Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
 (Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2018
OR
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For transition period from               to            
Commission File Number: 000-19756
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12536205&doc=13
PDL BIOPHARMA, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
94-3023969
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
932 Southwood Boulevard
Incline Village, Nevada 89451
(Address of principal executive offices and Zip Code)

(775) 832-8500
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ý    No   ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and such files).   Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer ý
Non-accelerated filer ¨
Smaller reporting company ¨
Emerging growth company ¨
 
 
 
 
 
If an emerging growth company, indicated by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  ý
As of October 30, 2018, there were 145,976,212 shares of the registrant’s Common Stock outstanding.




 PDL BIOPHARMA, INC.
2018 Form 10-Q
Table of Contents
 
Page
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
FINANCIAL STATEMENTS (unaudited)
 
 
 
 
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2018 and 2017
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2018 and 2017
 
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2018 and December 31, 2017
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017
 
 
 
 
Notes to the Condensed Consolidated Financial Statements
 
 
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 
 
ITEM 4.
CONTROLS AND PROCEDURES
 
PART II - OTHER INFORMATION
 
 
 
ITEM 1.
LEGAL PROCEEDINGS
 
 
 
ITEM 1A.
RISK FACTORS
 
 
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
 
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
 
 
ITEM 5.
OTHER INFORMATION
 
 
 
ITEM 6.
EXHIBITS
 
 
SIGNATURES
We own or have rights to certain trademarks, trade names, copyrights and other intellectual property used in our business, including PDL BioPharma and the PDL logo, each of which is considered a trademark. All other company names, product names, trade names and trademarks included in this Quarterly Report on Form 10-Q are trademarks, registered trademarks or trade names of their respective owners.

2



PART I. FINANCIAL INFORMATION

 ITEM  1.         FINANCIAL STATEMENTS

 PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues
 
 
 
 
 
 
 
 
Royalties from Queen et al. patents
 
$
533

 
$
1,443

 
$
4,534

 
$
31,884

Royalty rights - change in fair value
 
42,184

 
35,353

 
66,117

 
132,224

Interest revenue
 
754

 
6,051

 
2,254

 
16,968

Product revenue, net
 
24,387

 
20,067

 
79,472

 
51,477

License and other
 
40

 
(165
)
 
614

 
19,471

Total revenues
 
67,898

 
62,749

 
152,991

 
252,024

Operating expenses
 
 

 
 

 
 

 
 

Cost of product revenue (excluding intangible asset amortization and impairment)
 
11,926

 
5,565

 
37,016

 
12,632

Amortization of intangible assets
 
1,577

 
6,275

 
14,254

 
18,438

General and administrative
 
13,211

 
11,989

 
39,401

 
35,853

Sales and marketing
 
3,469

 
4,994

 
14,367

 
11,194

Research and development
 
672

 
605

 
2,149

 
6,652

Impairment of intangible assets
 

 

 
152,330

 

Change in fair value of anniversary payment and contingent consideration
 
302

 
700

 
(22,433
)
 
3,349

Total operating expenses
 
31,157

 
30,128

 
237,084

 
88,118

Operating income (loss)
 
36,741

 
32,621

 
(84,093
)
 
163,906

Non-operating expense, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
1,581

 
238

 
4,871

 
726

Interest expense
 
(2,866
)
 
(5,096
)
 
(9,262
)
 
(15,082
)
Gain (loss) on bargain purchase
 

 
(2,276
)
 

 
3,995

Total non-operating expense, net
 
(1,285
)
 
(7,134
)
 
(4,391
)
 
(10,361
)
Income (loss) before income taxes
 
35,456

 
25,487

 
(88,484
)
 
153,545

Income tax expense (benefit)
 
9,900

 
4,755

 
(3,346
)
 
65,180

Net income (loss)
 
25,556

 
20,732

 
(85,138
)
 
88,365

Less: Net loss attributable to noncontrolling interests
 

 

 

 
(47
)
Net income (loss) attributable to PDL’s shareholders
 
$
25,556

 
$
20,732

 
$
(85,138
)
 
$
88,412

 
 
 
 
 
 
 
 
 
Net income (loss) per share
 
 

 
 

 
 

 
 

Basic
 
$
0.18

 
$
0.14

 
$
(0.58
)
 
$
0.56

Diluted
 
$
0.18

 
$
0.14

 
$
(0.58
)
 
$
0.56

Weighted average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
143,171

 
151,146

 
147,159

 
156,802

Diluted
 
144,224

 
152,317

 
147,159

 
157,529

 
See accompanying notes.

3



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
25,556

 
$
20,732

 
$
(85,138
)
 
$
88,365

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 

 
 

 
 

 
 

Change in unrealized gains (losses) on investments in available-for-sale securities:
 
 
 
 
 
 
 
 
Change in fair value of investments in available-for-sale securities, net of tax
 

 
648

 
(578
)
 
648

Adjustment for net gains realized and included in net income (loss), net of tax
 

 

 
(603
)
 

Total change in unrealized gains on investments in available-for-sale securities, net of tax(a)
 

 
648

 
(1,181
)
 
648

Total other comprehensive income (loss), net of tax
 

 
648

 
(1,181
)
 
648

Comprehensive income (loss)
 
25,556

 
21,380

 
(86,319
)
 
89,013

Less: Comprehensive loss attributable to noncontrolling interests
 

 

 

 
(47
)
Comprehensive income (loss) attributable to PDL’s shareholders
 
$
25,556

 
$
21,380

 
$
(86,319
)
 
$
89,060

 ______________________________________________
(a) Net of tax of $349 for the three months ended September 30, 2017, and $314 and $349 for the nine months ended September 30, 2018 and 2017, respectively.

See accompanying notes.

4



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts) 
 
September 30,
 
December 31,
 
2018
 
2017
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
400,984

 
$
527,266

Short-term investments

 
4,848

Accounts receivable, net
15,437

 
31,183

Notes receivable
60,280

 
53,613

Inventories, net
12,515

 
9,147

Prepaid and other current assets
18,533

 
14,386

Total current assets
507,749

 
640,443

Property and equipment, net
8,838

 
7,222

Royalty rights - at fair value
378,291

 
349,223

Notes receivables, long-term
10,686

 
17,124

Intangible assets, net
52,895

 
215,823

Other assets
25,968

 
13,288

Total assets
$
984,427

 
$
1,243,123

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
9,011

 
$
19,785

Accrued liabilities
37,570

 
45,881

Accrued income taxes
91

 
1,377

Convertible notes payable

 
126,066

Total current liabilities
46,672

 
193,109

Convertible notes payable
122,780

 
117,415

Contingent consideration - at fair value
19,200

 
42,000

Other long-term liabilities
56,388

 
44,709

Total liabilities
245,040

 
397,233

 
 
 
 
Commitments and contingencies (Note 12)


 


 
 
 
 
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, 350,000 shares authorized; 145,976 and 153,775 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
1,460

 
1,538

Additional paid-in capital
(97,640
)
 
(102,443
)
Accumulated other comprehensive income

 
1,181

Retained earnings
835,567

 
945,614

Total stockholders’ equity
739,387

 
845,890

Total liabilities and stockholders’ equity
$
984,427

 
$
1,243,123


See accompanying notes.

5



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net (loss) income
$
(85,138
)
 
$
88,365

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
 

 
 

Amortization of convertible notes and term loan offering costs
5,745

 
8,195

Amortization of intangible assets
14,254

 
18,438

Impairment of intangible assets
152,330

 

Change in fair value of royalty rights - at fair value
(66,117
)
 
(132,224
)
Change in fair value of derivative asset
(114
)
 
29

Change in fair value of anniversary payment and contingent consideration
(22,433
)
 
3,349

Other amortization, depreciation and accretion of embedded derivative
3,061

 
1,478

Gain on sale of available-for-sale securities
(764
)
 
(108
)
Loss on disposal of property and equipment
66

 

Escrow receivable

 
(1,400
)
Bargain purchase gain

 
(3,995
)
Inventory obsolescence
(640
)
 
30

Bad debt allowance

 
22

Stock-based compensation expense
4,814

 
3,014

Deferred income taxes
(3,285
)
 
28,970

Changes in assets and liabilities, net of effects of acquisitions:
 

 
 

Accounts receivable
15,752

 
24,565

Prepaid and other current assets
(4,557
)
 
(4,166
)
Accrued interest on notes receivable
(230
)
 
1,577

Inventories, net
(2,831
)
 
(2,285
)
Other assets
(1,805
)
 
347

Accounts payable
(10,774
)
 
1,395

Accrued liabilities
(8,687
)
 
18,980

Accrued income taxes
(1,286
)
 
2,432

Other long-term liabilities
1,280

 
1,055

Net cash (used in) provided by operating activities
(11,359
)
 
58,063

Cash flows from investing activities
 

 
 

Purchase of investments

 
(23,213
)
Maturities of investments-other

 
75,000

Proceeds from sales of available-for-sale securities
4,116

 
37,895

Proceeds from the sale of notes receivables

 
144,829

Proceeds from royalty rights - at fair value
57,049

 
74,404

Proceeds from the sale of royalty rights - at fair value

 
108,169

Purchase of royalty rights
(20,000
)
 

Proceeds from sales of assets held for sale

 
8,142

Purchase of property and equipment
(4,641
)
 
(1,160
)
Net cash provided by investing activities
36,524

 
424,066

Cash flows from financing activities
 

 
 

Repayment of convertible notes
(126,447
)
 

Payment of anniversary payment

 
(87,007
)
Cash paid for purchase of noncontrolling interest

 
(2,170
)
Cash dividends paid

 
(21
)
Repurchase and retirement of common stock
(25,000
)
 
(30,000
)
Net cash used in financing activities
(151,447
)
 
(119,198
)
Net (decrease) increase in cash and cash equivalents
(126,282
)
 
362,931

Cash and cash equivalents at beginning of the period
527,266

 
147,154

Cash and cash equivalents at end of period
$
400,984

 
$
510,085

 
 
 
 

6



 
Nine Months Ended September 30,
 
2018
 
2017
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
4,019

 
$
35,120

Cash paid for interest
$
4,591

 
$
7,224

 
 
 
 
Supplemental schedule of non-cash investing and financing activities
 
 
 
Asset held for sale reclassified from notes receivable to other assets
$

 
$
10,000

Assets held for sale reclassified from other assets to intangible assets
$
1,811

 
$

Extinguishment of notes receivable
$

 
$
43,909

See accompanying notes.

7



PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2018
(Unaudited)

1. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited Condensed Consolidated Financial Statements of PDL Biopharma, Inc. and its subsidiaries (collectively, the “Company” or “PDL”) have been prepared in accordance with Generally Accepted Accounting Principles (United States) (“GAAP”) for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments), that management of the Company believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year.
 
The accompanying unaudited Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the Company’s audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2017, included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the Securities and Exchange Commission (“SEC”) on March 16, 2018. The Condensed Consolidated Balance Sheet at December 31, 2017, included herein, has been derived from the audited Consolidated Financial Statements at that date, but does not include all disclosures required by GAAP.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying Notes to the Condensed Consolidated Financial Statements. The accounting estimates that require management’s most significant, difficult and subjective judgments include the valuation of royalty rights - at fair value, revenue recognition and allowance for customer credits, the valuation of inventory, the assessment of recoverability of goodwill and intangible assets and their estimated useful lives, the valuation and recognition of share-based compensation, the recognition and measurement of current and deferred income tax assets and liabilities, and contingent consideration estimates. Actual results could differ from those estimates.

Significant Accounting Policies

The Company’s significant accounting policies are described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Summarized below are the accounting pronouncements adopted subsequent to December 31, 2017.

Adopted Accounting Pronouncements

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. The new standard provides for specific guidance how certain transactions are classified in the statement of cash flows. Effective January 1, 2018, the Company adopted the requirements of ASU No. 2016-15. The adoption did not have an effect on the Consolidated Financial Statements on the adoption date and no adjustment to prior year Consolidated Financial Statements was required.

In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which requires companies to account for the income tax effects of intercompany sales and transfers of assets other than inventory in the period in which the transfer occurs. Effective January 1, 2018, the Company adopted the requirements of ASU No. 2016-16. The adoption did not have an effect on the Consolidated Financial Statements on the adoption date and no adjustment to prior year Consolidated Financial Statements was required.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which requires entities to show the changes in total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. Effective January 1, 2018, the Company adopted the requirements of ASU No. 2016-18. The adoption did not have an effect on the Consolidated Financial Statements on the adoption date and no adjustment to prior year Consolidated Financial Statements was required.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). Effective January 1, 2018, the Company adopted the requirements of ASU No. 2014-09 using the modified retrospective method as discussed in Note 2, Revenue from Contracts with Customers. All amounts and disclosures set forth in this Quarterly Report on Form 10-Q reflect these changes.


8



Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases, which outlines a comprehensive lease accounting model that supersedes the current lease guidance and requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changes the definition of a lease and expands the disclosure requirements of lease arrangements. The new standard is to be applied using either a modified retrospective approach, or an optional transition method that allows an entity to apply the new standard at the adoption date with a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption and will be effective for the Company starting with the first quarter of 2019, with early adoption permitted. The Company will adopt the standard effective in the first quarter of 2019 and is currently assessing the impact of adopting this guidance on its consolidated financial statements and related disclosures. The Company does not expect the adoption will have a material impact on its consolidated statement of earnings. However, the new standard will require the Company to establish liabilities and corresponding right-of-use assets on its consolidated balance sheet for operating leases that exist as of the January 1, 2019 adoption date.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. The new guidance amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in more timely recognition of losses. ASU No. 2016-13 has an effective date of the fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating ASU No. 2016-13 and assessing the impact, if any, it may have to the Company’s consolidated results of operations, financial position and cash flows.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement.  The new guidance modifies disclosure requirements related to fair value measurement. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Implementation on a prospective or retrospective basis varies by specific disclosure requirement. Early adoption is permitted. The standard also allows for early adoption of any removed or modified disclosures upon issuance of this ASU while delaying adoption of the additional disclosures until their effective date.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software. The new guidance reduces complexity for the accounting for costs of implementing a cloud computing service arrangement and aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). For public companies, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted.  Implementation should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The effects of this standard on the Company’s financial position, results of operations or cash flows are not expected to be material.

 2. Revenue from Contracts with Customers

Adoption of New Revenue Standard

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers that supersedes Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition (“ASC 605”). Subsequently, the FASB issued several updates to ASU No. 2014-09, codified in ASC Topic 606 (“ASC 606”). ASC 606 also includes new guidance on costs related to a contract, which is codified in ASC Subtopic 340-40. The Company adopted ASC 606 on January 1, 2018 using the modified retrospective method for all contracts not substantially completed as of the date of adoption. The cumulative impact of the adoption of ASC 606 was not material to the Company; therefore, the Company did not record any adjustments to retained earnings. The reported results for 2018 reflect the application of ASC 606 guidance while the reported results for 2017 were prepared under the guidance of ASC 605, which is also referred to herein as “legacy GAAP” or the “previous guidance”.

Revenue

A. Significant Accounting Policy

In accordance with ASC 606, revenue is recognized when a customer obtains control of promised products and services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these products and services. A five-step model is utilized to achieve the core principle and includes the following steps: (1) identify the customer contract; (2) identify the contract’s performance obligation; (3) determine the transactions price; (4)

9



allocate the transactions price to the performance obligation; and (5) recognize revenue when the performance obligation is satisfied.

B. Practical Expedients

Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue.

Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of product revenue.

Sales commissions and other incremental costs of obtaining contracts are expensed as incurred as the amortization periods are less than one year.

C. Nature of Goods and Services

The following is a description of principal activities - separated by reportable segments - from which the Company generates its revenue. For more detailed information about reportable segments, see Note 20, Segment Information.

i. Pharmaceutical

The Pharmaceutical segment of the Company principally generates revenue from products sold to wholesalers and distributors. Customer orders are generally fulfilled within a few days of receipt resulting in minimal order backlog. Contractual performance obligations are usually limited to transfer of the product to the customer. The transfer occurs either upon shipment or upon receipt of the product in certain countries outside the United States after considering when the customer obtains control of the product. In addition, for some non-U.S. countries, the Company sells product on a consignment basis where control is not transferred until the customer resells the product to an end user. At these points, customers are able to direct the use of and obtain substantially all of the remaining benefits of the product.

Sales to customers are initially invoiced at contractual list prices. Payment terms are typically 30 to 90 days based on customary practice in each country. Revenue is reduced from the list price at the time of recognition for expected chargebacks, discounts, rebates, sales allowances and product returns, which are referred to as gross-to-net adjustments. These reductions are attributed to various commercial agreements, managed healthcare organizations and government programs such as Medicare, Medicaid, and the 340B Drug Pricing Program containing various pricing implications such as mandatory discounts, pricing protection below wholesaler list price and other discounts when Medicare Part D beneficiaries are in the coverage gap. These various reductions in the transaction price have been estimated using either a most likely amount, in the case of prompt pay discounts, or expected value method for all other variable consideration and have been reflected as liabilities and are settled through cash payments, typically within time periods ranging from a few months to one year. Significant judgment is required in estimating gross-to-net adjustments considering legal interpretations of applicable laws and regulations, historical experience, payer channel mix, current contract prices under applicable programs, unbilled claims, processing time lags and inventory levels in the distribution channel.

ii. Medical Devices

The Medical Devices segment of the Company principally generates revenue from the sale and lease of the LENSAR® Laser System, which may include equipment, Patient Interface Devices (“PIDs”), procedure licenses, and service agreements.

For bundled packages, the Company accounts for individual products and services separately if they are distinct - i.e. if a product or service is separately identifiable from other items in the bundled package and if the customer can benefit from it on its own or with other resources that are readily available to the customer. As the Company both sells and leases the LENSAR® Laser System, the consideration (including any discounts) is first allocated between lease and non-lease components and then allocated between the separate products and services based on their stand-alone selling prices. The stand-alone selling prices for the PIDs and procedure licenses are determined based on the prices at which the Company separately sells the PIDs and procedure licenses. The LENSAR® Laser System and warranty stand-alone selling prices are determined using the expected cost plus a margin approach.


10



The Company sells and leases the LENSAR® Laser System to customers. For LENSAR® Laser System sales, the Company recognizes revenue in product revenue when a customer takes possession of the system. This usually occurs after the customer signs a contract, LENSAR installs the system, and LENSAR performs the requisite training for use of the system. For LENSAR® Laser System leases, the Company recognizes revenue in product revenue over the length of the lease in accordance with ASC Topic 840, Leases.

The LENSAR® Laser System requires both a consumable, a PID, and a procedure license to perform each procedure. The Company recognizes revenue for PIDs in product revenue when the customer takes possession of the PID. PIDs are sold by the case. The Company recognizes revenue for procedure licenses in product revenue when a customer purchases a procedure license from the web portal. Typically, consideration for PIDs and procedure licenses is considered fixed consideration except for certain customer agreements that provide for tiered volume discount pricing which is considered variable consideration.

The Company offers an extended warranty that provides additional services beyond the standard warranty. The Company recognizes revenue in product revenue over the warranty period. Customers have the option of renewing the warranty period, which is considered a new and separate contract.

iii. Income Generating Assets

Licenses of intellectual property: If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer and the customer is able to use and benefit from the license.

In January 2018, DFM, LLC, a wholly-owned subsidiary of the Company, granted an exclusive license related to certain Direct Flow Medical assets in exchange for $0.5 million in cash and up to $2.0 million in royalty payments. The $0.5 million payment was accounted for in accordance with ASC 606 under which the full cash payment was recognized as revenue in the first quarter of 2018 as DFM, LLC had fulfilled its performance obligation under the agreement.

Royalties: The Company recognizes royalty revenues related to the sale of products by its licensees that incorporate the Company's technologies. Royalties qualify for the sales-and-usage exemption under ASC 606 as (i) royalties are based strictly on the sales-and-usage by the licensee; and (ii) a license of intellectual property is the sole or predominant item to which such royalties relate. Based on this exemption, these royalties are earned under the terms of a license agreement in the period the products are sold by the Company's partner and the Company has a present right to payment.

D. Disaggregation of Revenue

The Company disaggregates its revenue from contracts with customers by segment and geographic location as the Company believes it best depicts how the nature, amount, timing and uncertainty of its revenue and cash flows are affected by economic factors. In the following table, revenue is disaggregated by segment and primary geographical market for the three and nine months ended September 30, 2018:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2018
(in thousands)
 
Medical Devices
 
Pharmaceutical
 
Medical Devices
 
Pharmaceutical
 
 
 
 
 
 
 
 
 
Primary geographical markets:
 
 
 
 
 
 
 
 
North America
 
$
2,315

 
$
10,036

 
$
4,634

 
$
31,743

Europe
 
565

 
5,810

 
1,859

 
18,172

Asia
 
2,158

 
1,926

 
4,915

 
12,078

Other
 
65

 

 
285

 

Total revenue from contracts with customers1
 
$
5,103

 
$
17,772

 
$
11,693

 
$
61,993

_______________

11



1 The table above does not include lease revenue from the Company’s Medical Devices segment of $1.5 million and $5.8 million for the three and nine months ended September 30, 2018, respectively.

E. Contract Balances

The following table provides information about receivables, contract assets and contract liabilities from contracts with customers:
(in thousands)
 
September 30, 2018
 
January 1, 2018
 
 
 
 
 
Receivables, current and non-current, net
 
$
16,155

 
$
30,771

Contract assets
 
$
3,106

 
$

Contract liabilities
 
$
5,444

 
$
10,084


Receivables, Net—Receivables, net, include amounts billed and currently due from customers. The amounts due are stated at their net estimated realizable value. The Company maintains an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. The allowance is based upon an assessment of customer creditworthiness, historical payment experience, the age of outstanding receivables and collateral to the extent applicable.

Contract assets—The Company’s contract assets represent revenue recognized for performance obligations completed before an unconditional right to payment exists, and therefore invoicing or associated reporting from the customer regarding the computation of the net product sales has not yet occurred. The Company classifies contract assets in prepaid and other current assets in the Company’s consolidated balance sheet based on the timing of when it expects to receive payment.
(in thousands)
 
Medical Devices
 
Pharmaceutical
 
Total
 
 
 
 
 
 
 
Contract assets at January 1, 2018
 
$

 
$

 
$

Contract assets recognized
 

 
3,106

 
3,106

Contract assets at September 30, 2018
 
$

 
$
3,106

 
$
3,106


Contract Liabilities—The Company’s contract liabilities consist of deferred revenue for products sold to customers for which the performance obligation has not been completed by the Company. The Company classifies deferred revenue as current or noncurrent based on the timing of when it expects to recognize revenue. The noncurrent portion of deferred revenue is included in other long-term liabilities in the Company’s condensed consolidated balance sheets.
(in thousands)
 
Medical Devices
 
Pharmaceutical
 
Total
 
 
 
 
 
 
 
Contract liabilities at January 1, 2018
 
$
1,391

 
$
8,693

 
$
10,084

Additions
 
630

 
4,342

 
4,972

Amounts recognized into revenue
 
(919
)
 
(8,693
)
 
(9,612
)
Contract liabilities at September 30, 2018
 
$
1,102

 
$
4,342

 
$
5,444


F. Transaction Price Allocated to Future Performance Obligations

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of the reporting period.
 
 
Three Months Ended
 
 
 
 
(in thousands)
 
December 31, 2018
 
Thereafter
 
Total
 
 
 
 
 
 
 
Pharmaceutical product sales
 
$
1,000

 
$

 
$
1,000

Medical device sales
 
$
957

 
$
3,832

 
$
4,789


The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with original expected lengths of one year or less or (ii) contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for the products delivered or services performed.

12




3. Net Income (Loss) per Share
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
Net Income (Loss) per Basic and Diluted Share
 
2018
 
2017
 
2018
 
2017
 (in thousands, except per share amounts)
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
Income (loss) attributable to PDL’s shareholders used to compute net income per basic and diluted share
 
$
25,556

 
$
20,732

 
$
(85,138
)
 
$
88,412

 
 
 
 
 
 
 
 
 
Denominator
 
 

 
 

 
 
 
 
Total weighted average shares used to compute net income attributable to PDL’s shareholders, per basic share
 
143,171

 
151,146

 
147,159

 
156,802

Restricted stock outstanding
 
1,053

 
1,171

 

 
727

Shares used to compute net income (loss) attributable to PDL’s shareholders, per diluted share
 
144,224

 
152,317

 
147,159

 
157,529

 
 
 
 
 
 
 
 
 
Net income (loss) attributable to PDL’s shareholders per share - basic
 
$
0.18

 
$
0.14

 
$
(0.58
)
 
$
0.56

Net income (loss) attributable to PDL’s shareholders per share - diluted
 
$
0.18

 
$
0.14

 
$
(0.58
)
 
$
0.56


The Company computes net income per diluted share using the sum of the weighted-average number of common and common equivalent shares outstanding. Common equivalent shares used in the computation of net income per diluted share include shares that may be issued pursuant to outstanding stock options and restricted stock awards, the 4.0% Convertible Senior Notes due February 1, 2018 (the “February 2018 Notes”) that were repaid on February 1, 2018, and the 2.75% Convertible Senior Notes due December 1, 2021 (the “December 2021 Notes”), in each case, on a weighted average basis for the period that the notes were outstanding, including, if applicable, the effect of adding back interest expense and the underlying shares using the if converted method.

December 2021 Notes Capped Call Potential Dilution

In November 2016, the Company issued $150.0 million in aggregate principal of the December 2021 Notes, which provide in certain situations for the conversion of the outstanding principal amount of the December 2021 Notes into shares of the Company’s common stock at a predefined conversion rate. For additional information on the conversion rates on the Company’s convertible debt, see Note 13, Convertible Senior Notes. In conjunction with the issuance of the December 2021 Notes, the Company entered into a capped call transaction with a hedge counterparty. The capped call transaction is expected generally to reduce the potential dilution, and/or offset, to an extent, the cash payments the Company may choose to make in excess of the principal amount, upon conversion of the December 2021 Notes. The Company has excluded the capped call transaction from the net income (loss) per diluted share computation as such securities would have an anti-dilutive effect and those securities should be considered separately rather than in the aggregate in determining whether their effect on net income (loss) per diluted share would be dilutive or anti-dilutive. For additional information regarding the capped call transaction related to the Company’s December 2021 Notes, see Note 13, Convertible Senior Notes.

Anti-Dilutive Effect of Restricted Stock Awards and Stock Options

For the three months ended September 30, 2018 and 2017, the Company excluded approximately 1.3 million and 1.8 million shares underlying restricted stock awards, respectively, and for the nine months ended September 30, 2018 and 2017, the Company excluded approximately 2.3 million and 1.9 million shares underlying restricted stock awards, respectively, calculated on a weighted-average basis, from its net income (loss) per diluted share calculations because their effect was anti-dilutive.

For the three months ended September 30, 2018 and 2017, the Company excluded approximately 7.6 million and 126,000 shares underlying outstanding stock options, respectively, and for the nine months ended September 30, 2018 and 2017, the Company excluded approximately 7.6 million and 59,000 shares underlying outstanding stock options, respectively, calculated on a weighted-average basis, from its net income (loss) per diluted share calculations because their effect was anti-dilutive.

13




No 4. Fair Value Measurements

The fair value of the Company’s financial instruments are estimates of the amounts that would be received if the Company were to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date or exit price. The assets and liabilities are categorized and disclosed in one of the following three categories:

Level 1 – based on quoted market prices in active markets for identical assets and liabilities;
 
Level 2 – based on quoted market prices for similar assets and liabilities, using observable market-based inputs or unobservable market-based inputs corroborated by market data; and
 
Level 3 – based on unobservable inputs using management’s best estimate and assumptions when inputs are unavailable.

Assets/Liabilities Measured and Recorded at Fair Value on a Recurring Basis

The following table presents the fair value of the Company’s financial instruments measured at fair value on a recurring basis by level within the valuation hierarchy:
 
 
September 30, 2018
 
December 31, 2017
(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
225,513

 
$

 
$

 
$
225,513

 
$
417,563

 
$

 
$

 
$
417,563

Corporate securities
 

 

 

 

 
4,848

 

 

 
4,848

Warrants
 

 
143

 

 
143

 

 
29

 

 
29

Royalty rights - at fair value
 

 

 
378,291

 
378,291

 

 

 
349,223

 
349,223

Total
 
$
225,513

 
$
143

 
$
378,291

 
$
603,947

 
$
422,411

 
$
29

 
$
349,223

 
$
771,663

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 

Contingent consideration, current1
 
$

 
$

 
$
1,070

 
$
1,070

 
$

 
$

 
$

 
$

Contingent consideration, non-current
 

 

 
19,200

 
19,200

 

 

 
42,000

 
42,000

Total
 
$

 
$

 
$
20,270

 
$
20,270

 
$

 
$

 
$
42,000

 
$
42,000

 ___________________
1 Contingent consideration, current is classified as “Accrued liabilities” on the Condensed Consolidated Balance Sheet. See Note 11, Accrued Liabilities, for details.

There have been no transfers between levels during the periods presented in the table above. The Company recognizes transfers between levels on the date of the event or change in circumstances that caused the transfer.

Corporate Securities

Corporate securities consisted primarily of U.S. corporate equity holdings. The fair value of corporate securities was estimated using market quoted prices.

Warrants

Warrants consist primarily of purchased call options to buy U.S. corporate equity holdings and derivative assets acquired as part of note receivable investments. The fair value of the warrants is estimated using recently quoted market prices of the underlying equity security and the Black-Scholes option pricing model.


14



Royalty Rights - At Fair Value

Depomed Royalty Agreement

On October 18, 2013, the Company entered into the Royalty Purchase and Sale Agreement (the “Depomed Royalty Agreement”) with Depomed, Inc. and Depo DR Sub, LLC (together, “Depomed”), whereby the Company acquired the rights to receive royalties and milestones payable on sales of Type 2 diabetes products licensed by Depomed in exchange for a $240.5 million cash payment. Total consideration was $241.3 million, which was comprised of the $240.5 million cash payment to Depomed and $0.8 million in transaction costs.

The rights acquired include Depomed’s royalty and milestone payments accruing from and after October 1, 2013: (a) from Santarus, Inc. (“Santarus”) (which was subsequently acquired by Salix Pharmaceuticals, Inc. (“Salix”), which itself was acquired by Valeant Pharmaceuticals International, Inc. (“Valeant”) (which, in July 2018, changed its name to Bausch Health Companies Inc.) (“Bausch Health”)) with respect to sales of Glumetza (metformin HCL extended-release tablets) in the United States; (b) from Merck & Co., Inc. with respect to sales of Janumet® XR (sitagliptin and metformin HCL extended-release tablets); (c) from Janssen Pharmaceutica N.V. with respect to potential future development milestones and sales of its approved fixed-dose combination of Invokana® (canagliflozin) and extended-release metformin tablets, marketed as Invokamet XR®; (d) from Boehringer Ingelheim and Eli Lilly and Company with respect to potential future development milestones and sales of the investigational fixed-dose combinations of drugs and extended-release metformin subject to Depomed’s license agreement with Boehringer Ingelheim, including its approved products, Jentadueto XR® and Synjardy XR®; and (e) from LG Life Sciences and Bausch Health for sales of extended-release metformin tablets in Korea and Canada, respectively.

On August 2, 2018, PDL Investment Holding, LLC (“PDLIH”), a wholly-owned subsidiary of the Company and assignee from the Company under the Depomed Royalty Agreement, entered into an amendment to the Depomed Royalty Agreement with Depomed. Pursuant to the amendment, PDLIH purchased all of Depomed’s remaining interests in royalty and milestone payments payable on sales of Type 2 diabetes products licensed by Depomed for $20.0 million. Prior to the amendment, the Depomed Royalty Agreement provided that the Company would have received all royalty and milestone payments due under license agreements between Depomed and its licensees until the Company received payments equal to two times the cash payment it made to Depomed, or approximately $481.0 million, after which all net payments received by Depomed would have been shared equally between the Company and Depomed. Following the amendment, the Depomed Royalty Agreement provides that the Company will receive all royalty and milestone payments due under the license agreements between Depomed and its licensees. The Company has elected to continue to elect the fair value option and carry the financial asset at fair value.

The Depomed Royalty Agreement terminates on the third anniversary following the date upon which the later of the following occurs: (a) October 25, 2021, or (b) at such time as no royalty payments remain payable under any license agreement and each of the license agreements has expired by its terms.

As of December 31, 2017, the Company determined that its royalty purchase interest in Depo DR Sub, LLC represented a variable interest in a variable interest entity. However, the Company did not have the power to direct the activities of Depo DR Sub, LLC that most significantly impact Depo DR Sub, LLC’s economic performance and was not the primary beneficiary of Depo DR Sub, LLC; therefore, Depo DR Sub, LLC was not subject to consolidation by the Company.

As of September 30, 2018, in conjunction with the amendment described above, the Company was provided the power to direct the activities of Depo DR Sub, LLC and is the primary beneficiary of Depo DR Sub, LLC; therefore, Depo DR Sub, LLC is subject to consolidation by the Company. As of September 30, 2018, Depo DR Sub, LLC did not have any assets or liabilities of value for consolidation with the Company.

The financial asset acquired represents a single unit of accounting. The fair value of the financial asset acquired was determined by using a discounted cash flow analysis related to the expected future cash flows to be generated by each licensed product. This financial asset is classified as a Level 3 asset within the fair value hierarchy, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future commercialization for products not yet approved by regulatory agencies outside of the United States. The discounted cash flows are based upon expected royalties from sales of licensed products over approximately an nine-year period. The discount rates utilized range from 10% to 24%. Significant judgment is required in selecting appropriate discount rates. At September 30, 2018, an evaluation was performed to assess those rates and general market conditions potentially affecting the fair market value, of the financial asset. Should these discount rates increase or decrease by 2.5%, the fair value of the asset could decrease by $23.3 million or increase by $27.7 million, respectively. A third-party expert was engaged to assist management develop its original estimate of the expected future cash flows, which was updated after the acquisition of Depomed’s reversionary interest in August 2018. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from those estimates. The

15



Company periodically assesses the expected future cash flows and to the extent such payments are greater or less than its initial estimates, or the timing of such payments is materially different than the original estimates, the Company will adjust the estimated fair value of the asset. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $6.6 million, respectively.

When the Company acquired the Depomed royalty rights, Glumetza was marketed by Santarus. In January 2014, Salix acquired Santarus and assumed responsibility for commercializing Glumetza, which was generally perceived to be a positive development because of Salix’s larger sales force and track record in the successful commercialization of therapies. In late 2014, Salix made a number of disclosures relating to an excess of supply at the distribution level of Glumetza and other drugs that it commercialized and the practices leading to this excess of supply which were under review by Salix’s audit committee in relation to the related accounting practices. Because of these disclosures and the Company’s lack of direct access to information as to the levels of inventory of Glumetza in the distribution channels, the Company commenced a review of all public statements by Salix, publicly available historical third-party prescription data, analyst reports and other relevant data sources. The Company also engaged a third-party expert to specifically assess estimated inventory levels of Glumetza in the distribution channel and to ascertain the potential effects those inventory levels may have on expected future cash flows. Salix was acquired by Valeant in early April 2015. In mid-2015, Valeant implemented two price increases on Glumetza. At year-end 2015, a third-party expert was engaged by the Company to assess the impact of the Glumetza price adjustments and near-term market entrance of generic equivalents to the expected future cash flows. Based on the analysis performed, management revised the underlying assumptions used in the discounted cash flow analysis at year-end 2015. In February 2013 a generic equivalent to Glumetza was approved by the U.S. Food and Drug Administration (“FDA”) and in August 2016, two other generic equivalents to Glumetza were approved to enter the U.S. market. In February 2016, Lupin Pharmaceuticals, Inc., in August 2017, Teva Pharmaceutical Industries, Ltd., and in July 2018, Sun Pharmaceutical, Inc. (“Sun”) each launched a generic equivalent approved product.

In May 2017, the Company received notification that a subsidiary of Valeant had launched an authorized generic equivalent product in February 2017, and the Company received royalties on such authorized generic equivalent product under the same terms as the branded Glumetza product, retroactive to February 2017.

In February 2016, at the Company’s request and pursuant to the Depomed Royalty Agreement, Depomed exercised its audit right with respect to Glumetza royalties. The independent auditor engaged to perform the royalty audit completed it in July 2017, and based upon the results of the audit, Depomed, on behalf of the Company, filed a lawsuit on September 7, 2017, against Valeant and one of its subsidiaries, claiming damages for unpaid royalties, fees and interest. Valeant (now Bausch Health), Depomed and the Company entered into a settlement agreement on October 27, 2017 whereby the parties agreed to dismiss the litigation, with prejudice, and Valeant agreed to pay to Depomed $13.0 million. The full amount of the settlement payment was transferred to the Company under the terms of the Depomed Royalty Agreement in November 2017. In October 2018, PDL submitted notice of its intent to exercise its audit right under the Depomed Royalty Agreement with respect to the period beginning January 1, 2016 and ending December 31, 2018.

At December 31, 2017, management re-evaluated, with assistance of a third-party expert, the market share data, the gross-to-net revenue adjustment assumptions and Glumetza demand data, including the delay in launch of the additional generic equivalent products and the entry of an authorized generic product by Valeant. These data and assumptions are based on available but limited information. At September 30, 2018, management updated the expected future cash flows based on the current period demand and supply data of Glumetza and the authorized generic equivalent product launched by Bausch Health.

As of September 30, 2018, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date, including future cash flows for the authorized generic equivalent product. The Company continues to monitor whether the generic competition further affects sales of Glumetza and thus royalties on such sales paid to the Company, and the impact of the launched authorized generic equivalent. Due to the uncertainty around Bausch Health’s marketing and pricing strategy, as well as Sun’s recently launched generic product and limited historical demand data after generic market entrance, the Company may need to further evaluate future cash flows in the event of more rapid reduction or increase in market share of Glumetza and its authorized generic equivalent product and/or a further erosion in net pricing.

On May 31, 2016, the Company obtained a notification indicating that the FDA approved Jentadueto XR for use in patients with Type 2 diabetes. In June 2016, the Company received a $6.0 million approval milestone pursuant to the terms of the Depomed Royalty Agreement. The product approval was earlier than initially expected. Based on the FDA approval and anticipated timing of the product launch, the Company adjusted the timing of future cash flows and discount rate used in the discounted cash flow model at June 30, 2016. As of December 31, 2017, management re-evaluated, the cash flow assumptions for Jentadueto XR and revised the discounted cash flow model. As of September 30, 2018, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date.

16




On September 21, 2016, the Company obtained a notification indicating that the FDA approved Invokamet XR for use in patients with Type 2 diabetes. The product approval triggered a $5.0 million approval milestone payment to the Company pursuant to the terms of the Depomed Royalty Agreement. Based on the FDA approval and timing of the product launch, the Company adjusted the timing of future cash flows and discount rate used in the discounted cash flow model.

On December 13, 2016, the Company obtained a notification indicating that the FDA approved Synjardy XR for use in patients with Type 2 diabetes. The product approval triggered a $6.0 million approval milestone payment to the Company pursuant to the terms of the Depomed Royalty Agreement. Based on the FDA approval and the April 2017 launch of Synjardy XR by Boehringer Ingelheim, the Company adjusted the timing of future cash flows and discount rate used in the discounted cash flow model.

In August 2018, Depomed, Inc. was renamed Assertio Therapeutics, Inc. (“Assertio”).

As of September 30, 2018, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $265.7 million and the maximum loss exposure was $265.7 million.

Viscogliosi Brothers Royalty Agreement

On June 26, 2014, the Company entered into a Royalty Purchase and Sale Agreement (the “VB Royalty Agreement”) with Viscogliosi Brothers, LLC (“VB”), whereby VB conveyed to the Company the right to receive royalties payable on sales of a spinal implant that has received pre-market approval from the FDA held by VB and commercialized by Paradigm Spine, LLC (“Paradigm Spine”), in exchange for a $15.5 million cash payment, less fees.

The royalty rights acquired include royalties accruing from and after April 1, 2014. Under the terms of the VB Royalty Agreement, the Company receives all royalty payments due to VB pursuant to certain technology transfer agreements between VB and Paradigm Spine until the Company has received payments equal to 2.3 times the cash payment made to VB, after which all rights to receive royalties will be returned to VB. VB’s ability to repurchase the royalty right for a specified amount expired on June 26, 2018.

The fair value of the royalty rights at September 30, 2018, was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of licensed product over approximately a ten-year period. The discount rate utilized was 15.0%. Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $1.4 million or increase by $1.6 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $0.3 million, respectively. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows when deemed necessary. The fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. At each reporting period, an evaluation is performed to assess those estimates, discount rate utilized and general market conditions affecting fair market value.

As of September 30, 2018, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $13.9 million and the maximum loss exposure was $13.9 million.

University of Michigan Royalty Agreement

On November 6, 2014, the Company acquired a portion of all royalty payments of the Regents of the University of Michigan’s (“U-M”) worldwide royalty interest in Cerdelga (eliglustat) for $65.6 million pursuant to the Royalty Purchase and Sale Agreement with U-M (the “U-M Royalty Agreement”). Under the terms of the U-M Royalty Agreement, the Company receives 75% of all royalty payments due under U-M’s license agreement with Genzyme Corporation, a Sanofi company (“Genzyme”) until expiration of the licensed patents, excluding any patent term extension. Cerdelga, an oral therapy for adult patients with Gaucher disease type 1, was developed by Genzyme. Cerdelga was approved in the United States in August 2014, in the European Union in January 2015, and in Japan in March 2015. In addition, marketing applications for Cerdelga are under review by other regulatory authorities. While marketing applications have been approved in the United States, the European Union and Japan, national pricing and reimbursement decisions are delayed in some countries. At December 31, 2017, a third-party expert was engaged by the Company to assess the impact of the delayed pricing and reimbursement decisions to Cerdelga’s expected future cash flows. Based on the analysis performed, management revised the underlying assumptions used

17



in the discounted cash flow analysis. As of September 30, 2018, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows.

The fair value of the royalty right at September 30, 2018 was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of licensed product over approximately a four-year period. The discount rate utilized was approximately 12.8%. Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $1.3 million or increase by $1.4 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $0.7 million, respectively. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. The fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. An evaluation of those estimates, discount rate utilized and general market conditions affecting fair market value is performed in each reporting period.

As of September 30, 2018, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $27.5 million and the maximum loss exposure was $27.5 million.

AcelRx Royalty Agreement

On September 18, 2015, the Company entered into a royalty interest assignment agreement (the “AcelRx Royalty Agreement”) with ARPI LLC, a wholly owned subsidiary of AcelRx Pharmaceuticals, Inc. (“AcelRx”), whereby the Company acquired the rights to receive a portion of the royalties and certain milestone payments on sales of Zalviso® (sufentanil sublingual tablet system) in the European Union, Switzerland and Australia by AcelRx’s commercial partner, Grünenthal, in exchange for a $65.0 million cash payment. Under the terms of the AcelRx Royalty Agreement, the Company receives 75% of all royalty payments and 80% of the first four commercial milestone payments due under AcelRx’s license agreement with Grünenthal until the earlier to occur of (i) receipt by the Company of payments equal to three times the cash payments made to AcelRx and (ii) the expiration of the licensed patents (expected to be in January of 2032). Zalviso received marketing approval by the European Commission in September 2015. Grünenthal launched Zalviso in the second quarter of 2016 and the Company started to receive royalties in the third quarter of 2016.

As of September 30, 2018, and December 31, 2017, the Company determined that its royalty rights under the AcelRx Royalty Agreement represented a variable interest in a variable interest entity. However, the Company does not have the power to direct the activities of ARPI LLC that most significantly impact ARPI LLC’s economic performance and is not the primary beneficiary of ARPI LLC; therefore, ARPI LLC is not subject to consolidation by the Company.

The fair value of the royalty right at September 30, 2018 was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of licensed product over approximately a fourteen-year period. The discount rate utilized was approximately 13.4%. Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $9.9 million or increase by $12.3 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $1.7 million, respectively. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. The fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. Based on the number of treated patients to date, management adjusted the timing of the expected future cash flows used in the discounted cash flow model at December 31, 2017. At September 30, 2018, management performed an evaluation of those estimates, discount rate utilized and general market conditions to determine the fair market value of the asset, and such an evaluation is performed for each reporting period. As of September 30, 2018, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date.

As of September 30, 2018, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $68.3 million and the maximum loss exposure was $68.3 million.

Kybella Royalty Agreement

On July 8, 2016, the Company entered into a royalty purchase and sales agreement with an individual, whereby the Company acquired that individual’s rights to receive certain royalties on sales of KYBELLA® by Allergan plc in exchange for a $9.5

18



million cash payment and up to $1.0 million in future milestone payments based upon product sales targets. The Company started to receive royalty payments during the third quarter of 2016.

The fair value of the royalty right at September 30, 2018, was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of a licensed product over approximately a seven-year period. The discount rate utilized was approximately 14.4%. Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $0.2 million or increase by $0.3 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $0.1 million, respectively. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. The fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. An evaluation of those estimates, discount rate utilized and general market conditions affecting fair market value is performed in each reporting period.

As of September 30, 2018, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $2.9 million and the maximum loss exposure was $2.9 million.

The following tables summarize the changes in Level 3 assets and the gains and losses included in earnings for the nine months ended September 30, 2018:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Royalty Rights Assets
 
 
 
 
 
 
 
(in thousands)
 
Royalty Rights -
At Fair Value
Fair value as of December 31, 2017
 
 
 
$
349,223

 
 
 
 
 
 
 
 
Financial instruments purchased
 
 
 
20,000

 
Total net change in fair value for the period
 
 
 
 
 
 
Change in fair value of royalty rights - at fair value
 
$
66,117

 
 
 
 
Proceeds from royalty rights - at fair value
 
$
(57,049
)
 
 
 
 
Total net change in fair value for the period
 
 
 
9,068

 
 
 
 
 
 
 
Fair value as of September 30, 2018
 


 
$
378,291


Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Royalty Rights Assets
 
 
 
 
 
 
 
 
 
 
 
Fair Value as of
 
Purchase of
 
Royalty Rights -
 
Fair Value as of
(in thousands)
 
December 31, 2017
 
Royalty Assets
 
Change in Fair Value
 
September 30, 2018
 
 
 
 
 
 
 
 
 
Assertio (formerly Depomed)
 
$
232,038

 
$
20,000

 
$
13,665

 
$
265,703

VB
 
14,380

 

 
(494
)
 
13,886

U-M
 
26,769

 

 
755

 
27,524

AcelRx
 
72,894

 

 
(4,619
)
 
68,275

Avinger
 
396

 

 
(396
)
 

KYBELLA
 
2,746

 

 
157

 
2,903

 
 
$
349,223

 
$
20,000

 
$
9,068

 
$
378,291


19



Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Liabilities
 
 
 
(in thousands)
 
Contingent Consideration
Fair value as of December 31, 2017
 
$
(42,000
)
 
 
 
 
 
 
Financial instruments purchased
 
(1,560
)
 
Settlement of financial instrument
 
857

 
Total net change in fair value for the period
 
22,433

 
 
 
 
 
Fair value as of September 30, 2018
 
$
(20,270
)

The fair value of the contingent consideration was determined using an income approach derived from revenue estimates and a probability assessment with respect to the likelihood of (a) achieving predetermined levels of net sales or (b) a generic product launch that would trigger the milestone payments to Novartis Pharma AG (“Novartis”) for the Noden Products (as defined in Note 8, Inventories). The key assumptions in determining the fair value are the discount rate and the probability assigned to the potential milestones being achieved. The fair value of the contingent consideration is remeasured each reporting period, with changes in fair value recorded in the Condensed Consolidated Statements of Operations. The change in fair value of the contingent consideration during the nine months ended September 30, 2018 is due primarily to the changes in the probabilities in the generic entry milestones for the Noden Products and the additional contingent consideration acquired as part of the assets acquired by LENSAR from Precision Eye Services, as described in Note 9, Asset Acquisition.

Gains and losses from changes in Level 3 assets included in earnings for each period are presented in “Royalty rights - change in fair value” and gains and losses from changes in Level 3 liabilities included in earnings for each period are presented in “Change in fair value of anniversary payment and contingent consideration” as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands)
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for royalty right assets held at the end of the reporting period
 
$
42,184

 
$
35,353

 
$
66,117

 
$
132,224

 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for liabilities held at the end of the reporting period
 
$
(302
)
 
$
(700
)
 
$
22,433

 
$
(3,349
)

Assets/Liabilities Measured and Recorded at Fair Value on a Nonrecurring Basis

The Company remeasures the fair value of certain assets and liabilities upon the occurrence of certain events. Such assets consist of the 1.7 million shares of Alphaeon Class A common stock, received in connection with the LENSAR credit agreement, and long-lived assets, including property and equipment and intangible assets. The Company’s carrying value of the investment in Alphaeon as of both September 30, 2018 and December 31, 2017 is $6.6 million based on an estimated per share value of $3.84, which was established by a valuation performed when the shares were acquired. The value of our investment in Alphaeon is not readily determinable as Alphaeon’s shares are not publicly traded. The Company evaluates the fair value of this investment by performing a qualitative assessment each reporting period. If the results of this qualitative assessment indicate that the fair value is less than the carrying value, the investment is written down to its fair value. There have been no such write downs since the Company acquired these shares. This investment is included in other long-term assets. For additional information on the Alphaeon investment, see Note 7, Notes and Other Long-Term Receivables.

During the three months ended June 30, 2018, the Company recorded an impairment charge of $152.3 million for the Noden intangible assets related to the increased probability of a generic version of aliskiren being launched in the United States. As a result of this impairment charge, which was based on the estimated fair value of the assets, the remaining carrying value of these intangible assets were determined to be $40.1 million. The fair value calculation included level 3 inputs. For additional information on the impairment charge, see Note 10, Intangible Assets.


20



Assets/Liabilities Not Subject to Fair Value Recognition

The following tables present the fair value of assets and liabilities not subject to fair value recognition by level within the valuation hierarchy:
 
 
September 30, 2018
 
December 31, 2017
(in thousands)
 
Carrying Value
 
Fair Value
Level 2
 
Fair Value
Level 3
 
Carrying Value
 
Fair Value
Level 2
 
Fair Value
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics note receivable
 
$
50,191

 
$

 
$
59,881

 
$
50,191

 
$

 
$
51,308

Hyperion note receivable
 
1,200

 

 
1,200

 
1,200

 

 
1,200

CareView note receivable
 
19,575

 

 
19,723

 
19,346

 

 
18,750

Total
 
$
70,966

 
$

 
$
80,804

 
$
70,737

 
$

 
$
71,258

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

February 2018 Notes
 
$

 
$

 
$

 
$
126,066

 
$
126,131

 
$

December 2021 Notes
 
122,780

 
147,035

 

 
117,415

 
148,028

 

Total
 
$
122,780

 
$
147,035

 
$

 
$
243,481

 
$
274,159

 
$


As of September 30, 2018 and December 31, 2017, the estimated fair values of the Hyperion Catalysis International, Inc. (“Hyperion”) note receivable, and CareView Communications, Inc. (“CareView”) note receivable were determined using one or more discounted cash flow models, incorporating expected principal and interest payments.

The Company engages a third-party valuation expert when deemed necessary to assist in evaluating its investments and the related inputs needed to estimate the fair value of certain investments. The Company determined its notes receivable assets are Level 3 assets as the Company’s valuations utilized significant unobservable inputs, including estimates of future revenues, discount rates, expectations about settlement, terminal values and required yield. To provide support for the estimated fair value measurements, the Company considered forward-looking performance related to the investment and current measures associated with high yield indices and reviewed the terms and yields of notes placed by specialty finance and venture firms both across industries and in similar sectors.

The CareView note receivable is secured by substantially all assets of, and equity interests in CareView. The Wellstat Diagnostics note receivable is secured by substantially all assets of Wellstat Diagnostics and is supported by a guaranty from the Wellstat Diagnostics Guarantors (as defined in Note 7, Notes and Other Long-Term Receivables). The estimated fair value of the collateral assets was determined by using an asset approach and discounted cash flow model related to the underlying collateral and was adjusted to consider estimated costs to sell the assets.

On September 30, 2018, the carrying values of several of the Company’s notes receivable differed from their estimated fair value. This is the result of discount rates used when performing a discounted cash flow for fair value valuation purposes.

The fair values of the Company’s convertible senior notes were determined using quoted market pricing.


21



The following table represents significant unobservable inputs used in determining the estimated fair value of impaired notes receivable investments:
Asset
 
Valuation
Technique
 
Unobservable
Input
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics
 
 
 
 
 
 
 
 
Wellstat Guarantors intellectual property
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
12%
 
12%
 
 
 
 
Royalty amount
 
$21 million
 
$21 million
Settlement Amount
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
15%
 
15%
 
 
 
 
Settlement amount
 
$38 million
 
$32 million
 
 
 
 
 
 
 
 
 
Real Estate Property
 
Market Approach
 
 
 
 
 
 
 
 
 
 
Annual appreciation rate
 
4%
 
4%
 
 
 
 
Estimated realtor fee
 
6%
 
6%
 
 
 
 
Estimated disposal date
 
6/30/2019
 
6/30/2019
 
 
 
 
 
 
 
 
 
CareView
 
 
 
 
 
 
 
 
Note receivable cash flows
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
17.5%
 
17.5%

At September 30, 2018, the Company had three notes receivable investments on non-accrual status with a cumulative investment cost and fair value of approximately $71.0 million and $80.8 million, respectively, compared to three note receivable investments on non-accrual status at December 31, 2017 with a cumulative investment cost and fair value of approximately $70.7 million and $71.3 million, respectively. For the three and nine months ended September 30, 2018, the Company recognized $0.8 million and $2.3 million, respectively, of interest revenue for the CareView note receivable investment as a result of cash interest payments made during the period; for the three and nine months ended September 30, 2017, the Company did not recognize any interest for note receivable investments on non-accrual status. During each of the three months ended September 30, 2018 and 2017, and for the nine months ended September 30, 2018, the Company did not recognize any losses on extinguishment of notes receivable. During the nine months ended September 30, 2017, the Company recognized losses on extinguishment of notes receivable of $12.2 million.

5. Cash, Cash Equivalents and Short-term Investments
 
As of September 30, 2018 the Company had invested its excess cash balances primarily in cash and money market funds, and as of December 31, 2017, the Company had invested its excess cash balances primarily in cash, money market funds and a corporate equity security. The Company’s securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in “Accumulated other comprehensive income” in stockholders’ equity, net of estimated taxes. See Note 4, Fair Value Measurements. The cost of securities sold is based on the specific identification method. To date, the Company has not experienced credit losses on investments in these instruments, and it does not require collateral for its investment activities.


22



The following tables summarize the Company’s cash and available-for-sale securities’ amortized cost, gross unrealized gains and fair value by significant investment category reported as cash and cash equivalents, or short-term investments as of September 30, 2018 and December 31, 2017:
 
 
 
 
 
 
 
 
Reported as:
(in thousands)
 
 Amortized Cost
 
 Unrealized Gains
 
 Estimated Fair Value
 
 Cash and Cash Equivalents
 
Short-Term Investments
 
 
 
 
 
 
 
 
 
 
 
September 30, 2018
 
 
 
 
 
 
 
 
 
 
Cash
 
$
175,471

 
$

 
$
175,471

 
$
175,471

 
$

Money market funds
 
225,513

 

 
225,513

 
225,513

 

Total
 
$
400,984

 
$

 
$
400,984

 
$
400,984

 
$

 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
Cash
 
$
109,703

 
$

 
$
109,703

 
$
109,703

 
$

Money market funds
 
417,563

 

 
417,563

 
417,563

 

Corporate securities
 
3,353

 
1,495

 
4,848

 

 
4,848

Total
 
$
530,619

 
$
1,495

 
$
532,114

 
$
527,266

 
$
4,848


The Company recognized $0.8 million of gains on sales of available-for-sale securities in the nine months ended September 30, 2018. The Company did not recognize any gains or losses on sales of available-for-sale securities in the three months ended September 30, 2018 and in the three and nine months ended September 30, 2017.

The unrealized gains on investments included in “Other comprehensive income (loss), net of tax” was zero and $1.2 million as of September 30, 2018, and December 31, 2017, respectively.

6. Concentration of Credit Risk

Product Line Concentration

The percentage of total revenue recognized, which individually accounted for 10% or more of the Company’s total revenues in one or more of the periods presented below, was as follows:
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Licensee
 
Product Name
 
2018
 
2017
 
2018
 
2017
Biogen
 
Tysabri®
 
1%
 
2%
 
3%
 
13%
 
 
 
 
 
 
 
 
 
 
 
Assertio (formerly Depomed)
 
Glumetza, Janumet XR, Jentadueto XR, Synjardy XR and Invokamet XR
 
72%
 
50%
 
43%
 
50%
 
 
 
 
 
 
 
 
 
 
 
N/A
 
Tekturna, Tekturna HCT, Rasilez and Rasilez HCT
 
26%
 
24%
 
41%
 
17%
 
 
 
 
 
 
 
 
 
 
 
LENSAR
 
LENSAR Laser System
 
10%
 
8%
 
11%
 
3%

7. Notes and Other Long-Term Receivables

Notes and other long-term receivables included the following significant agreements:

Wellstat Diagnostics Note Receivable and Credit Agreement and Related Litigation

On November 2, 2012, the Company and Wellstat Diagnostics entered into a $40.0 million credit agreement pursuant to which the Company was to accrue quarterly interest payments at the rate of 5% per annum (payable in cash or in kind). In addition, the Company was to receive quarterly royalty payments based on a low double-digit royalty rate of Wellstat Diagnostics’ net revenues, generated by the sale, distribution or other use of Wellstat Diagnostics’ products, if any, commencing upon the

23



commercialization of its products. A portion of the proceeds of the $40.0 million credit agreement were used to repay certain notes receivable which Wellstat Diagnostics entered into in March 2012.

In January 2013, the Company was informed that, as of December 31, 2012, Wellstat Diagnostics had used funds contrary to the terms of the credit agreement and breached Sections 2.1.2 and 7 of the credit agreement. The Company sent Wellstat Diagnostics a notice of default on January 22, 2013, and accelerated the amounts owed under the credit agreement. In connection with the notice of default, the Company exercised one of its available remedies and transferred approximately $8.1 million of available cash from a bank account of Wellstat Diagnostics to the Company and applied the funds to amounts due under the credit agreement. On February 28, 2013, the parties entered into a forbearance agreement whereby the Company agreed to refrain from exercising additional remedies for 120 days. During such forbearance period, the Company provided approximately $1.3 million to Wellstat Diagnostics to fund ongoing operations of the business. During the year ended December 31, 2013, approximately $8.7 million was advanced pursuant to the forbearance agreement.

On August 15, 2013, the Company entered into an amended and restated credit agreement with Wellstat Diagnostics. The Company determined that the new agreement should be accounted for as a modification of the existing agreement.

Except as otherwise described herein, the material terms of the amended and restated credit agreement are substantially the same as those of the original credit agreement, including quarterly interest payments at the rate of 5% per annum (payable in cash or in kind). In addition, the Company was to continue to receive quarterly royalty payments based on a low double-digit royalty rate of Wellstat Diagnostics’ net revenues. However, pursuant to the amended and restated credit agreement: (i) the principal amount was reset to approximately $44.1 million, which was comprised of approximately $33.7 million original loan principal and interest, $1.3 million term loan principal and interest and $9.1 million forbearance principal and interest; (ii) the specified internal rates of return increased; (iii) the default interest rate was increased; (iv) Wellstat Diagnostics’ obligation to provide certain financial information increased in frequency to monthly; (v) internal financial controls were strengthened by requiring Wellstat Diagnostics to maintain an independent, third-party financial professional with control over fund disbursements; (vi) the Company waived the existing events of default; and (vii) the owners and affiliates of Wellstat Diagnostics were required to contribute additional capital to Wellstat Diagnostics upon the sale of an affiliate entity. The amended and restated credit agreement had an ultimate maturity date of December 31, 2021 (but has subsequently been accelerated as described below).

In June 2014, the Company received information from Wellstat Diagnostics showing that it was generally unable to pay its debts as they became due, constituting an event of default under the amended and restated credit agreement.

On August 5, 2014, the Company delivered a notice of default (the “Wellstat Diagnostics Borrower Notice”) to Wellstat Diagnostics, which accelerated all obligations under the amended and restated credit agreement and demanded immediate payment in full in an amount equal to approximately $53.9 million, (which amount, in accordance with the terms of the amended and restated credit agreement, included an amount that, together with interest and royalty payments already made to the Company, would generate a specified internal rate of return to the Company), plus accruing fees, costs and interest, and demanded that Wellstat Diagnostics protect and preserve all collateral securing its obligations.

On August 7, 2014, the Company delivered a notice (the “Wellstat Diagnostics Guarantor Notice”) to each of the guarantors of Wellstat Diagnostics’ obligations to the Company (collectively, the “Wellstat Diagnostics Guarantors”) under the credit agreement, which included a demand that the guarantors remit payment to the Company in the amount of the outstanding obligations. The guarantors include certain affiliates and related companies of Wellstat Diagnostics, including Wellstat Therapeutics and Wellstat Diagnostics’ stockholders.

On September 24, 2014, the Company filed an ex-parte petition for appointment of receiver with the Circuit Court of Montgomery County, Maryland (the “Wellstat Diagnostics Petition”), which was granted on the same day. Wellstat Diagnostics remained in operation during the period of the receivership with incremental additional funding from the Company. On May 24, 2017, Wellstat Diagnostics transferred substantially all of its assets to the Company pursuant to a credit bid. The credit bid reduced the outstanding balance of the loan by an immaterial amount.

On September 4, 2015, the Company filed in the Supreme Court of New York a motion for summary judgment in lieu of complaint which requested that the court enter judgment against certain of the Wellstat Diagnostics Guarantors for the total amount due on the Wellstat Diagnostics debt, plus all costs and expenses including lawyers’ fees incurred by the Company in enforcement of the related guarantees. On September 23, 2015, the Company filed in the same court an ex parte application for a temporary restraining order and order of attachment of the Wellstat Diagnostics Guarantor defendants’ assets. Although the court denied the Company’s request for a temporary restraining order at a hearing on September 24, 2015, it ordered that assets

24



of the Wellstat Diagnostics Guarantor defendants should be held in status quo ante and only used in the normal course of business.

On July 29, 2016, the Supreme Court of New York granted the Company’s motion for summary judgment and held that the Wellstat Diagnostics Guarantor defendants are liable for all “Obligations” owed by Wellstat Diagnostics to the Company. After appeal by the Wellstat Diagnostics Guarantor defendants, on February 14, 2017, the Appellate Division of the Supreme Court of New York reversed on procedural grounds a portion of the Memorandum of Decision granting the Company summary judgment in lieu of complaint, but affirmed the portion of the Memorandum of Decision denying the Wellstat Diagnostics Guarantor defendants’ motion for summary judgment in which they sought a determination that the guarantees had been released. As a result, the litigation has been remanded to the Supreme Court of New York to proceed on the Company’s claims as a plenary action. On June 21, 2017, the Supreme Court of New York ordered the Company to file a Complaint, which was filed by the Company on July 20, 2017. The Wellstat Diagnostics Guarantors filed their answer on August 9, 2017, including counterclaims against the Company alleging breach of contract, breach of fiduciary duty, and tortious interference with prospective economic advantage. This case is currently pending and in the pre-trial phase.

On October 14, 2016, the Company sent a notice of default and reference to foreclosure proceedings to certain of the Wellstat Diagnostics Guarantors which are not defendants in the New York action, but which are owners of real estate assets over which a deed of trust in favor of the Company securing the guarantee of the loan to Wellstat Diagnostics had been executed. On March 2, 2017, the Company sent a second notice to foreclose on the real estate assets, and noticed the sale for March 29, 2017. The sale was taken off the calendar by the trustee under the deed of trust and has not been re-scheduled yet. On March 6, 2017, the Company sent a letter to the Wellstat Diagnostics Guarantors seeking information in preparation for a UCC Article 9 sale of some or all of the intellectual property-related collateral of the Wellstat Diagnostics Guarantors. The Wellstat Diagnostics Guarantors did not respond to the Company’s letter, but on March 17, 2017, filed an order to show cause with the Supreme Court of New York to enjoin the Company’s sale of the real estate or enforcing its security interests in the Wellstat Diagnostics Guarantors’ intellectual property during the pendency of any action involving the guarantees at issue. On February 6, 2018, the Supreme Court of New York issued an order from the bench which enjoins the Wellstat Diagnostics Guarantors from selling, encumbering, removing, transferring or altering the collateral pending the outcome of the proceedings before it. The Supreme Court of New York also issued an order precluding the Company from foreclosing on certain of the Wellstat Diagnostics Guarantors’ collateral pending the outcome of the proceedings before it. In September of 2018, discovery in the New York action was completed. The Company expects that summary judgment motions will be filed by the parties in due time.

In an unrelated litigation, Wellstat Therapeutics filed a lawsuit against BTG International, Inc. for breach of contract (the “BTG Litigation”). In September 2017, the Delaware Chancery Court found in favor of Wellstat Therapeutics and awarded a judgment of $55.8 million in damages, plus interest. In October 2017, the Company filed a motion with the Supreme Court of New York requesting a pre-judgement attachment of the award. In June 2018, the Delaware Supreme Court largely affirmed the September 2017 decision of the Delaware Chancery Court, including the $55.8 million awarded in judgment. In August of 2018, in a letter to the Company’s counsel, Wellstat Guarantors’ counsel confirmed that the Wellstat Guarantors are preserving the BTG Litigation judgment award proceeds consistent with the New York Court’s prior directions.

On October 22, 2015, certain of the Wellstat Diagnostics Guarantors filed a separate complaint against the Company in the Supreme Court of New York seeking a declaratory judgment that certain contractual arrangements entered into between the parties subsequent to Wellstat Diagnostics’ default, and which relate to a split of proceeds in the event that the Wellstat Diagnostics Guarantors voluntarily monetize any assets that are the Company’s collateral, is of no force or effect. This case has been joined for all purposes, including discovery and trial, and consolidated with the pending case filed by the Company.

Effective April 1, 2014, and as a result of the event of default, the Company determined the loan to be impaired and it ceased to accrue interest revenue. At that time and as of September 30, 2018, it has been determined that an allowance on the carrying value of the note was not necessary, as the Company believes the value of the collateral securing Wellstat Diagnostics’ obligations exceeds the carrying value of the asset and is sufficient to enable the Company to recover the current carrying value of $50.2 million. The Company continues to closely monitor the timing and expected recovery of amounts due, including litigation and other matters related to Wellstat Diagnostics Guarantors’ assets. There can be no assurance that an allowance on the carrying value of the notes receivable investment will not be necessary in a future period depending on future developments.

Hyperion Agreement

On January 27, 2012, the Company and Hyperion (which is also a Wellstat Diagnostics Guarantor) entered into an agreement whereby Hyperion sold to the Company the royalty streams due from Showa Denko K.K. (“SDK”) related to a certain patent

25



license agreement between Hyperion and SDK dated December 31, 2008. The agreement assigned the patent license agreement royalty stream accruing from January 1, 2012 through December 31, 2013, to the Company in exchange for the lump sum payment to Hyperion of $2.3 million. In exchange for the lump sum payment, the Company was to receive two equal payments of $1.2 million on each of March 5, 2013 and 2014. The first payment of $1.2 million was paid on March 5, 2013, but Hyperion has not made the second payment that was due on March 5, 2014. Effective as of such date and as a result of the event of default, the Company ceased to accrue interest revenue. As of September 30, 2018, the estimated fair value of the collateral was determined to be in excess of the carrying value. There can be no assurance of realizing value from such collateral in the event of the Company’s foreclosure on the collateral.

Avinger Credit and Royalty Agreement

On April 18, 2013, the Company entered into a credit agreement with Avinger, Inc. (the “Avinger Credit and Royalty Agreement”). Under the terms of the Avinger Credit and Royalty Agreement, the Company received a low, single-digit royalty on Avinger’s net revenues until April 2018. Commencing in October 2015, after Avinger repaid $21.4 million pursuant to its note payable to the Company prior to its maturity date, the royalty on Avinger’s net revenues reduced by 50%, subject to certain minimum payments from the prepayment date until April 18, 2018. The Company has accounted for the royalty rights in accordance with the fair value option. As of April 18, 2018, there are no further obligations owed to the Company.

LENSAR Credit Agreement

On October 1, 2013, the Company entered into a credit agreement with LENSAR, Inc. (“LENSAR”), pursuant to which the Company made available to LENSAR up to $60.0 million to be used by LENSAR in connection with the commercialization of its currently marketed LENSAR® Laser System. Of the $60.0 million available to LENSAR, an initial $40.0 million, net of fees, was funded by the Company at the close of the transaction. The remaining $20.0 million was never funded. Outstanding borrowings under the loans bore interest at the rate of 15.5% per annum, payable quarterly in arrears.

On May 12, 2015, the Company entered into a forbearance agreement with LENSAR, pursuant to which the Company agreed to refrain from exercising certain remedies available to it resulting from the failure of LENSAR to comply with a liquidity covenant and make interest payments due under the credit agreement. Under the forbearance agreement, the Company agreed to provide LENSAR with up to an aggregate of $8.5 million in weekly increments through the period ended September 30, 2015 plus employee retention amounts of approximately $0.5 million in the form of additional loans, subject to LENSAR meeting certain milestones related to LENSAR obtaining additional capital to fund or to sell the business and repay outstanding amounts under the credit agreement. In exchange for the forbearance, LENSAR agreed to additional reporting covenants, the engagement of a chief restructuring officer and an increase on the interest rate to 18.5%, applicable to all outstanding amounts under the credit agreement.

On September 30, 2015, the Company agreed to extend the forbearance agreement until October 9, 2015 and provide for up to an additional $0.8 million in funding while LENSAR negotiated a potential sale of its assets. On October 9, 2015, the forbearance agreement expired, but the Company agreed to fund LENSAR’s operations while LENSAR continued to negotiate a potential sale of its assets.

On November 15, 2015, LENSAR, LLC (“LENSAR/Alphaeon”), a wholly owned subsidiary of Alphaeon Corporation (“Alphaeon”), and LENSAR entered into the Asset Purchase Agreement whereby LENSAR/Alphaeon agreed to acquire certain assets of LENSAR and assumed certain liabilities of LENSAR. The acquisition was consummated on December 15, 2015.

In connection with the closing of the acquisition, LENSAR/Alphaeon entered into an amended and restated credit agreement with the Company, assuming $42.0 million in loans as part of the borrowings under the Company’s prior credit agreement with LENSAR. In addition, Alphaeon issued 1.7 million shares of its Class A common stock to the Company which were valued at $6.6 million at the time the shares were received. For additional information on this investment in Alphaeon, see Note 4, Fair Value Measurements.

In December 2016, LENSAR, re-acquired the assets from LENSAR/Alphaeon and the Company entered into a second amended and restated credit agreement with LENSAR whereby LENSAR assumed all obligations under the amended and restated credit agreement with LENSAR/Alphaeon. Also in December, LENSAR filed for a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code (“Chapter 11 case”) with the support of the Company. In January 2017, the Company agreed to provide debtor-in-possession financing of up to $2.8 million in new advances to LENSAR so that it could continue to operate its business during the Chapter 11 case. LENSAR filed a Chapter 11 plan of reorganization with the Company’s support under which LENSAR would issue 100% of its equity interests to the Company in exchange for the cancellation of the Company’s claims as a secured creditor in the Chapter 11 case, other than with respect to the debtor-in-possession financing, and would

26



thereby become an operating wholly-owned subsidiary of the Company. On April 26, 2017, the bankruptcy court approved the plan of reorganization.

Pursuant to the plan of reorganization, LENSAR emerged from bankruptcy on May 11, 2017 as a wholly-owned subsidiary of the Company, and the Company started to consolidate LENSAR’s financial statements under the voting interest model beginning May 11, 2017.

For additional information on LENSAR please refer to Note 10, Intangible Assets, Note 19, Business Combinations and Note 20, Segment Information.

Direct Flow Medical Credit Agreement

On November 5, 2013, the Company entered into a credit agreement with Direct Flow Medical, Inc. (“Direct Flow Medical”) under which the Company agreed to provide up to $50.0 million to Direct Flow Medical. Of the $50.0 million available to Direct Flow Medical, an initial $35.0 million (tranche one), net of fees, was funded by the Company at the close of the transaction.

On November 10, 2014, the Company and Direct Flow Medical agreed to an amendment to the credit agreement to permit Direct Flow Medical to borrow an additional $15.0 million (tranche two) upon receipt by Direct Flow Medical of a specified minimum amount of proceeds from an equity offering prior to December 31, 2014. In exchange, the parties amended the credit agreement to provide for additional fees associated with certain liquidity events, such as a change of control or the consummation of an initial public offering, and granted the Company certain board of director observation rights. On November 19, 2014, upon Direct Flow Medical satisfying the amended tranche two milestone, the Company funded the $15.0 million second tranche to Direct Flow Medical, net of fees.

Outstanding borrowings under tranche one bore interest at the rate of 15.5% per annum, payable quarterly in arrears, until the occurrence of the second tranche. Upon occurrence of the borrowing of this second tranche, the interest rate applicable to all loans under the credit agreement was decreased to 13.5% per annum, payable quarterly in arrears.

Under the terms of the credit agreement, Direct Flow Medical’s obligation to repay loan principal commenced on the twelfth interest payment date, September 30, 2016. The principal amount outstanding at commencement of repayment was required to be repaid in equal installments until final maturity of the loans. The loans were scheduled to mature on November 5, 2018. The obligations under the credit agreement were secured by a pledge of substantially all of the assets of Direct Flow Medical and any of its subsidiaries.

On December 21, 2015, Direct Flow Medical and the Company entered into a waiver to the credit agreement in anticipation of Direct Flow Medical being unable to comply with the liquidity covenant and make interest payments due under the credit agreement, which was subsequently extended on January 14, 2016, and further delayed the timing of the interest payments through the period ending September 30, 2016 while Direct Flow Medical sought additional financing to operate its business.

On January 28, 2016, the Company funded an additional $5.0 million to Direct Flow Medical in the form of a short-term secured promissory note.

On February 26, 2016, the Company and Direct Flow Medical entered into the fourth amendment to the credit agreement that, among other things, (i) converted the $5.0 million short-term secured promissory note into a loan under the credit agreement with substantially the same interest and payment terms as the existing loans, (ii) added a conversion feature whereby the $5.0 million loan would convert into equity of Direct Flow Medical upon the occurrence of certain events and (iii) provided for a second $5.0 million convertible loan tranche commitment, to be funded at the option of the Company. The commitment for the second tranche was not funded and has since expired. In addition, (i) the Company agreed to waive the liquidity covenant and delay the timing of the unpaid interest payments until September 30, 2016 and (ii) Direct Flow Medical agreed to issue to the Company a specified amount of warrants to purchase shares of convertible preferred stock on the first day of each month for the duration of the waiver period at an exercise price of $0.01 per share.

On July 15, 2016, the Company and Direct Flow Medical entered into the fifth amendment and limited waiver to the credit agreement. The Company funded an additional $1.5 million to Direct Flow Medical in the form of a note with substantially the same interest and payment terms as the existing loans and a conversion feature whereby the $1.5 million loan would convert into equity of Direct Flow Medical upon the occurrence of certain events. In addition, Direct Flow Medical agreed to issue to the Company warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.


27



On September 12, 2016, the Company and Direct Flow Medical entered into the sixth amendment and limited waiver to the credit agreement under which the Company funded an additional $1.5 million to Direct Flow Medical in the form of a note with substantially the same interest and payment terms as the existing loans. In addition, Direct Flow Medical agreed to issue to the Company a specified amount of warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.

On September 30, 2016, the Company and Direct Flow Medical entered into a waiver to the credit agreement where the parties agreed, among other things, to (i) delay payment on all overdue interest payments until October 31, 2016, (ii) waive the initial principal repayment until October 31, 2016 and (iii) continue to waive the liquidity requirements until October 31, 2016. Further, Direct Flow Medical agreed to issue to the Company a specified amount of warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.

On October 31, 2016, the Company agreed to extend the waivers described above until November 30, 2016 and on November 14, 2016, the Company advanced an additional $1.0 million loan while Direct Flow Medical continued to seek additional financing.

On November 16, 2016, Direct Flow Medical advised the Company that its potential financing source had modified its proposal from an equity investment to a loan with a substantially smaller amount and under less favorable terms. Direct Flow Medical shut down its operations in December 2016 and in January 2017 made an assignment for the benefit of creditors. The Company then initiated foreclosure proceedings, resulting in the Company obtaining ownership of most of the Direct Flow Medical assets through the Company’s wholly-owned subsidiary, DFM, LLC. The assets were held for sale and carried at the lower of carrying amount or fair value, less estimated selling costs, which is primarily based on supporting data from market participant sources, and valid offers from third parties.

At December 31, 2016, the Company completed an impairment analysis and concluded that the situation qualified as a troubled debt restructuring and recognized an impairment loss of $51.1 million.

In January 2017, the Company started to actively market the asset held for sale. On January 23, 2017, the Company and DFM, LLC entered into an Intellectual Property Assignment Agreement with Hong Kong Haisco Pharmaceutical Co., Limited (“Haisco”), a Chinese pharmaceutical company, whereby Haisco acquired former Direct Flow Medical clinical, regulatory and commercial information and intellectual property rights exclusively in China for $7.0 million. The Company, through DFM, LLC, also sold Haisco certain manufacturing equipment for $450,000 and collected $692,000 on outstanding Direct Flow Medical accounts receivable during the year ended December 31, 2017.

On January 6, 2018, DFM, LLC and HaisThera Advisors Co., Limited (“HaisThera”) entered into a license agreement whereby DFM, LLC granted HaisThera an exclusive license to develop, manufacture and commercialize percutaneously implanting stentless aortic valves in the European Union. The consideration for the license agreement was $500,000 upfront and up to $2.0 million in royalty payments.

kaléo Note Purchase Agreement

On April 1, 2014, the Company entered into a note purchase agreement with Accel 300, LLC (“Accel 300”), a wholly-owned subsidiary of kaléo, Inc. (“kaléo”), pursuant to which the Company acquired $150.0 million of secured notes due 2029 (the “kaléo Note”). The kaléo Note was issued pursuant to an indenture between Accel 300 and U.S. Bank, National Association, as trustee, and was secured by 20% of net sales of its first approved product, Auvi-Q® (epinephrine auto-injection, USP) (known as Allerject® in Canada) and 10% of net sales of kaléo’s second proprietary auto-injector based product, EVZIO (naloxone hydrochloride injection) (the “kaléo Revenue Interests”), and a pledge of kaléo’s equity ownership in Accel 300.

On September 21, 2017, the Company entered into an agreement (the “kaléo Note Sale Agreement”) with MAM-Kangaroo Lender, LLC, a Delaware limited liability company (the “kaléo Purchaser”), pursuant to which the Company sold its entire interest in the kaléo Note.

Pursuant to the kaléo Note Sale Agreement, the kaléo Purchaser paid to the Company an amount equal to 100% of the then outstanding principal, a premium of 1% of such amount and accrued interest under the kaléo Note, for an aggregate cash purchase price of $141.7 million, subject to an 18-month escrow holdback of $1.4 million against certain potential contingencies. For a further discussion on this topic, see Note 12, Commitments and Contingencies.


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CareView Credit Agreement

On June 26, 2015, the Company entered into a credit agreement with CareView, under which the Company made available to CareView up to $40.0 million in loans comprised of two tranches of $20.0 million each, subject to CareView’s attainment of specified milestones relating to the placement of CareView Systems®. On October 7, 2015, the Company and CareView entered into an amendment of the credit agreement to modify certain definitions related to the first and second tranche milestones and the Company funded the first tranche of $20.0 million, net of fees, based on CareView’s attainment of the first milestone, as amended. The second $20.0 million tranche would be funded upon CareView’s attainment of specified milestones relating to the placement of CareView Systems and consolidated earnings before interest, taxes, depreciation and amortization, to be accomplished no later than June 30, 2017. Such milestones were not achieved by this date. The second $20.0 million tranche was not funded and there is no additional funding obligation due from the Company. Outstanding borrowings under the credit agreement bear interest at the rate of 13.5% per annum and are payable quarterly in arrears.

As part of the original credit agreement, the Company received a warrant to purchase approximately 4.4 million shares of common stock of CareView at an exercise price of $0.45 per share. The Company has accounted for the warrant as derivative asset with an offsetting credit as debt discount. At each reporting period the warrant is marked to market for changes in fair value.

In connection with the October 2015 amendment of the credit agreement, the Company and CareView also agreed to amend the warrant to purchase common stock agreement by reducing the warrant’s exercise price from $0.45 to $0.40 per share.

In February 2018, the Company entered into a modification agreement with CareView (the “February 2018 Modification Agreement”) whereby the Company agreed, effective December 28, 2017, to modify the credit agreement before remedies could otherwise have become available to the Company under the credit agreement in relation to certain obligations of CareView that would potentially not be met, including the requirement to make principal payments. Under the February 2018 Modification Agreement, the Company agreed that (i) a lower liquidity covenant would be applicable and (ii) principal repayment would be delayed until December 31, 2018. In exchange for agreeing to these modifications, among other things, the exercise price of the Company’s warrants to purchase 4.4 million shares of common stock of CareView was repriced from $0.40 to $0.03 per share and, subject to the occurrence of certain events, CareView agreed to grant the Company additional equity interests. In September 2018, the Company entered into an amendment to the February 2018 Modification Agreement with CareView whereby the Company agreed, effective as of September 28, 2018, that a lower liquidity covenant would be applicable. At September 30, 2018, the Company determined an estimated fair value of the warrant to be $0.1 million.

Effective October 1, 2017, the Company determined the loan to be impaired and it ceased to accrue interest revenue. At September 30, 2018, it has been determined that an allowance on the carrying value of the note was not necessary.

8. Inventories

Inventories consisted of the following:
 
 
September 30,
 
December 31,
(in thousands)
 
2018
 
2017
 
 
 
 
 
Raw materials
 
$
1,525

 
$
1,717

Work in process
 
1,026

 
1,119

Finished goods
 
9,964

 
6,311

Total inventory
 
$
12,515

 
$
9,147


As of September 30, 2018 and December 31, 2017, the Company deferred approximately $0.3 million and $1.3 million, respectively, of costs associated with inventory transfers made under the Company’s third party logistic provider service arrangement. These costs have been recorded as other assets on the Company’s Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017. The Company will recognize the cost of product sold as inventory is transferred from its third-party logistics provider to the Company’s customers.

During the three and nine months ended September 30, 2018, the Company recognized a reduction in the inventory reserve of $0.1 million and $0.6 million, respectively, and during the three and nine months ended September 30, 2017, the Company recognized an inventory write-down of $0.1 million and $0.1 million, respectively, related to Tekturna®, Tekturna HCT®,

29



Rasilez® and Rasilez HCT® (collectively, the “Noden Products” or “Tekturna”) that the Company would not be able to sell prior to their expiration.

9. Asset Acquisition

On January 8, 2018, LENSAR entered into an Asset Purchase Agreement with Precision Eye Services (“PES”) to purchase assets used in PES’ laser-assisted cataract surgery business. The assets purchased include equipment, inventory and PES’ customer contracts. No workforce was transferred as part of the transaction.

The Company assessed the acquisition of PES assets under ASC Topic 805, Business Combinations (“ASC 805”). Under ASC 805, the Company determined that the acquired assets did not constitute a business and that the transaction would be accounted for as an asset acquisition.

The following table summarizes the fair values of the identifiable assets acquired and liabilities assumed at the acquisition date (in thousands):
Equipment and inventory
 
$
848

Fixed assets
 
67

Intangible assets (customer relationships)
 
1,845

Total identifiable assets
 
$
2,760

 
 
 
Consideration paid at closing, cash
 
$
1,200

Conversion consideration
 
920

Contingent consideration
 
640

Total fair value of consideration
 
$
2,760


10. Intangible Assets

Intangible Assets, Net

On June 8, 2018, Noden Pharma DAC (“Noden DAC”), a wholly owned subsidiary of the Company, entered into a Settlement Agreement (the “Settlement Agreement”) with Anchen Pharmaceuticals, Inc. and its affiliates (“Anchen”) to resolve the patent litigation relating to infringement of U.S. Patent No. 8,617,595 (the “‘595 Patent”) based on their submission of an Abbreviated New Drug Application (“ANDA”) seeking authorization from the FDA to market a generic version of aliskiren, the active ingredient in the Tekturna and Tekturna HCT drug. Under the Settlement Agreement, Anchen, the sole ANDA filer of which the Company is aware, agreed to not commercialize its generic version of aliskiren prior to March 1, 2019. Per the Settlement Agreement, Anchen may commercialize their formulation of aliskiren, but is not permitted to commercialize a copy of Tekturna.

Accordingly, management evaluated the ongoing value of the Noden DAC asset group based upon the probability of Anchen’s market entry of a generic version of aliskiren in the United States and the associated cash flows and conducted a test for impairment. Due to the increased probability of a generic version of aliskiren being launched in the United States, the Company revised its estimates of future cash flows and as a result of this analysis, determined that the sum of undiscounted cash flows was not greater than the carrying value of the assets. Therefore, the Company performed a discounted cash flow analysis to estimate the fair value of the asset group in accordance with ASC Topic 360, Impairment or Disposal of Long-lived Assets. The cash flows used in this analysis are those expected to be generated by market participants, discounted to reflect an appropriate amount of risk, which was determined to be 21%. The Company concluded that the Noden DAC acquired product rights and customer relationship long-lived assets, with a carrying amount of $192.5 million, were no longer recoverable and wrote them down to their estimated fair value of $40.1 million, resulting in an impairment charge of $152.3 million in the second quarter of 2018. This write-down is included in “Impairment of intangible assets” in the Condensed Consolidated Statement of Operations and the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2018. The remaining Noden DAC intangible asset balance, included in the Pharmaceutical segment, will be amortized on a straight-line basis over the remaining useful life of eight years.

30




The components of intangible assets as of September 30, 2018 and December 31, 2017 were as follows:
 
 
September 30, 2018
 
December 31, 2017
(in thousands)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
Acquired products rights(1)
 
$
36,143

 
$
(1,129
)
 
$
35,014

 
$
216,690

 
$
(32,503
)
 
$
184,187

Customer relationships(1) (2)
 
8,028

 
(561
)
 
7,467

 
26,080

 
(3,729
)
 
22,351

Acquired technology(2) (3)
 
11,011

 
(1,005
)
 
10,006

 
9,200

 
(409
)
 
8,791

Acquired trademarks(2)
 
570

 
(162
)
 
408

 
570

 
(76
)
 
494

 
 
$
55,752

 
$
(2,857
)
 
$
52,895

 
$
252,540

 
$
(36,717
)
 
$
215,823

________________
(1) The Company acquired certain intangible assets as part of the Noden Transaction. They are being amortized on a straight-line basis over a weighted-average period of eight years.
(2) The Company acquired certain intangible assets as part of the LENSAR transaction, as described further in Note 19, Business Combinations. They are being amortized on a straight-line basis over a weighted-average period of 15 years. The intangible assets for customer relationships are being amortized using a double-declining method of amortization as such method better represents the economic benefits to be obtained.
(3)
The Company acquired certain intangible assets as part of the foreclosure on certain of Direct Flow Medical assets, as described further in Note 7, Notes and Other Long-Term Receivables. They are being amortized on a straight-line basis over a weighted-average period of 10 years.

For the three and nine months ended September 30, 2018, amortization expense was $1.6 million and $14.3 million, respectively, and for the three and nine months ended September 30, 2017, amortization expense was $6.3 million and $18.4 million, respectively.

Based on the intangible assets recorded at September 30, 2018, and assuming no subsequent additions to or impairment of the underlying assets, the remaining estimated amortization expense is expected to be as follows (in thousands):
Fiscal Year
 
Amount
 
 
 
2018 (Remaining three months)
 
$
1,577

2019
 
6,275

2020
 
6,240

2021
 
6,209

2022
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