revenues," he said. "There are many humanized antibodies in development - we anticipate that there are more than 40." Besides approved Xolair, those antibodies include Raptiva, for psoriasis, and Avastin - drugs "expected to contribute to a growing royalty stream" for PDL.

Without that potentially large revenue stream, PDL suffers, Reed said.

"If they don't get the Xolair royalty, and if you assume that Genentech might be difficult on Raptiva and Avastin as well and they get thrown into question, I don't get them to profitability to after 2007," Reed said. "That's as far as my model goes. It probably [reaches profitability] in 2008. But if they do get that royalty, I'm assuming they would be profitable in '06."

Absent Xolair, Reed forecasts earnings per share of 9 cents in 2006 and 32 cents in 2007. Without the trio of Xolair, Avastin and Raptiva royalties, she forecasts an earnings-per-share loss in 2006 of 30 cents, which drops to a 20-cent loss per share in 2007.

It's early yet, and not much is known about either company's position. However, PDL said Genentech showed PDL the amino-acid sequence for Xolair and said it doesn't believe the product is covered by claims under PDL's humanization patents. PDL viewed the material and simply does not agree. The next step, Goff said, "is planning discussions between the scientific and legal groups to continue" a dialogue, with PDL's goal being "to get a better understanding of Genentech's view."

For those on the outside, the landmarks ahead are Sept. 23, the day the original option agreement is scheduled to expire, as well as mid-November, when PDL would expect to receive its first royalty check from Genentech if Xolair falls under the humanization patents. The agreement stipulates payment is to be made 45 days after the close of a quarter, and the first Xolair sales were recorded in July. (See BioWorld Today, June 23, 2003.)

Both sides have an option to extend the agreement. If Genentech chooses not to, that's a bad omen for PDL, Reed said. In her research note, she wrote, "We would view a decision not to extend the deal as an indicator that Genentech does not believe a royalty on Xolair, as well as Avastin and Raptiva, is due." However, she cautioned, "Extension of the deal does not mean that a royalty on Xolair is owed."

If the discussions aren't fruitful or if PDL isn't happy, "litigation always remains a possibility," Goff said, although he added, "We would do that as the avenue of last resort. Right now our next step is to plan the discussions."

On a day when portions of the Northeast, including New York and parts of Canada, recovered from a far-reaching power outage, trading on Wall Street was light. However, PDL, whose average trading volume is about 3 million shares daily, watched Friday as 18 million shares were exchanged. Due to the companies' history and the fact that Xolair was launched in July, the news hit an anticipatory market, as far as PDL was concerned.

"When [Genentech] took the license for Herceptin, they did so about a month after the product was launched," Reed told BioWorld Today. "So, people have been waiting."

Until the issue is resolved, Reed expects PDL shares to be under fire, and in her note she recommended that "investors avoid the shares."

When asked about the stock's activity, Goff said analysts and shareholders could be looking beyond Xolair toward Avastin, Genentech's late-stage, much-ballyhooed colorectal cancer drug.

"I would say these [license] questions began surfacing because of Avastin," he said. "Because if you have followed that, some analysts estimates have gotten very, very large. So, it's not only Xolair but also Avastin - the interest has been driven by the large predictions for Avastin in particular."