PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-K, Received: 02/23/2012 16:08:31)
Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
Commission File Number: 000-19756

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)
 
Registrant’s telephone number, including area code
(775) 832-8500

Securities registered pursuant to Section 12(b) of the Act:
 
Title of Class
Name of Exchange on which Registered
Common Stock, par value $0.01 per share
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x   No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ¨   No x
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 x   No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x   No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ¨   No x
The aggregate market value of shares of common stock held by non-affiliates of the registrant, based on the closing sale price of a share of common stock on June 30, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter, as reported on the NASDAQ Global Select Market, was $818,628,832.
 
As of February 15 , 2012, the registrant had outstanding 139,875,399 shares of common stock.
 
 
 

 
 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement to be delivered to stockholders with respect to the registrant’s 2012 Annual Meeting of Stockholders to be filed by the registrant with the U.S. Securities and Exchange Commission (hereinafter referred to as the “Proxy Statement”) are incorporated by reference into Part III of this Annual Report on Form 10-K. The registrant intends to file its proxy statement within 120 days after its fiscal year end.


 
 

 
 
PDL BIOPHARMA, INC.
 
2011 Form 10-K Annual Report
 
Table of Contents
 
PART I
 
 
 
       
       
Item 1
 
 
1
Item 1A
 
 
7
Item 1B
 
 
12
Item 2
 
 
12
Item 3
 
 
13
Item 4
 
 
14
         
PART II
 
 
 
       
       
Item 5
 
 
15
Item 6
 
 
17
Item 7
 
 
18
Item 7A
 
 
32
Item 8
 
 
35
Item 9
 
 
60
Item 9A
 
 
60
Item 9B
 
 
62
         
PART III
 
 
 
       
Item 10
 
 
62
Item 11
 
 
62
Item 12
 
 
62
Item 13
 
 
62
Item 14
 
 
62
         
PART IV
 
 
 
       
Item 15
 
 
62
         
 
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Table of Contents
PART I
 
Forward-looking Statements
 
This Annual Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, including any statements concerning new licensing, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue” or “opportunity,” or the negative thereof or other comparable terminology. Although we believe that the expectations presented in the forward-looking statements contained herein are reasonable at the time of filing, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below, and for the reasons described elsewhere in this Annual Report. All forward-looking statements and reasons why results may differ included in this Annual Report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.
 
As used in this Annual Report, the terms “we,” “us,” “our,” the “Company” and “PDL” mean PDL BioPharma, Inc. (unless the context indicates a different meaning).
 
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 Annual Report are trademarks, registered trademarks or trade names of their respective owners.
 
ITEM 1.          BUSINESS
 
Overview
 
PDL BioPharma, Inc. (we, us, our, PDL and the Company) pioneered humanization of monoclonal antibodies and, by doing so, enabled the discovery of a new generation of targeted treatments for cancer and immunologic diseases. Today, PDL is focused on intellectual property asset management, investing in new royalty bearing assets and maximizing the value of its patent portfolio and related assets. We receive royalties based on sales of humanized antibody products marketed today and may also receive royalty payments on additional humanized antibody products launched before final patent expiry of our Queen et al. patents in December 2014. Under most of our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies. We have also entered into licensing agreements under which we have licensed certain rights for development stage products that have not yet reached commercialization including products that are currently in Phase 3 clinical trials. While our intellectual property asset management protects our current revenue streams, we compete with other entities in the pursuit of new royalty bearing assets.
 
We were organized as a Delaware corporation in 1986 under the name Protein Design Labs, Inc. In 2006, we changed our name to PDL BioPharma, Inc. Until December 2008, our business included a biotechnology operation which was focused on the discovery and development of novel antibodies which we spun-off (the Spin-Off) as Facet Biotech Corporation (Facet).   We continuously evaluate alternatives to increase return for our stockholders, for example, purchasing royalty generating assets, buying back or redeeming our convertible notes, repurchasing our common stock, selling the Company and paying dividends.
 
2012 Dividends
 
We currently utilize dividends to increase return for our stockholders. On January 18, 2012, our board of directors declared that the regular quarterly dividends to be paid to our stockholders in 2012 will be $0.15 per share of common stock, payable on March 14, June 14, September 14 and December 14 of 2012 to stockholders of record on March 7, June 7, September 7 and December 7 of 2012, the record dates for each of the dividend payments, respectively. At the beginning of each fiscal year, our board of directors reviews the Company’s total annual dividend payments for the prior year and determines whether to increase, maintain or decrease the regular quarterly dividend payments for that year. The board of directors evaluates the financial condition of the Company and considers the economic outlook, corporate cash flow, the Company’s liquidity needs and the health and stability of credit markets when determining whether to maintain or change the dividend.
 
Royalty Asset Acquisitions
 
The last of PDL’s Queen et al. patents expire in December 2014, with the obligation to pay royalties under our various license agreements expiring sometime thereafter. We do not expect to receive any meaningful revenue from the inventories produced prior to the expiration of our Queen et al. patents beyond the first quarter of 2016. Consequently, we are interested in acquiring new royalty generating assets if such royalty assets can be acquired on terms that allow us to increase the return to our stockholders. Our royalty asset focus is on commercial stage therapies having strong economic fundamentals and intellectual property protection, with less of an emphasis on therapeutic area. While we will consider transactions of various sizes, our preference is for assets with a net present value of $75 million to $150 million.
 
 
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Convertible Notes
 
We have actively been working to restructure the Company’s capital and reduce the potential dilution associated with our convertible notes. As part of those efforts, in May 2011, we issued $155.3 million in aggregate principal of 3.75% Senior Convertible Notes due 2015 (May 2015 Notes) in an underwritten public offering.  Our May 2015 Notes “net share settle,” generally meaning that if a conversion occurs, the principal amount is due in cash, and to the extent that the conversion value exceeds the principal amount, the difference is due in shares of our common stock. The proceeds from our May 2015 Notes were used to redeem the outstanding principal amount of our 2.00% Convertible Senior Notes due February 15, 2012 (2012 Notes). As a result, our 2012 Notes are no longer outstanding. By issuing our May 2015 Notes with the net share settle feature and redeeming our 2012 Notes we eliminated 19.7 million shares of potential dilution to our stockholders.
 
In January 2012, we completed an exchange transaction where we exchanged and subsequently retired approximately $169.0 million aggregate principal amount, representing approximately 93.9%, of our 2.875% Convertible Senior Notes due February 15, 2015 (February 2015 Notes), for approximately $169.0 million aggregate principal amount of new 2.875% Series 2012 Convertible Senior Notes due February 15, 2015 (Series 2012 Notes), plus a cash payment of $5.00 for each $1,000 principal amount tendered for a total cash incentive payment of approximately $0.8 million. In February 2012, we entered into separate privately negotiated exchange agreements under which we retired an additional $10.0 million aggregate principal amount of our February 2015 Notes for $10.0 million aggregate principal amount of our Series 2012 Notes. Following settlement of the private exchanges on February 2, 2012, $1.0 million of our February 2015 Notes and $179.0 million of our Series 2012 Notes were outstanding. Like our May 2015 Notes, our Series 2012 Notes net share settle. The effect of issuing $179.0 million aggregate principal of our Series 2012 Notes with the net share settle feature in exchange for our February 2015 Notes was the reduction of 27.8 million shares of potential dilution to our stockholders.
 
Effect of December 15, 2011, Dividend Payment on Conversion Rates for the Convertible Notes
 
In connection with the December 15, 2011, dividend payment, the conversion rates for our convertible notes increased. The conversion rate for our February 2015 Notes was adjusted to 155.396 common shares per $1,000 principal amount, or approximately $6.44 per share, effective December 9, 2011. The conversion rate for our May 2015 Notes was adjusted to 135.9607 common shares per $1,000 principal amount, or approximately $7.36 per share, effective December 6, 2011. The adjustments were based on the amount of the dividend and the trading price of our stock under the terms of the applicable indenture. The conversion rate for our new Series 2012 Notes is 155.396 shares of the Company’s common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $6.44 per share of common stock.
 
Intellectual Property
 
Patents
 
We have been issued patents in the United States and elsewhere, covering the humanization of antibodies, which we refer to as our Queen et al. patents. Our Queen et al. patents, for which final patent expiry is in December 2014, cover, among other things, humanized antibodies, methods for humanizing antibodies, polynucleotide encoding in humanized antibodies and methods of producing humanized antibodies.
 
The following is a list of our U.S. patents within our Queen et al. patent portfolio:
 
Application Number
Filing Date
 
Patent Number
 
Issue Date
 
Expiration Date
08/477,728
06/07/95
    5,585,089  
12/17/96
 
06/25/13
08/474,040
06/07/95
    5,693,761  
12/02/97
 
12/02/14
08/487,200
06/07/95
    5,693,762  
12/02/97
 
06/25/13
08/484,537
06/07/95
    6,180,370  
01/30/01
 
06/25/13
 
Our U.S. Patent No. 5,693,761 patent (‘761 patent), which is the last to expire of our U.S. patents, covers methods and materials used in the manufacture of humanized antibodies. In addition to covering methods and materials used in the manufacture of humanized antibodies, coverage under our ‘761 patent will typically extend to the use or sale of compositions made with those methods and/or materials.
 
The European Patent No. 0 451 216B (‘216B Patent) expired in Europe in December 2009. We have been granted Supplementary Protection Certificates (SPCs) for the Avastin ® , Herceptin ® , Lucentis ® , Xolair ® and Tysabri ® products in many of the jurisdictions in the European Union in connection with the ‘216B Patent. These SPCs effectively extend our patent protection with respect to these products generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014. Because SPCs are granted on a jurisdiction-by-jurisdiction basis, the duration of the extension varies slightly in certain jurisdictions. We may still be eligible for royalties notwithstanding the unavailability of SPC protection if the relevant royalty-bearing humanized antibody product is also made, used, sold or offered for sale in or imported from a jurisdiction in which we have an unexpired Queen et al. patent such as the United States. In the year ending December 31, 2011, approximately 33% of our royalty revenues were derived from sales of products that were made in Europe and sold outside of the United States.
 
 
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  Licensing Agreements
 
We have entered into licensing agreements with numerous entities that are independently developing or have developed humanized antibodies under which we have licensed certain rights under our Queen et al. patents to make, use, sell, offer for sale and import humanized antibodies. We receive royalties on net sales of products that are made, used or sold prior to patent expiry. In general, these agreements cover antibodies targeting antigens specified in the license agreements. Under our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies. Our licensing agreements generally entitle us to royalties following the expiration of our patents with respect to sales of products manufactured prior to patent expiry in jurisdictions providing patent protection. We also expect to receive minimal annual maintenance fees from licensees of our Queen et al. patents prior to patent expiry as well as periodic milestone payments. Total annual milestone payments in each of the last several years have been less than 1% of total revenue and we expect this trend will continue through the expiration of the Queen et al. patents.
 
Our total revenues from U.S. based licensees were $137.3 million, $130.1 million and $154.7 million for the years ended December 31, 2011, 2010 and 2009, respectively. Our total revenues from foreign based licensees were $224.7 million, $214.9 million and $163.5 million for the years ended December 31, 2011, 2010 and 2009, respectively.
 
Licensing Agreements for Marketed Products
 
In the year ended December 31, 2011, we received royalties on sales of the seven humanized antibody products listed below, all of which are currently approved for use by the U.S. Food and Drug Administration (FDA) and other regulatory agencies outside the United States.
 
Licensee
 
Product Names
Genentech, Inc. (Genentech)
 
Avastin ®
   
Herceptin ®
   
Xolair ®
   
Lucentis ®
     
Elan Corporation, Plc (Elan)
 
Tysabri ®
     
Wyeth Pharmaceuticals, Inc. (Wyeth)
 
Mylotarg ®
     
Chugai Pharmaceutical Co., Ltd. (Chugai)
 
Actemra ®
 
For the years ended December 31, 2011, 2010 and 2009, we received royalty revenues under license agreements of approximately $351.6 million, $343.5 million and $305.0 million, respectively.
 
In June 2010, after results from a clinical trial raised concerns about the efficacy and safety of Mylotarg ® , Pfizer Inc. (Pfizer), the parent company of Wyeth, announced that it will be discontinuing commercial availability of Mylotarg. For the years ended December 31, 2011, 2010 and 2009, we received royalties of $0.3 million, $0.9 million and $1.9 million for sales of Mylotarg, respectively.
 
Genentech
 
We entered into a master patent license agreement, effective September 25, 1998, under which we granted Genentech a license under our Queen et al. patents to make, use and sell certain antibody products. Our master patent license agreement with Genentech provides for a tiered royalty structure under which the royalty rate Genentech must pay on royalty-bearing products sold in the United States or manufactured in the United States and used or sold anywhere in the world (U.S.-based Sales) in a given calendar year decreases on incremental U.S.-based Sales above certain sales thresholds based on 95% of the underlying gross U.S.-based Sales. The net sales thresholds and the applicable royalty rates are outlined below:
 
Aggregate Net Sales on Product Made or Sold in U.S.
 
Royalty Rate
 
Net sales up to $1.5 billion
    3.0%  
Net sales between $1.5 billion and $2.5 billion
    2.5%  
Net sales between $2.5 billion and $4.0 billion
    2.0%  
Net sales exceeding $4.0 billion
    1.0%  
 
As a result of the tiered royalty structure, Genentech’s average annual royalty rate for a given year will decline as Genentech’s U.S.-based Sales increase during that year. Because we receive royalties one quarter in arrears, the average royalty rates for the payments we receive from Genentech for U.S.-based Sales in the second calendar quarter for Genentech’s sales from the first calendar quarter have been and are expected to continue to be higher than the average royalty rates for following quarters. The average royalty rates for payments we receive from Genentech are generally lowest in the fourth and first calendar quarters for Genentech’s sales from the third and fourth calendar quarters when more of Genentech’s U.S.-based Sales bear royalties at the 1% royalty rate.
 
 
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With respect to royalty-bearing products that are both manufactured and sold outside of the United States (ex-U.S.-based Manufacturing and Sales), the royalty rate that we receive from Genentech is a fixed rate of 3.0% based on 95% of the underlying gross ex-U.S.-based Manufacturing and Sales. The mix of U.S.-based Sales and ex-U.S.-based Manufacturing and Sales has fluctuated in the past and may continue to fluctuate in future periods, particularly in light of the 2009 acquisition of Genentech by F. Hoffman LaRoche, Ltd. (Roche). The percentage of net global sales that were generated outside of the United States and the percentage of net global sales that were ex-U.S.-based Manufacturing and Sales are outlined in the following table:
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Avastin
                       
Ex-U.S.-based sales
    55 %       50 %       46 %  
Ex-U.S.-based Manufacturing and Sales
    21 %       21 %       0 %  
Herceptin
                             
Ex-U.S.-based sales
    71 %       70 %       70 %  
Ex-U.S.-based Manufacturing and Sales
    35 %       44 %       29 %  
Lucentis
                             
Ex-U.S.-based sales
    59 %       56 %       53 %  
Ex-U.S.-based Manufacturing and Sales
    0 %       0 %       0 %  
Xolair
                             
Ex-U.S.-based sales
    40 %       35 %       29 %  
Ex-U.S.-based Manufacturing and Sales
    40 %       35 %       29 %  
 
The information in the table above is based on information provided to us by Genentech. We were not provided the reasons for the shift in the manufacturing split between U.S.-based Sales and ex-U.S.-based Manufacturing and Sales.
 
In the years ended December 31, 2011 and 2010, PDL received royalties generated from three of Genentech’s licensed products that were ex-U.S.-based manufactured and sold: Herceptin, Avastin and Xolair. Prior to 2010, only Herceptin and Xolair generated royalties from ex-U.S.-based Manufacturing and Sales. Roche has announced that there are new plants in Singapore for the production of Avastin and Lucentis. The plants were registered by the FDA to produce bulk Avastin and Lucentis for use in the United States in 2010 and Roche expects the plants to be registered to produce bulk Avastin and Lucentis for use in Europe. The master patent license agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Genentech prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events.
 
Elan
 
We entered into a patent license agreement, effective April 24, 1998, under which we granted to Elan a license under our Queen et al. patents to make, use and sell antibodies that bind to the cellular adhesion molecule a 4 in patients with multiple sclerosis. Under the agreement, we are entitled to receive a flat royalty rate in the low single digits based on Elan’s net sales of the Tysabri product. The agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Elan prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events.
 
Wyeth
 
We entered into a patent license agreement, effective September 1, 1999, under which we granted to Wyeth a license under our Queen et al. patents to make, use and sell antibodies that bind to CD33, an antigen that is found in about 80% of patients with acute myeloid leukemia, and conjugated to a cytotoxic agent. Under the agreement, we are entitled to receive a flat royalty rate in the low single digits based on Wyeth’s net sales of the Mylotarg product. The agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Wyeth prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events. In June 2010, after results from a recent clinical trial raised concerns about the efficacy and safety of Mylotarg, Pfizer, the parent company of Wyeth, announced that it will be discontinuing commercial availability of Mylotarg.
 
 
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Chugai
 
We entered into a patent license agreement, effective May 18, 2000, with Chugai, a majority owned subsidiary of Roche, under which we granted to Chugai a license under our Queen et al. patents to make, use and sell antibodies that bind to interleukin-6 receptors to prevent inflammatory cascades involving multiple cell types for the treatment of rheumatoid arthritis. Under the agreement, we are entitled to receive a flat royalty rate in the low single digits based on net sales of the Actemra ® product. The agreement continues until the expiration of the last to expire of our Queen et al. patents but may be terminated (i) by Chugai prior to such expiration upon sixty days written notice, (ii) by either party upon a material breach by the other party or (iii) upon the occurrence of certain bankruptcy-related events.
 
Licensing Agreements for Non-Marketed Products
 
We have also entered into licensing agreements under which we have licensed certain rights under our Queen et al. patents to make, use and sell certain products in development that have not yet reached commercialization. Certain of these development-stage products are currently in Phase 3 clinical trials. With respect to these agreements, we may receive payments based on certain development milestones and annual maintenance fees. We may also receive royalty payments if the licensed products receive marketing approval and are manufactured or generate sales before the expiration of our Queen et al. patents. For example, trastuzumab-DM1 (T-DM1) which is an experimental, antibody-drug conjugate that links Herceptin to a cytotoxic, or cell killing agent, DM1, is being developed by Genentech. This approach is designed to increase the already significant tumor fighting ability of Herceptin by coupling it with an additional cell killing agent that is efficiently and simultaneously delivered to the targeted cancer cells by the antibody. Two additional examples are the Eli Lilly and Company (Lilly) and Wyeth licensed antibodies for the treatment of Alzheimer’s disease that are currently in Phase 3 clinical trials. If Lilly’s antibody for Alzheimer’s disease is approved, we would also be entitled to receive a royalty based on a “know-how” license for technology provided in the design of this antibody. Unlike the royalty for the patent license, the royalty payable for “know-how” runs for 12.5 years after the product’s initial commercialization.
 
Protection of our Intellectual Property
 
Our intellectual property, namely our Queen et al. patents and related license agreements, are integral to our business and generate nearly all of our revenues. Protection of our intellectual property is key to our success. In 2011, we entered into settlement agreements, which terminated several challenges against the Queen et al patents in the U.S. and Europe, including a declaratory judgment proceeding in U.S. District Court initiated by MedImmune, LLC (MedImmune), two interference proceedings in the United States Patent and Trademark Office provoked by UCB Pharma S.A. (UCB) and an opposition proceeding in Europe against our European Queen Patent involving UCB, Novartis AG (Novartis) and BioTransplant Inc. (BioTransplant).
 
Genentech / Roche Matter
 
Communications with Genentech regarding European SPCs
 
In August 2010, we received a letter from Genentech, sent on behalf of Roche and Novartis, asserting that Avastin, Herceptin, Lucentis and Xolair (the Genentech Products) do not infringe the SPCs granted to PDL by various countries in Europe for each of the Genentech Products and seeking a response from PDL to these assertions. Genentech did not state what actions, if any, it intends to take with respect to its assertions. PDL’s SPCs were granted by the relevant national patent offices in Europe and specifically cover the Genentech Products. The SPCs covering the Genentech Products effectively extend our European patent protection for the ‘216B Patent generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014.
 
Genentech’s letter does not suggest that the Genentech Products do not infringe PDL’s U.S. patents to the extent that such Genentech Products are U.S.-based Sales. Genentech’s quarterly royalty payments received after receipt of the letter have included royalties generated on all worldwide sales of the Genentech Products.
 
If Genentech is successful in asserting this position, then under the terms of our license agreements with Genentech, it would not owe us royalties on sales of the Genentech Products that are ex-U.S.-based Manufacturing and Sales. Royalties on sale of the Genentech Products that are ex-U.S.-based Manufacturing and Sales accounted for approximately 33% of our royalty revenues for the year ended December 31, 2011. Based on announcements by Roche regarding moving more manufacturing outside of the United States, we expect this amount to increase in the future.
 
We believe that the SPCs are enforceable against the Genentech Products, that Genentech’s letter violates the terms of the 2003 settlement agreement and that Genentech owes us royalties on sales of the Genentech Products on a worldwide basis. We intend to vigorously assert our SPC-based patent rights.
 
 
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Nevada Litigation with Genentech, Roche and Novartis in Nevada State Court
 
In August 2010, we filed a complaint in the Second Judicial District of Nevada, Washoe County, naming Genentech, Roche and Novartis as defendants. We intend to enforce our rights under our 2003 settlement agreement with Genentech and are seeking an order from the court declaring that Genentech is obligated to pay royalties to us on ex-U.S.-based Manufacturing and Sales of the Genentech Products.
 
The 2003 settlement agreement was entered into as part of a definitive agreement resolving intellectual property disputes between the two companies at that time. The agreement limits Genentech’s ability to challenge infringement of our patent rights and waives Genentech’s right to challenge the validity of our patent rights. Certain breaches of the 2003 settlement agreement as alleged by our complaint require Genentech to pay us liquidated and other damages of potentially greater than one billion dollars. This amount includes a retroactive royalty rate of 3.75% on past U.S.-based Sales of the Genentech Products and interest, among other items. We may also be entitled to either terminate our license agreements with Genentech or be paid a flat royalty of 3.75% on future U.S.-based Sales of the Genentech Products.
 
In November 2010, Genentech and Roche filed a motion to dismiss our complaint against them in which we seek to enforce our rights under the 2003 settlement agreement with Genentech. Genentech and Roche's motions to dismiss under Nevada Rule of Civil Procedure 12(b)(5) alleged that all of our claims for relief relating to the 2003 settlement agreement should be dismissed because the 2003 settlement agreement applies only to our U.S. patents. In addition, Roche filed a separate motion to dismiss our complaint under Nevada Rule of Civil Procedure 12(b)(2) on the ground that the Nevada court lacks personal jurisdiction over Roche. On July 7, 2011, the Second Judicial District Court of Nevada ruled in favor of us on the two motions to dismiss filed by Genentech and Roche. The court denied Genentech and Roche's motion to dismiss four of our five claims for relief and, further, denied Roche's separate motion to dismiss for lack of personal jurisdiction. The court dismissed one of our claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing stating that, based on the current state of the pleadings, no "special relationship" had been established between Genentech and us as required under Nevada law. On November 1, 2011, the Nevada court issued an order accepting Roche’s stipulation of waiver to its personal jurisdiction defense. As a result of the order, Roche is foreclosed from reliance on lack of personal jurisdiction in defending against our claims.
 
On February 25, 2011, we reached a settlement with Novartis under which, among other things, we agreed to dismiss our claims against Novartis in the action in Nevada state court against Genentech, Roche and Novartis. Genentech and Roche continue to be parties to the Nevada suit.
 
The court has scheduled trial to commence on May 13, 2013. The outcome of this litigation is uncertain and we may not be successful in our allegations.
 
Major Customers
 
Our revenues consist almost entirely of royalties. We also receive periodic milestone payments from licensees of our Queen et al. patents and may continue to receive payments if the licensed products in development achieve certain development milestones. In addition, we will receive royalty payments if the licensed products receive marketing approval and are manufactured or generate sales before the expiration of our Queen et al. patents. In 2011, 2010 and 2009, Genentech accounted for 86%, 86% and 71% of our revenues, respectively; Elan accounted for 12%, 10% and 9% of our revenues, respectively; and MedImmune accounted for zero, zero and 13% of our revenues, respectively.
 
Employees
 
As of February 22, 2012, we had less than ten full-time employees managing our intellectual property, our licensing operations and other corporate activities as well as providing for certain essential reporting and management functions of a public company. None of our employees are covered by a collective bargaining agreement.
 
Available Information
 
We file electronically with the Securities and Exchange Commission (SEC) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that website is www.sec.gov.
 
We make available free of charge on or through our website at www.pdl.com our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and proxy statements, as well as amendments to these reports and statements, as soon as practicable after we have electronically filed such material with, or furnished them to, the SEC. You may also obtain copies of these filings free of charge by calling us at (775) 832-8500. Also, our Audit Committee Charter, Compensation Committee Charter, Nominating and Governance Committee Charter, Litigation Committee Charter, Corporate Governance Guidelines and Code of Business Conduct are also available free of charge on our website or by calling the number listed above.
 
 
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ITEM 1A.         RISK FACTORS
 
You should carefully consider and evaluate all of the information included and incorporated by reference in this Annual Report, including the risk factors listed below. Any of these risks, as well as other risks and uncertainties, could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of shares of our common stock. Additional risks not currently known or currently material to us may also harm our business.
 
Keep these risk factors in mind when you read forward-looking statements contained in this Annual Report and the documents incorporated by reference in this Annual Report. These statements relate to our expectations about future events and time periods. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue” or “opportunity,” the negative of these words or words of similar import. Similarly, statements that describe our reserves and our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward-looking statements. Forward-looking statements involve risks and uncertainties, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements.
 
We must protect our patent and other intellectual property rights to succeed.
 
Our success is dependent in significant part on our ability to protect the scope, validity and enforceability of our intellectual property, including our patents, SPCs and license agreements. The scope, validity, enforceability and effective term of patents and SPCs can be highly uncertain and often involve complex legal and factual questions and proceedings. In addition, the legal principles applicable to patents in any given jurisdiction may be altered through changing court precedent and legislative action, and such changes may affect the scope, strength and enforceability of our patent rights or the nature of proceedings which may be brought by us or a third party related to our patent rights. A finding in a proceeding related to our patent rights which narrows the scope or which affects the validity or enforceability of some or all of our patent rights could have a material impact on our ability to continue to collect royalty payments from our licensees or execute new license agreements.
 
Any of these proceedings could further result in either loss of a patent or loss or reduction in the scope of one or more of the claims of the patent or claims underlying an SPC. These proceedings could be expensive, last several years and result in a significant reduction in the scope or invalidation of our patents. Any limitation in claim scope could reduce our ability to collect royalties or commence enforcement proceedings based on these patents. Moreover, the scope of a patent in one country does not assure similar scope of a patent with similar claims in another country. Also, claim interpretation and infringement laws vary among countries. Additionally, we depend on our license agreements to enforce royalty obligations against our licensees. Any limitations in our ability to enforce, such as limits on the scope of and/or an adverse interpretation of, the various licensee obligations in our licenses and related agreements could reduce our ability to collect royalties based on our license agreements . As a result of these factors, we are unable to predict the extent of our intellectual property protection in any country.  For further information, see “Item 3— Legal Proceedings.”
 
Our common stock may lose value, our common stock could be delisted from NASDAQ and our business may be liquidated due to several factors, including the expiration of our Queen et al. patents, the failure to acquire other sources of royalty revenue, the payment of dividends or distributions to our stockholders and failure to meet analyst expectations.
 
Our revenues consist almost entirely of royalties from licensees of our Queen et al. patents, which finally expire in December of 2014. The continued payment of dividends or distributions to our stockholders without other revenue sources and the approaching patent expiration will likely reduce the price of our common stock. If the price of our common stock were to fall below NASDAQ listing standards, our common stock may be delisted. If our common stock were delisted, market liquidity for our common stock could be severely affected and our stockholders’ ability to sell securities in the secondary market could be limited. Delisting from NASDAQ would negatively affect the value of our common stock. Delisting could also have other negative results, including, but not limited to, the potential loss of confidence by employees, the loss of institutional investor interest and fewer business development opportunities.
 
Unless we are able to acquire patents or other sources of royalty revenue on commercially reasonable terms, we will no longer receive patent-related royalties once our licensees have sold all their inventory of licensed product that was manufactured before the expiration of the Queen et al. patents. If we are unsuccessful in acquiring new sources of royalty revenue, we will likely liquidate our business.
 
If we fail to meet the expectations of securities analysts or investors, or if adverse conditions prevail or are perceived to prevail with respect to our business, the price of the common stock would likely drop significantly.
 
Our revenues in Europe depend on the validity and enforceability of our SPCs and an adverse judgment would severely reduce our future revenues.
 
Our ‘216B Patent in Europe was granted in 1996 by the European Patent Office (EPO). The ‘216B Patent expired on December 28, 2009. To extend the period of enforceability of the ‘216B Patent against specific products which received marketing approval in Europe as of the expiration date of the ‘216B Patent, we applied for SPCs in various European national patent offices to cover Avastin, Herceptin, Xolair, Lucentis and Tysabri to the extent these products are made and sold outside the United States (the SPC Products). These SPCs generally expire in 2014. While our SPCs extend the period of enforceability of our ‘216B Patent against the SPC Products, their enforcement will be subject to varying, complex and evolving national requirements and standards relevant to enforcement of patent claims pursuant to SPCs. In the event that our SPCs are challenged in the national courts of the various countries in Europe in which we own granted SPCs, such a challenge could be directed against the validity of the SPC, the validity of the underlying patent claims and/or whether the product named in the SPC actually infringes those claims and whether the SPC was properly granted pursuant to controlling European law. Such a proceeding would involve complex legal and factual questions and proceedings. In addition, the European Court of Justice has the authority to interpret the SPC regulation and could do so in a manner that materially impacts the enforceability of our SPCs against the SPC Products. As a result of these factors, we are unable to predict the extent of protection afforded by our SPCs.
 
 
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Based on information provided to us in the quarterly royalty statements from our licensees, the royalties we collect on sales of the SPC Products approximated 33% of our royalty revenues for the year ended December 31, 2011. Based on announcements by Roche regarding moving manufacturing outside of the United States, we expect this amount to increase in the future. Our inability to collect those royalties would have a material negative impact on our cash flow, our ability to pay dividends in the future and our ability to service our debt obligations. An adverse decision could also encourage challenges to our related Queen et al. patents in other jurisdictions including the United States. For further information, see “Item 3—Legal Proceedings.”
 
We derive a significant portion of our royalty revenues from Genentech and our future success depends on continued market acceptance of their products and approval of their licensed products that are in development, as well as continued performance by Genentech of its obligations under its agreements with us.
 
Our revenues consist almost entirely of royalties from licensees of our Queen et al. patents of which the Genentech Products accounted for 86%, 86% and 71% of our revenues for the years ended December 31, 2011, 2010 and 2009, respectively. Our future success depends upon the continued market acceptance of the Genentech products and upon the ability of Genentech to develop, introduce and deliver products that achieve and sustain market acceptance. We have no control over the sales efforts of Genentech and our other licensees, and our licensees might not be successful. Reductions in the sales volume or average selling price of Genentech Products could have a material adverse effect on our business.
 
In addition, our business and results of operations also depend on Genentech continuing to perform its obligations under its license agreements with us. For example, 60% of the royalties we currently receive from Genentech are dedicated to service the debt related to our QHP PhaRMA SM Senior Secured Notes due March 15, 2015 (Non-recourse Notes) that we, through our wholly-owned subsidiary, QHP Royalty Sub LLC, issued in November 2009.
 
In August 2010, we received a letter from Genentech on behalf of Roche and Novartis asserting that the Genentech Products do not infringe our SPCs for each of the Genentech Products. If Genentech is successful in asserting this position, then under the terms of our license agreements with Genentech, it would not owe us royalties on ex-U.S.-based Manufacturing and Sales of the Genentech Products. These royalties accounted for approximately 33% of our royalty revenues for the year ended December 31, 2011. If Roche, as Roche has publicly announced, moves more manufacturing outside of the United States, this percentage will increase.
 
We believe that these SPCs are enforceable against the Genentech Products and intend to vigorously assert our SPC-based patent rights. If we are unable to resolve the dispute with Genentech, we will incur significant additional costs and senior management time in asserting our rights under our various agreements with Genentech, whether through continued litigation, arbitration or otherwise. To the extent Genentech stops or reduces payment of royalties on ex-U.S.-based Manufacturing and Sales of the Genentech Products, this would have a material negative impact on our cash flow and our ability to pay dividends in the future and would also cause us to extend the anticipated repayment of our Non-recourse Notes due in March 2015 for which we currently anticipate full repayment in the third quarter of 2012. See “Item 3—Legal Proceedings.”
 
Our licensees may be unable to maintain regulatory approvals for currently licensed products, or to obtain regulatory approvals for new products, and they may voluntarily remove currently licensed products from marketing and commercial distribution. Any of such events, whether due to safety issues or other factors, could reduce our revenues.
 
Our licensees are subject to stringent regulation with respect to product safety and efficacy by various international, federal, state and local authorities. Of particular significance are the FDA requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use in the United States. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical information required for approval of a biologic license application or new drug application are substantial and can require a number of years. In addition, even if our licensees’ products receive regulatory approval, they remain subject to ongoing FDA and other international regulations including, but not limited to, obligations to conduct additional clinical trials or other testing, changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisements to physicians and/or a product recall or withdrawal. Our licensees may not maintain necessary regulatory approvals for their existing licensed products or our licensees may not obtain necessary regulatory approvals on a timely basis, if at all, for any of the licensed products our licensees are developing or manufacturing. The occurrence of adverse events reported by any licensee may result in the revocation of regulatory approvals or decreased sales of the applicable product due to a change in physicians’ willingness to prescribe, or patients’ willingness to use the applicable product.   Our licensees could also choose to voluntarily remove their licensed products from marketing and commercial distribution. In any of these cases, our revenues could be materially and adversely affected.
 
 
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For example, in November 2011, the FDA removed the indication for breast cancer from Avastin’s label. Other licensed products have been suspended from marketing and commercial distribution, such as Mylotarg, which is currently suspended, and Tysabri, which was temporarily suspended and then returned to the market. In such a case, our revenues could be materially and adversely affected.
 
In addition, the current regulatory framework could change or additional regulations could arise at any stage during our licensees’ product development or marketing which may affect our licensees’ ability to obtain or maintain approval of their licensed products. Delays in our licensees receiving regulatory approval for licensed products or their failure to maintain existing regulatory approvals could have a material adverse effect on our business.
 
Our licensees face competition.
 
Our licensees face competition from other pharmaceutical and biotechnology companies. The introduction of new competitive products or follow-on biologics may result in lost market share for our licensees, reduced use of licensed products, lower prices and/or reduced licensed product sales, any of which could reduce our royalty revenues and have a material adverse effect on our results of operations.
 
We may enter into acquisitions or other material royalty asset transactions now and in the future and such acquisitions may not produce anticipated royalty revenues.
 
We are engaged in a continual review of opportunities to acquire existing royalty assets or to acquire companies that hold royalty assets. We currently, and generally at any time, have acquisition opportunities in various stages of active review, including, for example, our engagement of consultants and advisors to analyze particular opportunities, technical, financial and other confidential information, submission of indications of interest and involvement as a bidder in competitive auctions. Many potential acquisition targets do not meet our criteria, and for those that do, we may face significant competition for these acquisitions from other royalty buyers and enterprises. Competition for future royalty asset acquisition opportunities in our markets could increase the price we pay for royalty assets we acquire and could reduce the number of potential acquisition targets. The success of our royalty asset acquisitions is based on our ability to make accurate assumptions regarding the valuation, timing and amount of royalty payments. The failure of any of these acquisitions to produce anticipated royalty revenues may materially and adversely affect our financial condition and results of operations.
 
We intend to reserve from time to time a certain amount of cash in order to satisfy the obligations relating to our convertible notes. T he maturity or conversion of any of our convertible notes may adversely affect our financial condition and operating results, which could adversely affect the amount or timing of dividends to our stockholders.
 
As of February 2, 2012, $155.3 million in principal remained outstanding under our May 2015 Notes, $1.0 million in principal remained outstanding under our February 2015 Notes and $179.0 million in principal remained outstanding under our Series 2012 Notes. At maturity, we will have to pay the holders of such notes the full aggregate principal amount of the convertible notes, then outstanding. For example, on February 15, 2015, we will have to pay the full aggregate principal amount of our Series 2012 Notes, $179.0 million as of February 2, 2012.
 
Holders of the February 2015 Notes may convert their notes at any time, at the holder’s election. Holders of the May 2015 Notes and Series 2012 Notes may convert their notes at their option under the following circumstances: (i) during any fiscal quarter commencing after the fiscal quarter ending June 30, 2011, in the case of our May 2015 Notes, and December 31, 2011, in the case of our Series 2012 Notes, if the last reported sale price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price for the notes on the last day of such preceding fiscal quarter; (ii) during the five business-day period immediately after any five consecutive trading-day period, which we refer to as the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes for each such day; or (iii) upon the occurrence of specified corporate events. On and after November 1, 2014, in the case of our May 2015 Notes, and August 15, 2014, in the case of our Series 2012 Notes, holders may convert their notes at any time, regardless of the foregoing circumstances. These notes “net share settle,” meaning that if a conversion occurs, the principal amount is due in cash, and to the extent that the conversion value exceeds the principal amount, the difference is due in shares of our common stock. If one or more holders elect to convert their notes when conversion is permitted, we would be required to make cash payments to satisfy up to the face value of our conversion obligation in respect of each note, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their May 2015 Notes or Series 2012 Notes, because our May 2015 Notes and Series 2012 Notes are net share settled, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of our May 2015 Notes and Series 2012 Notes as a current rather than long-term liability, which could result in a material reduction of our net working capital.
 
We intend to reserve from time to time a certain amount of cash in order to satisfy these repurchase or other obligations relating to the convertible notes which could adversely affect the amount or timing of any distribution to our stockholders or any royalty asset acquisition. In addition, we may redeem (except in the case of our Series 2012 Notes that are unredeemable by us), repurchase or otherwise acquire the convertible notes in the open market in the future, any of which could adversely affect the amount or timing of any cash distribution to our stockholders.
 
 
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The conversion of any of our February 2015 Notes, our May 2015 Notes or our Series 2012 Notes into shares of our common stock would have a dilutive effect which could cause our stock price to go down.
 
Our May 2015 Notes, until November 1, 2014, and our Series 2012 Notes, until August 15, 2014, are convertible into shares of our common stock only if specified conditions are met and thereafter convertible at any time, at the option of the holder. Our February 2015 Notes are convertible at any time at the holder’s election. We have reserved shares of our authorized common stock for issuance upon conversion of these convertible notes. Upon conversion, the principal amount is due in cash, and to the extent that the conversion value exceeds the principal amount, the difference is due in shares of common stock. If any or all of these convertible notes are converted into shares of our common stock, our existing stockholders will experience immediate dilution of voting rights and our common stock price may decline. Furthermore, the perception that such dilution could occur may cause the market price of our common stock to decline.
 
The conversion rate as of February 2, 2012, for our February 2015 Notes and Series 2012 Notes is 155.396 shares of common stock per $1,000 principal amount or a conversion price of approximately $6.44 per share of common stock and the conversion rate for our May 2015 Notes is 135.9607 shares of common stock per $1,000 principal amount, or a conversion price of approximately $7.36 per share of common stock. Because the conversion rates of these convertible notes adjust upward upon the occurrence of certain events, such as a dividend payment, our existing stockholders may experience more dilution if any or all of these convertible notes are converted into shares of our common stock after the adjusted conversion rates became effective.
 
We entered into purchased call option and warrant transactions in connection with the issuance of our May 2015 Notes that may affect the value of our common stock.
 
In connection with the issuance of our May 2015 Notes, we entered into purchased call option transactions. Separately, we also entered into warrant transactions at that time. The purchased call option transactions are expected to reduce the potential dilution with respect to our common stock upon conversion of our May 2015 Notes. The warrant transactions could separately have a dilutive effect from the issuance of our common stock pursuant to the warrants.

The purchased call option and warrant transactions are accounted for as an adjustment to our stockholders’ deficit. In connection with hedging these transactions, the hedge counterparties to the hedge transactions or their respective affiliates may enter into, or may unwind, various derivative transactions and/or purchase or sell our common stock in secondary market transactions prior to maturity of our May 2015 Notes (and are likely to do so during any cash settlement averaging period related to any conversion of our May 2015 Notes). Such activities could have the effect of decreasing the trading price of our common stock during any cash settlement averaging period related to a conversion of our May 2015 Notes.

In addition, we intend to exercise the purchased call options whenever May 2015 Notes are converted, if ever. In order to unwind their hedge positions with respect to those exercised options, the hedge counterparties or their respective affiliates may sell shares of our common stock in secondary market transactions or unwind various derivative transactions with respect to our common stock during the cash settlement averaging period for the converted notes. The effect, if any, of any of these transactions and activities on the trading price of our common stock will depend, in part, on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the value of our common stock.
 
Further, a failure by the hedge counterparties or their respective affiliates (due to bankruptcy or otherwise) to pay or deliver, as the case may be, amounts owed to us under the purchased call option transactions will not reduce the consideration we are required to deliver to a holder upon its conversion of our May 2015 Notes and may result in an increase in dilution with respect to our common stock.
 
Changes in the third-party reimbursement environment may affect product sales from which we generate royalty revenues.
 
Sales of products from which we generate royalties will depend significantly on the extent to which reimbursement for the cost of such products and related treatments will be available to physicians and patients from various levels of U.S. and international government health authorities, private health insurers and other organizations. Third-party payers and government health administration authorities increasingly attempt to limit and/or regulate the reimbursement of medical products and services, including branded prescription drugs. Changes in government legislation or regulation, such as the Health Care and Education Reconciliation Act of 2010; the Medicare Improvements for Patients and Providers Act of 2009 and the Medicare, Medicaid and State Children’s Health Insurance Program Extension Act of 2007; changes in formulary or compendia listing or changes in private third-party payers’ policies toward reimbursement for such products may reduce reimbursement of the cost of such products to physicians, pharmacies and distributors. Decreases in third-party reimbursement could reduce usage of such products and sales to collaborators, which may have a material adverse effect on our royalties. In addition, macroeconomic factors may affect the ability of patients to pay or co-pay for costs or otherwise pay for products from which we generate royalties by, for example, decreasing the number of patients covered by insurance policies or increasing costs associated with such policies.
 
 
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  Our revenues and operating results will likely fluctuate in future periods.
 
Our royalty revenues may be unpredictable and fluctuate because they depend upon, among other things, the rate of growth of sales of licensed products as well as the mix of U.S.-based Sales and ex-U.S.-based Manufacturing and Sales in connection with our master patent license agreement with Genentech.
 
The Genentech agreement provides for a tiered royalty structure. The royalty rate Genentech must pay on 95% of the underlying gross U.S.-based Sales in a given calendar year decreases on incremental U.S.-based Sales above certain net sales thresholds. As a result of the tiered royalty structure, Genentech’s average annual royalty rate for a given year declines as Genentech’s U.S.-based Sales increase during that year. Because we receive royalties one quarter in arrears, the average royalty rate for the payments we receive from Genentech in the second calendar quarter, which would be for Genentech’s sales from the first calendar quarter, has been and is expected to continue to be higher than the average royalty rate for following quarters. The average royalty rate for payments we receive from Genentech is generally lowest in the fourth quarter and first calendar quarter of the following year, which would be for Genentech’s sales from the third and fourth calendar quarter, when Genentech’s U.S.-based Sales bear royalties at a 1% royalty rate. With respect to the ex-U.S.-based Manufacturing and Sales, the royalty rate that we receive from Genentech is a fixed rate of 3% based on 95% of the underlying gross ex-U.S.-based Manufacturing and Sales. The mix of U.S.-based Sales and ex-U.S.-based Manufacturing and Sales has fluctuated in the past and may continue to fluctuate in future periods, particularly in light of the 2009 acquisition of Genentech by Roche. For example, Roche has announced plans to move certain Avastin and Lucentis manufacturing to Singapore.
 
We may experience increases and decreases in our royalty revenues due to fluctuations in foreign currency exchange rates and we may be unsuccessful in our attempts to mitigate this risk.
 
A material portion of our royalties are calculated based on sales in currencies other than the U.S. dollar. Fluctuations in foreign currency rates, particularly the Eurodollar, relative to the U.S. dollar can significantly affect our revenues and operating results. While foreign currency conversion terms vary by license agreement, generally most agreements require that royalties first be calculated in the currency of sale and then converted into U.S. dollars using the average daily exchange rates for that currency for a specified period at the end of the calendar quarter. For example, when the U.S. dollar weakens in relation to other currencies, the converted amount is greater than it would have been had the U.S. dollar exchange rates remained unchanged. More than 50% of our licensees’ product sales are in currencies other than U.S. dollars; as such, our revenues may fluctuate due to changes in foreign currency exchange rates and is subject to foreign currency exchange risk. For example, in a quarter in which we generate $70 million in royalty revenues, approximately $35 million is based on sales in currencies other than the U.S. dollar. If the U.S. dollar strengthens across all currencies by 10% during the conversion period for that quarter, when compared to the same amount of local currency royalties for the prior year, U.S. dollar converted royalties will be approximately $3.5 million less in the current quarter than in the prior year.
 
To compensate for Eurodollar currency fluctuations, we hedge Eurodollar currency exposures with Eurodollar forward contracts and Eurodollar option contracts (collectively, Eurodollar contracts) to offset the risks associated with these Eurodollar currency exposures. We may suspend the use of these contracts from time to time or we may be unsuccessful in our attempt to hedge our Eurodollar currency risk. We will continue to experience foreign currency related fluctuations in our royalty revenues in certain instances when we do not enter into foreign currency exchange contracts or where it is not possible or cost effective to hedge our foreign currency related exposures. Currency related fluctuations in our royalty revenues will vary based on the currency exchange rates associated with these exposures and changes in those rates, whether we have entered into foreign currency exchange contracts to offset these exposures and other factors. All of these factors could materially impact our results of operations, financial position and cash flows, the timing of which is variable and generally outside of our control.
 
 
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We must attract, retain and integrate key employees in order to succeed. It may be difficult to recruit, retain and integrate key employees.
 
To be successful, we must attract, retain and integrate qualified personnel. Our business is intellectual property asset management, investing in new royalty bearing assets and maximizing the value of our patent portfolio and related assets, which requires only a small number of employees. Due to the unique nature and remote location of our company, it may be difficult for us to recruit and retain qualified personnel. If we are unsuccessful in attracting, retaining and integrating qualified personnel, our business could be impaired.
 
Our agreements with Facet may not reflect terms that would have resulted from arm’s-length negotiations between unaffiliated third parties.
 
The agreements associated with the Spin-Off of Facet in December 2008, including the Separation and Distribution Agreement, Tax Sharing and Indemnification Agreement and Cross License Agreement, were negotiated in the context of the Spin-Off while Facet was still part of PDL and, accordingly, may not reflect more favorable terms that may have resulted from arm’s-length negotiations between unaffiliated third parties.
 
We may have obligations for which we may not be able to collect under our indemnification rights from Facet.
 
Under the terms of the Separation and Distribution agreement with Facet, we and Facet agreed to indemnify the other from and after the Spin-Off with respect to certain indebtedness, liabilities and obligations that were retained by our respective companies. These indemnification obligations could be significant. The ability to satisfy these indemnities, if called upon to do so, will depend upon the future financial strength of each of our companies. We cannot assure you that, if Facet has to indemnify us for any substantial obligations, Facet will have the ability to satisfy those obligations. If Facet does not have the ability to satisfy those obligations, we may be required to satisfy those obligations instead. For example, in connection with the Spin-Off, we entered into amendments to the leases for the facilities in Redwood City, California, which formerly served as our corporate headquarters, under which Facet was added as a co-tenant under the leases and a Co-Tenancy Agreement under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the Spin-Off date. Should Facet default under its lease obligations, we would be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities, the disposition of which could have a material adverse effect on the amount or timing of any distribution to our stockholders. As of December 31, 2011, the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $110.8 million. We would also be responsible for lease related payments including utilities, property taxes and common area maintenance which may be as much as the actual lease payments. In April 2010, Abbott Laboratories (Abbott) acquired Facet and later renamed the company Abbott Biotherapeutics Corp. We do not know how Abbott’s acquisition of Facet will impact our ability to collect under our indemnification rights or whether Facet’s ability to satisfy its obligations will change. In addition, we have limited information rights under the Co-Tenancy Agreement. As a result, we are unable to determine definitively whether Facet continues to occupy the space and whether it has subleased the space to another party. See “Item 2—Properties.”
 
We depend on our licensees for the determination of royalty payments. We may not be able to detect errors and payment calculations may call for retroactive adjustments.
 
The royalty payments we receive are determined by our licensees based on their reported sales. Each licensee’s calculation of the royalty payments is subject to and dependent upon the adequacy and accuracy of its sales and accounting functions, and errors may occur from time to time in the calculations made by a licensee. Our license agreements provide us the right to audit the calculations and sales data for the associated royalty payments; however, such audits may occur many months following our recognition of the royalty revenue, may require us to adjust our royalty revenues in later periods and may require expense on the part of the Company.
 
ITEM 1B.        UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.           PROPERTIES
 
We lease 4,800 square feet of office space in Incline Village, Nevada, which serves as our corporate headquarters. The lease expires in May 2012. We may, at our option, extend the term of this lease.
 
 
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In July 2006, we entered into two leases and a sublease for the facilities in Redwood City, California, which formerly served as our corporate headquarters and cover approximately 450,000 square feet of office space. Under the amendments to the leases entered into in connection with the Spin-Off, Facet was added as a co-tenant under the leases. As a co-tenant, Facet is bound by all of the terms and conditions of the leases. PDL and Facet are jointly and severally liable for all obligations under the leases, including the payment of rental obligations. However, we also entered into a Co-Tenancy Agreement with Facet in connection with the Spin-Off and the lease amendments under which we assigned to Facet all rights under the leases, including, but not limited to, the right to amend the leases, extend the lease term or terminate the leases, and Facet assumed all of our obligations under the leases. Under the Co-Tenancy Agreement, we also relinquished any right or option to regain possession, use or occupancy of these facilities. Facet agreed to indemnify us for all matters associated with the leases attributable to the period after the Spin-Off date and we agreed to indemnify Facet for all matters associated with the leases attributable to the period before the Spin-Off date. In addition, in connection with the Spin-Off, the sublease was assigned by PDL to Facet. In April 2010, Abbott acquired Facet and later renamed the company Abbott Biotherapeutics Corp. To date, Facet has satisfied all obligations under the Redwood City lease.
 
Except as set forth above, we do not own or lease other properties.
 
ITEM 3.           LEGAL PROCEEDINGS
 
Genentech / Roche Matter
 
Communications with Genentech regarding European SPCs
 
In August 2010, we received a letter from Genentech, sent on behalf of Roche and Novartis, asserting that the Genentech Products do not infringe the SPCs granted to PDL by various countries in Europe for each of the Genentech Products and seeking a response from PDL to these assertions. Genentech did not state what actions, if any, it intends to take with respect to its assertions. PDL’s SPCs were granted by the relevant national patent offices in Europe and specifically cover the Genentech Products. The SPCs covering the Genentech Products effectively extend our European patent protection for the ‘216B Patent generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014.
 
Genentech’s letter does not suggest that the Genentech Products do not infringe PDL’s U.S. patents to the extent that such Genentech Products are U.S.-based Sales. Genentech’s quarterly royalty payments received after receipt of the letter have included royalties generated on all worldwide sales of the Genentech Products.
 
If Genentech is successful in asserting this position, then under the terms of our license agreements with Genentech, it would not owe us royalties on sales of the Genentech Products that are both manufactured and sold outside of the United States. Royalties on sale of the Genentech Products that are ex-U.S.-based Manufacturing and Sales accounted for approximately 33% of our royalty revenues for the year ended December 31, 2011. Based on announcements by Roche regarding moving more manufacturing outside of the United States, we expect this amount to increase in the future.
 
We believe that the SPCs are enforceable against the Genentech Products, that Genentech’s letter violates the terms of the 2003 settlement agreement and that Genentech owes us royalties on sales of the Genentech Products on a worldwide basis. We intend to vigorously assert our SPC-based patent rights.
 
Nevada Litigation with Genentech, Roche and Novartis in Nevada State Court
 
In August 2010, we filed a complaint in the Second Judicial District of Nevada, Washoe County, naming Genentech, Roche and Novartis as defendants. We intend to enforce our rights under our 2003 settlement agreement with Genentech and are seeking an order from the court declaring that Genentech is obligated to pay royalties to us on ex-U.S.-based Manufacturing and Sales of the Genentech Products.
 
The 2003 settlement agreement was entered into as part of a definitive agreement resolving intellectual property disputes between the two companies at that time. The agreement limits Genentech’s ability to challenge infringement of our patent rights and waives Genentech’s right to challenge the validity of our patent rights. Certain breaches of the 2003 settlement agreement as alleged by our complaint require Genentech to pay us liquidated and other damages of potentially greater than one billion dollars. This amount includes a retroactive royalty rate of 3.75% on past U.S.-based Sales of the Genentech Products and interest, among other items. We may also be entitled to either terminate our license agreements with Genentech or be paid a flat royalty of 3.75% on future U.S.-based Sales of the Genentech Products.
 
In November 2010, Genentech and Roche filed a motion to dismiss our complaint against them in which we seek to enforce our rights under the 2003 settlement agreement with Genentech. Genentech and Roche's motions to dismiss under Nevada Rule of Civil Procedure 12(b)(5) alleged that all of our claims for relief relating to the 2003 settlement agreement should be dismissed because the 2003 settlement agreement applies only to our U.S. patents. In addition, Roche filed a separate motion to dismiss our complaint under Nevada Rule of Civil Procedure 12(b)(2) on the ground that the Nevada court lacks personal jurisdiction over Roche. On July 7, 2011, the Second Judicial District Court of Nevada ruled in favor of us on the two motions to dismiss filed by Genentech and Roche. The court denied Genentech and Roche's motion to dismiss four of our five claims for relief and, further, denied Roche's separate motion to dismiss for lack of personal jurisdiction. The court dismissed one of our claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing stating that, based on the current state of the pleadings, no "special relationship" had been established between Genentech and us as required under Nevada law. On November 1, 2011, the Nevada court issued an order accepting Roche’s stipulation of waiver to its personal jurisdiction defense. As a result of the order, Roche is foreclosed from reliance on lack of personal jurisdiction in defending against our claims.
 
 
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On February 25, 2011, we reached a settlement with Novartis under which, among other things, we agreed to dismiss our claims against Novartis in the action in Nevada state court against Genentech, Roche and Novartis. Genentech and Roche continue to be parties to the Nevada suit.
 
The court has scheduled trial to commence on May 13, 2013. The outcome of this litigation is uncertain and we may not be successful in our allegations.
 
Other Legal Proceedings
 
In addition, from time to time, we are subject to various other legal proceedings and claims that arise in the ordinary course of business and which we do not expect to materially impact our financial statements.
 
ITEM 4.           MINE SAFETY DISCLOSURES
 
Not applicable.
 
 
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PART II
 
ITEM 5.           MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
 SECURITIES
 
Our common stock trades on the NASDAQ Global Select Market under the symbol “PDLI.” Prices indicated below are the high and low intra-day sales prices per share of our common stock as reported by the NASDAQ Global Select Market for the periods indicated.
 
   
High
   
Low
 
2011
           
First Quarter
  $ 6.40     $ 4.66  
Second Quarter
  $ 6.70     $ 5.70  
Third Quarter
  $ 6.44     $ 5.40  
Fourth Quarter
  $ 6.46     $ 5.15  
                 
2010
               
First Quarter
  $ 7.30     $ 6.05  
Second Quarter
  $ 6.68     $ 5.03  
Third Quarter
  $ 6.75     $ 4.97  
Fourth Quarter
  $ 6.55     $ 5.13  
 
As of February 15 , 2012, we had approximately 151 common stockholders of record. Most of our outstanding shares of common stock are held of record by one stockholder, Cede & Co., a nominee for the Depository Trust Company. Many brokers, banks and other institutions hold shares of common stock as nominees for beneficial owners which deposit these shares of common stock in participant accounts at the Depository Trust Company. The actual number of beneficial owners of our stock is likely significantly greater than the number of stockholders of record; however, we are unable to reasonably estimate the total number of beneficial owners.
 
At the beginning of each fiscal year, our board of directors reviews the Company’s total annual dividend payment for the prior year and determines whether to increase, maintain or decrease the quarterly dividend payments for that year. The board of directors evaluates the financial condition of the Company and considers the economic outlook, corporate cash flow, the Company’s liquidity needs and the health and stability of credit markets when determining whether to maintain or change the dividend.
 
On January 18, 2012, our board of directors declared a regular quarterly dividend of $0.15 per share of common stock on March 14, June 14, September 14 and December 14 of 2012 to stockholders of record on March 7, June 7, September 7 and December 7 of 2012, the record dates for each of the dividend payments, respectively.
 
On February 25, 2011, our board of directors declared a regular quarterly dividend of $0.15 per share of common stock. On March 15, June 15, September 15 and December 15 of 2011, we paid quarterly cash dividends of approximately $21.0 million or $0.15 per share to stockholders of record on March 8, June 8, September 8 and December 8 of 2011, the record dates for each of the dividend payments, respectively.
 
In April and October 2010, we paid cash dividends of $59.9 million, or $0.50 per share of common stock, and $69.8 million, or $0.50 per share of common stock, respectively, to our stockholders.
 
 
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Comparison of Stockholder Returns
 
The line graph below compares the cumulative total stockholder return on our common stock between December 31, 2006, and December 31, 2011, with the cumulative total return of (i) the NASDAQ Biotechnology Index and (ii) the NASDAQ Composite Index over the same period. This graph assumes that $100.00 was invested on December 31, 2006, in our common stock at the closing sales price for our common stock on that date and at the closing sales price for each index on that date and that all dividends were reinvested. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns and are not intended to be a forecast.
 
   
12/31/2006
   
12/31/2007
   
12/31/2008
   
12/31/2009
   
12/31/2010
   
12/31/2011
 
PDL BioPharma, Inc.
    100.00       86.99       62.02       97.96       104.42       114.91  
Nasdaq Biotechnology Index
    100.00       110.26       65.65       95.19       112.10       110.81  
Nasdaq Composite Index
    100.00       102.53       96.57       110.05       117.19       124.54  
 
The information in this section shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference in such filing.
 
 
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ITEM 6.           SELECTED FINANCIAL DATA
 
The following selected consolidated financial information has been derived from our consolidated financial statements. The information below is not necessarily indicative of the results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 1A, “Risk Factors,” of this Form 10-K and the consolidated financial statements and related notes thereto included in Item 8 of this Form 10-K in order to fully understand factors that may affect the comparability of the information presented below.
 
The financial results relating to our former biotechnology, manufacturing and commercial operations have been presented as discontinued operations for all periods presented in the table below.
 
Consolidated Statements of Operations Data
 
   
For the Years Ended December 31,
 
(In thousands, except per share data)
 
2011
   
2010
   
2009
   
2008
   
2007
 
                               
Revenues:
 
 
                         
Royalties
  $ 351,641     $ 343,475     $ 305,049     $ 278,713     $ 224,735  
License and other
    10,400       1,500       13,135       15,483       350  
Total revenues
    362,041       344,975       318,184       294,196       225,085  
                                         
General and administrative expenses
    18,338       41,396       21,064       51,544       41,176  
Accrued legal settlement expense
    -       92,500       -       -       -  
Operating income
    343,703       211,079       297,120       242,652       183,909  
Non-operating income (expense), net
    (36,275 )     (60,709 )     (16,835 )     682       7,164  
Income from continuing operations before income taxes
    307,428       150,370       280,285       243,334       191,073  
Income tax expense
    108,039       58,496       90,625       5,014       10,624  
Income from continuing operations
    199,389       91,874       189,660       238,320       180,449  
Loss on discontinued operations, net of income taxes (1)
    -       -       -       (169,933 )     (201,510 )
Net income (loss)
  $ 199,389     $ 91,874     $ 189,660     $ 68,387     $ (21,061 )
                                         
Net income (loss) per basic share
                                       
Continuing operations
  $ 1.43     $ 0.73     $ 1.59     $ 2.01     $ 1.55  
Net income
  $ 1.43     $ 0.73     $ 1.59     $ 0.58     $ (0.18 )
                                         
Net income (loss) per diluted share
                                       
Continuing operations
  $ 1.15     $ 0.54     $ 1.07     $ 1.48     $ 1.34  
Net income
  $ 1.15     $ 0.54     $ 1.07     $ 0.47     $ (0.08 )
                                         
Dividends per share:
                                       
Cash dividends declared and paid
  $ 0.60     $ 1.00     $ 2.67     $ 4.25     $ -  
Stock distribution in connection with the Spin-Off of Facet
  $ -     $ -     $ -     $ 2.60     $ -  
 
Consolidated Balance Sheet Data
 
   
December 31,
 
(In thousands)
 
2011
   
2010
   
2009
   
2008
   
2007
 
                               
Cash, cash equivalents, investments and restricted cash
  $ 227,946     $ 248,229     $ 303,227     $ 147,527     $ 440,788  
Working capital
  $ 100,506     $ 90,672     $ 22,320     $ 149,168     $ 598,346  
Assets held for sale (2)
  $ -     $ -     $ -     $ -     $ 269,390  
Total assets
  $ 269,471     $ 316,666     $ 338,411     $ 191,142     $ 1,192,192  
Long-term obligations, less current portion
  $ 340,737     $ 446,857     $ 460,848     $ 510,698     $ 534,847  
Accumulated deficit
  $ (42,035 )   $ (241,424 )   $ (333,298 )   $ (522,958 )   $ (591,345 )
Total stockholders’ equity (deficit)
  $ (204,273 )   $ (324,182 )   $ (415,953 )   $ (352,569 )   $ 507,610  
 

(1)
The financial results for our former biotechnology, manufacturing and commercial operations have been presented as discontinued operations in our Consolidated Statements of Operations.
 
( 2)
The assets associated with our former commercial operations were presented as “held for sale” on our Consolidated Balance Sheet as of December 31, 2007, and such assets were fully divested in March 2008.
 
 
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ITEM 7.           MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Overview
 
PDL BioPharma Inc. (we, us, our, PDL and the Company) pioneered humanization of monoclonal antibodies and, by doing so, enabled the discovery of a new generation of targeted treatments for cancer and immunologic diseases. Today, PDL is focused on intellectual property asset management, investing in new royalty bearing assets and maximizing the value of its patent portfolio and related assets. We receive royalties based on sales of humanized antibody products marketed today and may also receive royalty payments on additional humanized antibody products launched before final patent expiry in December 2014. Under most of our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies . We have also entered into licensing agreements under which we have licensed certain rights for development stage products that have not yet reached commercialization including products that are currently in Phase 3 clinical trials.
 
Until December 2008, our business included a biotechnology operation which was focused on the discovery and development of novel antibodies which we spun-off (the Spin-Off) as Facet.
 
2011 Developments
 
Resolution of Challenges against the Queen et al. Patents in the United States and Europe
 
MedImmune Settlement
 
On February 10, 2011, we entered into a definitive settlement agreement with MedImmune, LLC (MedImmune) resolving all legal disputes with them, including those relating to MedImmune’s product Synagis ® and PDL’s patents known as the Queen et al. patents. Under the settlement agreement, PDL paid MedImmune $65.0 million on February 15, 2011, and an additional $27.5 million on February 9, 2012, for a total of $92.5 million. No further payments will be owed by MedImmune to PDL under its license to the Queen et al. patents as a result of past or future Synagis sales and MedImmune ceased any support, financial or otherwise, of any party involved in the appeal proceeding before the European Patent Office (EPO) relating to the opposition against the European Patent No. 0 451 216B (‘216B Patent) including the opposition owned by BioTransplant Inc. (BioTransplant).
 
Settlement with UCB
 
On February 2, 2011, we reached a settlement with UCB Pharma S.A. (UCB). Under the settlement agreement, PDL provided UCB a covenant not to sue UCB for any royalties regarding UCB’s Cimzia ® product under the Queen et al. patents in return for a lump sum payment of $10 million to PDL and termination of pending patent interference proceedings before the U.S. Patent and Trademark office (PTO) involving our U.S. Patent No. 5,585,089 patent (the ‘089 Patent) and our U.S. Patent No. 6,180,370 (‘370 Patent) in PDL’s favor. UCB also agreed to formally withdraw its opposition appeal challenging the validity of the ‘216B Patent.
 
Settlement with Novartis
 
On February 25, 2011, we reached a settlement with Novartis AG (Novartis). Under the settlement agreement, PDL agreed to dismiss its claims against Novartis in its action in Nevada state court which also includes Genentech and Roche as defendants. Novartis agreed to withdraw its opposition appeal in the EPO challenging the validity of the ‘216B Patent. Under the settlement agreement with Novartis, we will pay Novartis certain amounts based on net sales of Lucentis made by Novartis during calendar year 2011 and beyond. The settlement does not affect our claims against Genentech and Roche in the Nevada state court action. We do not currently expect such amount to materially impact our total annual revenues.
 
European Opposition to ‘216B Patent
 
Termination of European Opposition to ‘216B Patent
 
Pursuant to our settlements with UCB, MedImmune and Novartis, and as a result of our acquisition of BioTransplant and subsequent withdrawal of BioTransplant’s appeal, all of the active appellants in the EPO opposition have formally withdrawn their participation in the appeal proceeding. Accordingly, the EPO has cancelled the appeal proceeding and terminated the opposition proceeding in its entirety, with the result that the 2007 EPO decision upholding the claims of our ‘216B Patent as valid is the final decision of the EPO. In the year ending December 31, 2011, approximately 33% of our royalty revenues were derived from sales of products that were made in Europe and sold outside of the United States.
 
 
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Genentech / Roche Matter
 
Communications with Genentech regarding European SPCs
 
In August 2010, we received a letter from Genentech, sent on behalf of Roche and Novartis, asserting that Avastin ® , Herceptin ® , Lucentis ® and Xolair ® (the Genentech Products) do not infringe the supplementary protection certificates (SPCs) granted to PDL by various countries in Europe for each of the Genentech Products and seeking a response from PDL to these assertions. Genentech did not state what actions, if any, it intends to take with respect to its assertions. PDL’s SPCs were granted by the relevant national patent offices in Europe and specifically cover the Genentech Products. The SPCs covering the Genentech Products effectively extend our European patent protection for the ‘216B Patent generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014.
 
Genentech’s letter does not suggest that the Genentech Products do not infringe PDL’s U.S. patents to the extent that such Genentech Products are made, used or sold in the United States (U.S.-based Sales). Genentech’s quarterly royalty payments received after receipt of the letter have included royalties generated on all worldwide sales of the Genentech Products.
 
If Genentech is successful in asserting this position, then under the terms of our license agreements with Genentech, it would not owe us royalties on sales of the Genentech Products that are made and sold outside of the United States (ex-U.S.-based Manufacturing and Sales). Royalties on sale of the Genentech Products that are ex-U.S.-based Manufacturing and Sales accounted for approximately 33% of our royalty revenues for the year ended December 31, 2011. Based on announcements by Roche regarding moving more manufacturing outside of the United States, we expect this amount to increase in the future.
 
We believe that the SPCs are enforceable against the Genentech Products, that Genentech’s letter violates the terms of the 2003 settlement agreement and that Genentech owes us royalties on sales of the Genentech Products on a worldwide basis. We intend to vigorously assert our SPC-based patent rights.
 
Nevada Litigation with Genentech, Roche and Novartis in Nevada State Court
 
In August 2010, we filed a complaint in the Second Judicial District of Nevada, Washoe County, naming Genentech, Roche and Novartis as defendants. We intend to enforce our rights under our 2003 settlement agreement with Genentech and are seeking an order from the court declaring that Genentech is obligated to pay royalties to us on ex-U.S.-based Manufacturing and Sales of the Genentech Products.
 
The 2003 settlement agreement was entered into as part of a definitive agreement resolving intellectual property disputes between the two companies at that time. The agreement limits Genentech’s ability to challenge infringement of our patent rights and waives Genentech’s right to challenge the validity of our patent rights. Certain breaches of the 2003 settlement agreement as alleged by our complaint require Genentech to pay us liquidated and other damages of potentially greater than one billion dollars. This amount includes a retroactive royalty rate of 3.75% on past U.S.-based Sales of the Genentech Products and interest, among other items. We may also be entitled to either terminate our license agreements with Genentech or be paid a flat royalty of 3.75% on future U.S.-based Sales of the Genentech Products.
 
In November 2010, Genentech and Roche filed a motion to dismiss our complaint against them in which we seek to enforce our rights under the 2003 settlement agreement with Genentech. Genentech and Roche's motions to dismiss under Nevada Rule of Civil Procedure 12(b)(5) alleged that all of our claims for relief relating to the 2003 settlement agreement should be dismissed because the 2003 settlement agreement applies only to our U.S. patents. In addition, Roche filed a separate motion to dismiss our complaint under Nevada Rule of Civil Procedure 12(b)(2) on the ground that the Nevada court lacks personal jurisdiction over Roche. On July 7, 2011, the Second Judicial District Court of Nevada ruled in favor of us on the two motions to dismiss filed by Genentech and Roche. The court denied Genentech and Roche's motion to dismiss four of our five claims for relief and, further, denied Roche's separate motion to dismiss for lack of personal jurisdiction. The court dismissed one of our claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing stating that, based on the current state of the pleadings, no "special relationship" had been established between Genentech and us as required under Nevada law. On November 1, 2011, the Nevada court issued an order accepting Roche’s stipulation of waiver to its personal jurisdiction defense. As a result of the order, Roche is foreclosed from reliance on lack of personal jurisdiction in defending against our claims.
 
On February 25, 2011, we reached a settlement with Novartis under which, among other things, we agreed to dismiss our claims against Novartis in the action in Nevada state court against Genentech, Roche and Novartis. Genentech and Roche continue to be parties to the Nevada suit.
 
The court has scheduled trial to commence on May 13, 2013. The outcome of this litigation is uncertain and we may not be successful in our allegations.
 
 
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Convertible Notes
 
We have actively been working to restructure the Company’s capital and reduce dilution associated with our convertible notes. As part of those efforts, in May 2011, we issued $155.3 million in aggregate principal of 3.75% Senior Convertible Notes due 2015 (May 2015 Notes) in an underwritten public offering. Our May 2015 Notes “net share settle,” meaning that if a conversion occurs, the principal amount is due in cash, and to the extent that the conversion value exceeds the principal amount, the difference is due in shares of common stock. The proceeds from our May 2015 Notes were used to redeem the outstanding principal amount of our 2.00% Convertible Senior Notes due February 15, 2012 (2012 Notes). As a result, our 2012 Notes are no longer outstanding. By issuing our May 2015 Notes with the net share settle feature and redeeming our 2012 Notes, we eliminated 19.7 million shares of potential dilution to our stockholders.
 
In January 2012, we completed an exchange transaction where we exchanged and subsequently retired approximately $169.0 million aggregate principal amount, representing approximately 93.9%, of our 2.875% Convertible Senior Notes due February 15, 2015 (February 2015 Notes), for approximately $169.0 million aggregate principal amount of new 2.875% Series 2012 Convertible Senior Notes due February 15, 2015 (Series 2012 Notes), plus a cash payment of $5.00 for each $1,000 principal amount tendered for a total cash incentive payment of approximately $0.8 million. In February 2012, we entered into separate privately negotiated exchange agreements under which we retired an additional $10.0 million aggregate principal amount of our February 2015 Notes for $10.0 million aggregate principal amount of our Series 2012 Notes. Following settlement of the private exchanges on February 2, 2012, $1.0 million of our February 2015 Notes and $179.0 million of our Series 2012 Notes were outstanding. Like our May 2015 Notes, our Series 2012 Notes net share settle. The effect of issuing $179.0 million aggregate principal of our Series 2012 Notes with the net share settle feature in exchange for our February 2015 Notes was the reduction of 27.8 million shares of potential dilution to our stockholders.
 
Effect of December 15, 2011, Dividend Payment on Conversion Rates for the Convertible Notes
 
In connection with the December 15, 2011, dividend payment, the conversion rates for our convertible notes increased. The conversion rate for our February 2015 Notes was adjusted to 155.396 common shares per $1,000 principal amount, or approximately $6.44 per share, effective December 9, 2011.The conversion rate for our May 2015 Notes was adjusted to 135.9607 common shares per $1,000 principal amount, or approximately $7.36 per share, effective December 6, 2011.The adjustment was based on the amount of the dividend and the trading price of our stock under the terms of the applicable indenture. The conversion rate for our new Series 2012 Notes is 155.396 shares of the Company’s common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $6.44 per share of common stock.
 
2012 Dividends
 
On January 18, 2012, our board of directors declared regular quarterly dividends of $0.15 per share of common stock, payable on March 14, June 14, September 14 and December 14 of 2012 to stockholders of record on March 7, June 7, September 7 and December 7 of 2012, the record dates for each of the dividend payments, respectively. At the beginning of each fiscal year, our board of directors reviews the Company’s total annual dividend payment for the prior year and determines whether to increase, maintain or decrease the quarterly dividend payments for that year. The board of directors evaluates the financial condition of the Company and considers the economic outlook, corporate cash flow, the Company’s liquidity needs and the health and stability of credit markets when determining whether to maintain or change the dividend.
 
Critical Accounting Policies and Uses of Estimates
 
The preparation of our financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates. The items in our financial statements requiring significant estimates and judgments comprise:
 
Royalty Revenues
 
Under most of our patent license agreements, we receive royalty payments based upon our licensees’ net sales of covered products. Generally, under these agreements we receive royalty reports and payments from our licensees approximately one quarter in arrears, that is, generally in the second month of the quarter after the licensee has sold the royalty bearing product or products. We recognize royalty revenues when we can reliably estimate such amounts and collectability is reasonably assured. As such, we generally recognize royalty revenues in the quarter reported to us by our licensees, that is, royalty revenues are generally recognized one quarter following the quarter in which sales by our licensees occurred. Under this accounting policy, the royalty revenues we report are not based upon our estimates and are typically reported in the same period in which we receive payment from our licensees.
 
We may also receive minimal annual license maintenance fees from licensees of our Queen et al. patents prior to patent expiry as well as periodic milestone payments, payable at the election of the licensee, to maintain the license in effect. We have no performance obligations with respect to such fees. Maintenance fees are recognized as they are due and when payment is reasonably assured. Total milestone payments in each of the last several years have been less than 1% of total revenue.
 
 
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Foreign Currency Hedging
 
We hedge Eurodollar currency exposures related to our licensees’ product sales with Eurodollar forward contracts and Eurodollar option contracts. In general, these contracts are intended to offset the underlying Eurodollar market risks in our royalty revenues. We do not enter into speculative foreign currency transactions. We have designated the Eurodollar contracts as cash flow hedges. At the inception of the hedging relationship and on a quarterly basis, we assess hedge effectiveness. The fair value of the Eurodollar contracts is estimated using pricing models using readily observable inputs from actively quoted markets. The aggregate unrealized gain or loss on the effective portion of our Eurodollar contracts, net of estimated taxes, is recorded in stockholders’ deficit as accumulated other comprehensive income (loss). Gains or losses on cash flow hedges are recognized as royalty revenue in the same period that the hedged transaction, royalty revenue, impacts earnings. The hedge effectiveness is dependent upon the amounts of future royalties and, if future royalties, based on Eurodollar, are lower than forecasted, the amount of ineffectiveness would be reported in our Consolidated Statements of Income.
 
Income Taxes
 
Our income tax provision is based on income before taxes and is computed using the liability method. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using tax rates projected to be in effect for the year in which the differences are expected to reverse. We record a valuation allowance to reduce our deferred tax assets to the amounts that are more likely than not to be realized. Significant estimates are required in determining our provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations, or the expected results from any future tax examinations. Various internal and external factors may have favorable or unfavorable effects on our future provision for income taxes. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, the results of any future tax examinations, changing interpretations of existing tax laws or regulations, changes in estimates of prior years’ items, past levels of research and development spending, acquisitions, changes in our corporate structure and state of domicile and changes in overall levels of income before taxes all of which may result in periodic revisions to our provision for income taxes. We accrue tax related interest and penalties associated with uncertain tax positions and include these in income tax expense in the Consolidated Statements of Income. We expect that our effective income tax rate going forward will be approximately 35%.
 
Convertible Notes
 
In 2011 we issued our May 2015 Notes with a net share settlement feature, meaning that upon any conversion, the principal amount will be settled in cash and the remaining amount, if any, will be settled in shares of our common stock. In accordance with accounting guidance for convertible debt instruments that may be settled in cash or other assets on conversion, we separated the principal balance between the fair value of the liability component and the common stock conversion feature using a market interest rate for a similar nonconvertible instrument at the date of issuance. Using an assumed borrowing rate of 7.5%, which represents the estimated market interest rate for a similar convertible instrument available to us on the date of issuance, we recorded a total debt discount of $18.9 million, allocated $12.3 million to additional paid-in capital and $6.6 million to deferred tax liability.
 
Lease Guarantee
 
In connection with the Spin-Off, we entered into amendments to the leases for our former facilities in Redwood City, California, under which Facet was added as a co-tenant under the leases, and a Co-Tenancy Agreement, under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the Spin-Off date. Should Facet default under its lease obligations, we could be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities. As of December 31, 2011, the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $110.8 million. If Facet were to default, we could also be responsible for lease related costs including utilities, property taxes and common area maintenance which may be as much as the actual lease payments. In April 2010, Abbott Laboratories acquired Facet and later renamed the company Abbott Biotherapeutics Corp.
 
We recorded a liability of $10.7 million on our Consolidated Balance Sheets as of December 31, 2011 and 2010, for the estimated fair value of this guarantee. We prepared a discounted, probability-weighted cash flow analysis to calculate the estimated fair value of the lease guarantee as of the Spin-Off. We were required to make assumptions regarding the probability of Facet’s default on the lease payment, the likelihood of a sublease being executed and the times at which these events could occur. These assumptions are based on information that we received from real estate brokers and the then-current economic conditions, as well as expectations of future economic conditions. The fair value of this lease guarantee was charged to additional paid-in capital upon the Spin-Off and any future adjustments to the carrying value of the obligation will also be recorded in additional paid-in capital. On a quarterly basis, we review the underlying cash flow analysis assumptions and update them if necessary. In future periods, we may increase the recorded liability for this obligation if we conclude that a loss, which is larger than the amount recorded, is both probable and estimable.
 
 
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Summary of 2011, 2010 and 2009 Financial Results
 
·   
Our net income for the years ended December 31, 2011, 2010 and 2009, was $199.4 million, $91.9 million and $189.7 million, respectively;
 
·   
At December 31, 2011, we had cash, cash equivalents and investments of $227.9 million as compared with $248.2 million at December 31, 2010; and
 
·   
At December 31, 2011, we had $473.7 million in total liabilities as compared with $640.8 million at December 31, 2010.
 
Revenues
 
Revenues were $362.0 million, $345.0 million and $318.2 million for the years ended December 31, 2011, 2010 and 2009, respectively, and consist of royalty revenues as well as other license related revenues. During the years ended December 31, 2011, 2010 and 2009, our royalty revenues consisted of royalties and maintenance fees earned on sales of products under license agreements associated with our Queen et al. patents. Over this same time period, our other license related revenues primarily consisted of milestone payments from licensees under our patent license agreements as well as a $10.0 million payment in 2011 from our legal settlement with UCB and a $12.5 million payment in 2009 from our legal settlement with Alexion. Our revenues consist primarily of royalty revenues, which represent more than 95% of total revenues for each of the past three years. Revenue for the year ended December 31, 2011, is net of the payment made under our February 2011 settlement agreement with Novartis, which is based on a portion of the royalties that the company receives from Lucentis sales made by Novartis outside the United States.
 
A summary of our revenues for the years ended December 31, 2011, 2010 and 2009, is presented below:
 
(Dollars in thousands)
 
2011
   
2010
   
Change from Prior Year %
   
2009
   
Change from Prior Year %
 
Revenues
                             
Royalties
  $ 351,641     $ 343,475       2 %   $ 305,049       13 %
License and other
    10,400       1,500       593 %     13,135       -89 %
Total revenues
  $ 362,041     $ 344,975       5 %   $ 318,184       8 %
 
In the year ended December 31, 2011, we received royalties on sales of the seven humanized antibody products listed below, all of which are currently approved for use by the U.S. Food and Drug Administration (FDA) and other regulatory agencies outside the United States.
 
The licensees with commercial products as of December 31, 2011, are listed below:
 
Licensee
 
Product Names
Genentech, Inc. (Genentech)
 
Avastin ®
   
Herceptin ®
   
Xolair ®
   
Lucentis ®
     
Elan Corporation, Plc (Elan)
 
Tysabri ®
     
Wyeth Pharmaceuticals, Inc. (Wyeth)
 
Mylotarg ®
     
Chugai Pharmaceutical Co., Ltd. (Chugai)
 
Actemra ®
 
In June 2010, after results from a clinical trial raised concerns about the efficacy and safety of Mylotarg ® , Pfizer Inc. (Pfizer), the parent company of Wyeth, announced that it would be discontinuing commercial availability of Mylotarg. Approval for Raptiva ® , which was marketed by Genentech and Merck Serono S.A., was suspended in the European Union and in Canada in February 2009 and the product was withdrawn from the market in the United States in April 2009; accordingly, we do not expect to receive royalties on future sales of Raptiva.
 
Prior to 2010, we also received royalties for Synagis, which is marketed by MedImmune. In February 2011, we settled our dispute with MedImmune, and will not receive royalties on past or future sales of Synagis.
 
 
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For the years ended December 31, 2011, 2010 and 2009, we received royalties of $0.3 million, $0.9 million, and $1.9 million for sales of Mylotarg. For the years ended December 31, 2011 and 2010, we did not receive royalties for sales of Synagis or Raptiva. For the year ended December 31, 2009, we received royalties of $40.7 million and $1.2 million for sales of Synagis and Raptiva, respectively.
 
Under most of the agreements for the license of rights under our Queen et al. patents, we receive a flat-rate royalty based upon our licensees’ net sales of covered products. Royalty payments are generally due one quarter in arrears, that is, generally in the second month of the quarter after the licensee has sold the royalty-bearing product. Our agreement with Genentech provides for a tiered royalty structure under which the royalty rates Genentech must pay on the U.S.-based Sales in a given calendar year decreases on incremental U.S.-based Sales above certain sales thresholds based on 95% of the underlying gross U.S.-based Sales. As a result of the tiered royalty structure, Genentech’s average annual royalty rate for a given year will decline as Genentech’s U.S.-based Sales increase during that year. Because we receive royalties in arrears, the average royalty rate for the payments we receive from Genentech in our second calendar quarter for Genentech’s sales from the first calendar quarter has been and is expected to continue to be higher than the average royalty rate for following quarters. The average royalty rate for payments we receive from Genentech are generally lowest in our fourth and first calendar quarters for Genentech’s sales from the third and fourth calendar quarters when more of Genentech’s U.S.-based Sales bear royalties at the 1% royalty rate.
 
The net sales thresholds and the applicable royalty rates for Genentech’s U.S.-based Sales are outlined below:
 
Aggregate Net Sales on Product Made or Sold in U.S .
 
Royalty Rate
 
Net sales up to $1.5 billion
    3.0%  
Net sales between $1.5 billion and $2.5 billion
    2.5%  
Net sales between $2.5 billion and $4.0 billion
    2.0%  
Net sales exceeding $4.0 billion
    1.0%  
 
With respect to the ex-U.S.-based Manufacturing and Sales, the royalty rate that we receive from Genentech is a fixed rate of 3% based on 95% of the underlying gross ex-U.S.-based Manufacturing and Sales. The mix of U.S.-based Sales and ex-U.S.-based Manufacturing and Sales has fluctuated in the past and may continue to fluctuate in future periods, particularly in light of the 2009 acquisition of Genentech by Roche and Roche’s announcement that there are new plants in Singapore for the production of Avastin and Lucentis. The mix of net ex-U.S.-based Sales and net ex-U.S.-based Manufacturing and Sales for the Genentech Products, as outlined below, is based on information provided to us by Genentech. We were not provided the reasons for the shift in the manufacturing split between U.S.-based Sales and ex-U.S.-based Manufacturing and Sales.
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Avastin
                       
Ex-U.S.-based sales
    55 %       50 %       46 %  
Ex-U.S.-based Manufacturing and Sales
    21 %       21 %       0 %  
Herceptin
                             
Ex-U.S.-based sales
    71 %       70 %       70 %  
Ex-U.S.-based Manufacturing and Sales
    35 %       44 %       29 %  
Lucentis
                             
Ex-U.S.-based sales
    59 %       56 %       53 %  
Ex-U.S.-based Manufacturing and Sales
    0 %       0 %       0 %  
Xolair
                             
Ex-U.S.-based sales
    40 %       35 %       29 %  
Ex-U.S.-based Manufacturing and Sales
    40 %       35 %       29 %  
 
For the year ended December 31, 2011, compared to December 31, 2010
 
Royalty revenues increased 2% for the year ended December 31, 2011, when compared to the same period in 2010. The growth is primarily driven by increased net sales of Lucentis, Herceptin and Tysabri by our licensees. Net sales of Avastin, Herceptin and Lucentis are subject to a tiered royalty rate for product that is U.S.-based Sales and a flat royalty rate of 3% for product that is ex-U.S.-based Manufacturing and Sales.
 
·   
Reported net sales of Herceptin increased $0.7 billion or 13% compared to the same period for the prior year. Roche recently reported that global sales of Herceptin for HER2-postive breast cancer and advanced stomach cancer increased 8% in the first nine months of 2011 driven by further penetration in the early and metastatic breast cancer settings, particularly in emerging markets. Additionally, Roche reported that sales continue to benefit from uptake in advanced HER2-positive stomach cancer in Europe and other markets. While Herceptin net sales increased 13%, royalties on Herceptin only increased 5% due to a shift in site of manufacture: ex-U.S. manufactured and sold Herceptin declined to 35% compared to 44% for the same period in 2010.
 
 
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·   
Reported sales of Lucentis increased $1.0 billion or 33% compared to the same period for the prior year. Lucentis is approved for the treatment of age-related macular degeneration in the United States and in Europe and received approval for the treatment of macular edema following retinal vein occlusion in June 2010 in the United States and June 2011 in Europe. Reported sales in 2011 increased 27% in the United States and 38% internationally.
 
·   
Reported sales of Tysabri increased $0.3 billion or 22% compared to the same period for the prior year. Tysabri royalties are determined at a flat rate as a percent of the sales regardless of location of manufacture or sale.
 
·  
Reported net sales of Avastin decreased $0.1 billion or 2% compared to the same period for the prior year. Roche recently reported that sales in the United States were negatively impacted by reimbursement uncertainty regarding the metastatic breast cancer indication which was revoked by the U.S. Food and Drug Administration in November 2011. In Europe, austerity measures and declines in the metastatic breast cancer indication also affected sales. Additionally, Roche reported that sales of Avastin for advanced colorectal, breast, lung and kidney cancer and for relapsed glioblastoma, rose 9% in international markets, including China, for the first nine months of 2011 driven by a positive uptake of the product.
 
For the year ended December 31, 2010, compared to December 31, 2009
 
Excluding royalties for Synagis, royalty revenues for the year ended December 31, 2010, increased 30% when compared to the same period of 2009. The growth was primarily driven by increased sales of Avastin, Herceptin and Lucentis by our licensees.
 
·  
Reported net sales of Avastin increased $0.8 billion or 15% compared to the same period for the prior year. In addition, net Ex-U.S. manufactured and sold Avastin accounted for 21% of net sales compared to zero the same period for the prior year.
 
·  
Reported net sales of Herceptin increased $0.5 billion or 11% compared to the same period for the prior year. Also, net Ex-U.S. manufactured and sold Herceptin increased $1.0 billion or 68% compared to the same period for the prior year.
 
·   
Reported net sales of Lucentis increased $0.9 billion or 43% when compared to the same period for the prior year. Ex-U.S. net sales of Lucentis increased 51% compared to the same period for the prior year and represented 53% of total global net sales.
 
The following table summarizes the percentage of our total revenues earned from our licensees’ net product sales, which individually accounted for 10% or more of our total revenues for the years ended December 31, 2011, 2010 and 2009:

       
Year Ended December 31,
 
Licensee
 
Product Name
 
2011
   
2010
   
2009
 
Genentech
 
Avastin
    31 %       34 %       27 %  
   
Herceptin
    33 %       33 %       29 %  
   
Lucentis
    15 %       13 %       10 %  
                                   
Elan
 
Tysabri
    12 %       10 %       9 %  
                                   
MedImmune (1)
 
Synagis
    0 %       0 %       13 %  
 
(1)
In February 2011, we settled our dispute with MedImmune and will not receive royalties on past or future sales of Synagis.
 
Foreign currency exchange rates also impact our revenue results. More than 50% of our licensees’ product sales are in currencies other than U.S. dollars; as such, our revenues may fluctuate due to changes in foreign currency exchange rates and are subject to foreign currency exchange risk. While foreign currency conversion terms vary by license agreement, generally most agreements require that royalties first be calculated in the currency of sale and then converted into U.S. dollars using the average daily exchange rates for that currency for a specified period at the end of the calendar quarter. Accordingly, when the U.S. dollar weakens against other currencies, the converted amount is greater than it would have been had the U.S. dollar not weakened. For example, in a quarter in which we generate $70 million in royalty revenues, approximately $35 million is based on sales in currencies other than U.S. dollar. If the U.S. dollar strengthens across all currencies by ten percent during the conversion period for that quarter, when compared to the same amount of local currency royalties for the prior year, U.S. dollar converted royalties will be approximately $3.5 million less in the current quarter than in the prior year quarter. For the year ended December 31, 2011, royalty revenue was favorably impacted by changes in foreign currency compared to the year ended December 31, 2010. In comparison, for the year ended December 31, 2010, royalty revenue was unfavorably impacted by changes in foreign currency compared to the year ended December 31, 2009. The impact on full year revenue is greatest in the second quarter when we receive the largest amount of royalties because the Genentech tiered royalties are at their highest rate for first quarter sales.
 
 
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We hedge Eurodollar exposures related to our licensees’ product sales with Eurodollar contracts. In general, these contracts are intended to offset the underlying Eurodollar currency market risks in our royalty revenues. We have designated the Eurodollar contracts as cash flow hedges. The aggregate unrealized gain or loss on our Eurodollar contracts, net of estimated taxes, on the effective portion of the hedge is recorded in stockholders’ deficit as accumulated other comprehensive income (loss). Gains or losses on cash flow hedges are recognized as royalty revenue in the same period that the hedged transaction, royalty revenue, impacts earnings. For the years ended December 31, 2011 and 2010, we recognized $1.0 million and $5.2 million in royalty revenues from our Eurodollar contracts, respectively. Prior to 2010, we did not have any foreign currency exchange contracts.
 
The following table presents the quarterly, five-day average U.S. dollar per Eurodollar exchange rate for quarterly royalty payments received in each of the years ended December 31, 2011, 2010 and 2009:
 
5 Day Average USD/EUR Rate
 
2011
   
2010
   
2009
 
Royalties received in Q1
    1.32       1.44       1.41  
Royalties received in Q2
    1.41       1.34       1.34  
Royalties received in Q3
    1.43       1.23       1.40  
Royalties received in Q4
    1.35       1.35       1.47  
 
Operating Expenses
 
A summary of our operating expenses for the years ended December 31, 2011, 2010 and 2009, is presented below:
 
(Dollars in thousands)
 
2011
   
2010
   
Change from Prior Year %
   
2009
   
Change from Prior Year %
 
Operating expenses
                             
General and administrative
  $ 18,338     $ 41,396       -56 %   $ 21,064       97 %
Legal settlement
    -       92,500       N/A       -       N/A  
Total operating expenses
  $ 18,338     $ 133,896       -86 %   $ 21,064       536 %
 
For the year ended December 31, 2011, compared to December 31, 2010
 
The decrease in operating expenses was primarily driven by reduced legal fees with the resolution of the MedImmune litigation and the UCB interference proceedings.
 
For the year ended December 31, 2010, compared to December 31, 2009
 
The increase in operating expenses was primarily driven by our $92.5 million legal settlement with MedImmune as well as increases in other legal related fees, professional services expense and compensation expense. The increase in professional services expense is due to costs associated with the implementation of a global royalty audit program, tax consultation and the preparation of long term sales and royalty forecasts by outside consultants. Compensation expense increased primarily as a result of filling staff positions which were vacant in the first half of 2009.
 
 
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Individual components of operating expenses for the years ended December 31, 2011 and 2010, comprise:
 
   
Year Ended December 31,
   
Change from
 
(In thousands)
 
2011
   
2010
    Prior Year %  
Operating expenses:
                 
General and administrative
                 
Compensation and benefits
  $ 4,428     $ 4,065       9 %
Legal fees
    7,942       29,315       -73 %
Professional services
    2,674       2,943       -9 %
Insurance
    724       793       -9 %
Stock-based compensation
    387       662       -42 %
Depreciation
    58       91       -36 %
Other
    2,125       3,527       -40 %
Total general and administrative
    18,338       41,396       -56 %
Legal settlement
    -       92,500       N/A  
Total operating expenses
  $ 18,338     $ 133,896       -86 %
 
Non-operating Expense, Net
 
A summary of our non-operating expense, net, for the years ended December 31, 2011, 2010 and 2009, is presented below:
 
(Dollars in thousands)
 
2011
   
2010
   
Change from Prior Year %
   
2009
   
Change from Prior Year %
 
Gain (loss) on retirement or conversion of convertible notes
  $ (766 )   $ (17,648 )  
NM (1)
    $ 1,518    
NM (1)
 
Interest and other income, net
    593       468       27 %     1,004       -53 %
Interest expense
    (36,102 )     (43,529 )     -17 %     (19,357 )     125 %
Total non-operating expense, net
  $ (36,275 )   $ (60,709 )     -40 %   $ (16,835 )     261 %
 

(1)
NM – Not meaningful
 
For the year ended December 31, 2011, compared to December 31, 2010
 
Non-operating expense, net, decreased primarily due to lower costs related to our convertible note retirement and conversions and lower interest as a result of our $110.9 million reduction in the principal balance of our Non-recourse Notes.
 
For the year ended December 31, 2010, compared to December 31, 2009
 
Non-operating expense, net, increased $43.9 million due primarily to an increase of $24.2 million in interest expense with the issuance of $300.0 million of our subsidiary’s Non-recourse Notes in November 2009 that bear interest at 10.25% per annum. Additionally, the loss on retirement or conversion of convertible notes was $19.2 million higher than the prior year primarily due to the exchange and retirement transactions on our 2023 Notes.
 
Income Taxes
 
Income tax expense for the year ended December 31, 2011, was $108.0 million, which resulted primarily from applying the federal statutory income tax rate to operating income. Income tax expense for the year ended December 31, 2010, was $58.5 million, which resulted primarily from applying the federal statutory income tax rate to operating income and adjusting for a portion of the loss on the retirement or conversion of our 2023 Notes that was not tax deductible. Income tax expense for the year ended December 31, 2009, was $90.6 million, which resulted primarily from applying the federal statutory income tax rate to operating income less an adjustment to re-establish net operating loss carryforwards and certain other adjustments. We no longer pay state income taxes because we moved our operations from California to Nevada in December 2008 and Nevada does not impose a corporate income tax.
 
During the year ended December 31, 2011, we recorded a $0.5 million increase in our liability for interest and penalties associated with uncertain tax positions. The future impact of the unrecognized tax benefit of $23.6 million, if recognized, comprises $12.7 million which would affect the effective tax rate and $10.9 million which would result in adjustments to deferred tax assets and corresponding adjustments to the valuation allowance.
 
 
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Estimated interest and penalties associated with unrecognized tax benefits increased our income tax expense in the Consolidated Statements of Income by $0.5 million during the year ended December 31, 2011, and decreased income tax expense by $26,000, and $0.4 million during the years ended December 31, 2010 and 2009, respectively. Although the timing of the resolution of income tax examinations is highly uncertain, and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year, we do not anticipate any material change to the amount of our unrecognized tax benefit over the next 12 months.
 
As of December 31, 2011, we had deferred tax assets in excess of our deferred tax liabilities of approximately $21.5 million. We recorded a valuation allowance to reduce our deferred tax assets to amounts that are more likely than not to be realized. As of December 31, 2011, we had a valuation allowance of $10.9 million, primarily related to net operating loss carry forwards and research and development tax credits.
 
Net Income per Share
 
Net income per share for the years ended December 31, 2011, 2010 and 2009, was:

   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Net income per basic share
  $ 1.43     $ 0.73     $ 1.59  
Net income per diluted share
  $ 1.15     $ 0.54     $ 1.07  
 
Non-GAAP Net Income per Share
 
We are presenting net income per share in conformance with GAAP and also on a non-GAAP basis for the years ended December 31, 2011, 2010 and 2009, because we believe that this non-GAAP information gives investors an additional way to review profitability taken in conjunction with the Company’s GAAP financial statements. For example, we had a significant litigation settlement in 2010 and convertible debt retirements and conversions in the three years presented that affect comparability between the years. We do not use these non-GAAP measures for any other purpose, such as compensation determination. Non-GAAP financial information is not prepared under a comprehensive set of accounting rules and should only be used to supplement an understanding of the Company’s net income as reported under GAAP. The effect of the non-GAAP adjustments to net income per share:
 
·
Increases net income per diluted share from $1.15 to $1.17 for the year ended December 31, 2011;
 
·  
Increases net income per diluted share from $0.54 to $0.97 for the year ended December 31, 2010; and
 
·  
Decreases net income per diluted share from $1.07 to $1.06 for the year ended December 31, 2009.
 
The adjustments comprise:
 
For the year ended December 31, 2011, we redeemed $133.5 million in aggregate principal of our 2012 Notes, at a redemption price of 100.29% of face value for aggregate consideration of $133.9 million plus interest of $1.0 million. This transaction resulted in a charge to non-operating expense, net, of $0.8 million, or $0.5 million net of tax. Additionally, in May 2011, we issued our May 2015 Notes, which in accordance with the accounting guidance for convertible debt instruments that may be settled in cash or other assets on conversion, required us to separately account for the liability component of the instrument in a manner that reflects the market interest rate for a similar nonconvertible instrument at the date of issuance. As a result, we separated the principal balance of our May 2015 Notes between the fair value of the debt component and the common stock conversion feature. Using an assumed borrowing rate of 7.5%, which represents the estimated market interest rate for a similar nonconvertible instrument available to us on the date of issuance, we recorded a total debt discount of $18.9 million, allocated $12.3 million to additional paid-in capital and $6.6 million to deferred tax liability. For the year ended December 31, 2011, the additional interest expense attributable to using an implied borrowing rate of 7.5% rather than the stated coupon rate of 3.75% was $2.6 million, or $1.7 million net of tax.
 
For the year ended December 31, 2010, we recorded a $92.5 million, $60.1 million, net of tax, legal settlement related to a definitive settlement agreement with MedImmune. In addition, to limit the further dilution from our 2023 Notes, we exchanged an aggregate $61.6 million principal value of our 2023 Notes in privately negotiated transactions with institutional holders for consideration consisting of the issuance of the number of shares of common stock convertible per the terms of our 2023 Notes plus three additional shares per $1,000 in principal for a total of 11.1 million shares. This exchange resulted in a charge to non-operating expense, net, of $1.2 million plus transaction fees of $1.2 million for an aggregate charge of $2.4 million which is not deductible for income tax purposes. We also repurchased at market prices an aggregate $84.2 million principal value of our 2023 Notes at an average premium of 19% to principal value for total consideration of $100.4 million in cash, plus accrued interest. Additionally, we exchanged $92.0 million in aggregate principal of our 2012 Notes for February 2015 Notes. In the aggregate, these transactions resulted in a charge to non-operating expense, net, of $17.6 million, $16.4 million net of tax.
 
 
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During the year ended December 31, 2009, we repurchased $22.0 million principal value of our 2012 Notes, in two separate transactions, at a combined discount of approximately a 4.8% discount to principal value for total consideration of $21.0 million in cash plus accrued interest. We also repurchased $50.0 million principal value of our 2023 Notes at approximately a 2% discount to principal value for total consideration of $49.0 million in cash, plus accrued interest. In the aggregate, these transactions resulted in a gain of $1.5 million, $0.9 million net of tax.
 
Excluding the gain (loss) on the retirement or conversion of convertible notes, the non-cash interest expense on our May 2015 Notes, the 2010 MedImmune settlement and the tax effect of these transactions, non-GAAP net income per diluted share was:

   
Year Ended December 31,
 
(In thousands)
 
2011
   
2010
   
2009
 
Numerator
                 
Net income
  $ 199,389     $ 91,874     $ 189,660  
Add back legal settlement expense
    -       92,500       -  
Deduct income tax benefit on legal settlement expense
    -       (32,375 )     -  
Add back loss (gain) on retirement or conversion of convertible notes
    766       17,648       (1,518 )
Deduct income tax expense (benefits) on retirement or conversion of convertible notes
    (268 )     (1,217 )     531  
Amortization of debt discount on May 2015 Notes, net of $0.9 million estimated taxes
    1,716       -       -  
Non-GAAP net income
    201,603       168,430       188,673  
Add back interest expense for convertible notes, net of estimated tax
    5,544       5,087       7,079  
Non-GAAP income used to compute non-GAAP net income per diluted share
  $ 207,147     $ 173,517     $ 195,752  
                         
Denominator
                       
Shares used to compute net income per diluted share
    177,441       178,801       184,400  
Adjustment to shares issued to induce note conversion to common stock (1)
    -       (73 )     -  
Shares used to compute non-GAAP net income per diluted share
    177,441       178,728       184,400  
                         
Non-GAAP net income per diluted share
  $ 1.17     $ 0.97     $ 1.06  
 

(1)  
The shares used to compute non-GAAP net income per diluted share amounts are the same as the shares used to compute GAAP net income per diluted share amounts, except the shares for the year ended December 31, 2010, non-GAAP net income per diluted share, exclude the weighted average effect of shares issued as an incentive to induce conversion of our 2023 Notes in August 2010.
 
Liquidity and Capital Resources
 
We finance our operations primarily through royalty and other license related revenues, public and private placements of debt and equity securities and interest income on invested capital. We currently have fewer than ten employees managing our intellectual property, our licensing operations and other corporate activities as well as providing for certain essential reporting and management functions of a public company.
 
We had cash, cash equivalents and investments in the aggregate of $227.9 million and $248.2 million at December 31, 2011 and 2010, respectively. The $20.3 million decrease was primarily attributable to payment of dividends of $83.8 million, repurchase of convertible notes of $133.9 million, including the $0.4 million incentive, repayment of our Non-recourse Notes of $110.9 million, and purchase of call options, including legal fees, of $20.8 million, offset by net cash provided by operating activities of $169.8 million, net proceeds from the issuance of our May 2015 Notes of $149.7 million and $10.9 million from the issuance of warrants. We believe that cash from future royalty revenues, net of operating expenses, debt service and income taxes, plus cash on hand, will be sufficient to fund our operations over the next several years. The last of our Queen et al. patents expire in December 2014, with the obligation to pay royalties under various license agreements expiring sometime thereafter, and we do not expect to receive any meaningful revenue from the inventories produced prior to the expiration of our Queen et al. patents beyond the first quarter of 2016. As such, we are pursuing the acquisition of new royalty generating assets if such royalty assets can be acquired on terms that allow us to increase the return to stockholders.
 
We continuously evaluate alternatives to increase return for our stockholders, for example, purchasing royalty generating assets, buying back our convertible notes, repurchasing our common stock, selling the Company and paying dividends. On January 18, 2012, our board of directors declared regular quarterly dividends of $0.15 per share of common stock, payable on March 14, June 14, September 14 and December 14 of 2012 to stockholders of record on March 7, June 7, September 7 and December 7 of 2012, the record dates for each of the dividend payments, respectively.
 
 
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Convertible Notes
 
May 2015 Notes
 
In May 2011, we issued May 2015 Notes, with a principal amount of $155.3 million. Our May 2015 Notes are due May 1, 2015, and are convertible into 135.9607 shares of the Company’s common stock per $1,000 of principal amount, or approximately $7.36 per share, subject to further adjustment upon certain events including dividend payments. We pay interest at 3.75% on our May 2015 Notes semiannually in arrears on May 1 and November 1 of each year, beginning November 1, 2011. Upon the occurrence of a fundamental change, as defined in the indenture, holders have the option to require PDL to repurchase their May 2015 Notes at a purchase price equal to 100% of the principal, plus accrued interest.   Our May 2015 Notes are convertible under any of the following circumstances:
 
·    
During any fiscal quarter ending after the quarter ending June 30, 2011, if the last reported sale price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price for the notes on the last day of such preceding fiscal quarter;
 
·    
During the five business-day period immediately after any five consecutive trading-day period, which we refer to as the measurement period, in which the trading price per $1,000 principal amount of notes for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes for each such day;
 
·   
Upon the occurrence of specified corporate events as described further in the indenture; or

·   
At any time on or after November 1, 2014.
 
If a conversion occurs, to the extent that the conversion value exceeds the principal amount, the principal amount is due in cash and the difference between the conversion value and the principal amount is due in shares of the Company’s common stock.

In connection with the issuance of our May 2015 Notes, we entered into purchased call option transactions with two hedge counterparties entitling the Company to initially purchase up to 19.6 million shares of the Company’s common stock. In addition, we sold to the hedge counterparties warrants exercisable, on a cashless basis, for up to 27.5 million shares of the Company’s common stock. The purchased call option transactions and warrant sales effectively serve to reduce the potential dilution associated with conversion of our May 2015 Notes. The strike prices are approximately $7.36 and $8.65, subject to further adjustment upon certain events including dividend payments, for the purchased call options and warrants, respectively.

If the share price is above $7.36, upon conversion of our May 2015 Notes, the purchased call options will offset the share dilution, because the Company will receive shares on exercise of the purchased call options equal to the shares that the Company must deliver to the note holders. If the share price is above $8.65, upon exercise of the warrants, the Company will deliver shares to the counterparties in an amount equal to the excess of the share price over $8.65. For example, a 10% increase in the share price above $8.65 would result in the issuance of 1.9 million incremental shares upon exercise of the warrants. As our share price continues to increase, additional dilution would occur.

While the purchased call options are expected to reduce the potential equity dilution upon conversion of our May 2015 Notes, prior to conversion or exercise, our May 2015 Notes and the warrants could have a dilutive effect on the Company’s earnings per share to the extent that the price of the Company’s common stock during a given measurement period exceeds the respective exercise prices of those instruments. As of December 31, 2011, the if-converted amount of our May 2015 Notes was less than the principal amount. Therefore, no purchased call options or warrants were exercised at December 31, 2011.

The purchased call options and warrants are considered indexed to PDL stock, require net-share settlement, and met all criteria for equity classification at inception and at December 31, 2011. The purchased call options cost, including legal fees, of $20.8 million, less deferred taxes of $7.2 million, and the $10.9 million received for the warrants were recorded as adjustments to additional paid-in capital. Subsequent changes in fair value will not be recognized as long as the purchased call options and warrants continue to meet the criteria for equity classification. As of December 31, 2011, $155.3 million of our May 2015 Notes were outstanding.

Purchased Call Options

We paid an aggregate amount of $20.8 million to two hedge counterparties, plus legal fees, for the purchased call options with terms substantially similar to the embedded conversion options in our May 2015 Notes. The purchased call options cover, subject to anti-dilution and certain other customary adjustments substantially similar to those in our May 2015 Notes, approximately 21.1 million shares of our common stock at a strike price of approximately $7.36, which corresponds to the conversion price of our May 2015 Notes. We may exercise the purchased call options upon conversion of our May 2015 Notes and require the hedge counterparty to deliver shares to the Company in an amount equal to the shares required to be delivered by the Company to the note holder for the excess conversion value. The purchased call options expire on May 1, 2015, or the last day any of our May 2015 Notes remain outstanding.
 
 
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Warrants

We received an aggregate amount of $10.9 million from the two hedge counterparties for the sale of rights to receive up to 27.5 million shares of common stock underlying our May 2015 Notes, at a current strike price of approximately $8.65 per share, subject to additional anti-dilution and certain other customary adjustments. The warrant counterparties may exercise the warrants on their specified expiration dates that occur over a period of time ending on January 20, 2016. If the volume weighted average share price (VWAP) of our common stock, as defined in the warrants , exceeds the strike price of the warrants, we will deliver to the warrant counterparties shares equal to the spread between the VWAP on the date of exercise or expiration and the strike price. If the VWAP is less than the strike price, neither party is obligated to deliver anything to the other.
 
February 2015 Notes
 
On November 1, 2010, we completed an exchange of $92.0 million in aggregate principal of our 2012 Notes in separate, privately negotiated transactions with the note holders. In the exchange transactions, the note holders received $92.0 million in aggregate principal of our February 2015 Notes. As part of the transaction, the Company also placed an additional $88.0 million in aggregate principal of our February 2015 Notes. Our February 2015 Notes are due February 15, 2015, and are convertible at any time, at the holders’ option, into our common stock at a conversion price of 155.396 shares of common stock per $1,000 principal amount or $6.44 per share of common stock, subject to further adjustment in certain events including dividend payments. Interest on our February 2015 Notes is payable semiannually in arrears on February 15 and August 15 of each year. Our February 2015 Notes are senior unsecured debt and are redeemable by us in whole or in part on or after August 15, 2014, at 100% of principal amount. Our February 2015 Notes are not puttable by the note holders other than in the context of a fundamental change resulting in the reclassification, conversion, exchange or cancellation of our common stock. Such repurchase event or fundamental change is generally defined to include a merger involving PDL, an acquisition of a majority of PDL’s outstanding common stock and a change of a majority of PDL’s board of directors without the approval of the board of directors. The issuance of our February 2015 Notes was not registered under the Securities Act of 1933, as amended, in reliance on exemption from registration thereunder. As of December 31, 2011, $180.0 million of our February 2015 Notes were outstanding.
 
Series 2012 Notes
 
In January 2012, we completed an exchange transaction where we exchanged and subsequently retired approximately $169.0 million aggregate principal amount, representing approximately 93.9%, of our February 2015 Notes, for approximately $169.0 million aggregate principal amount of new Series 2012 Notes, plus a cash payment of $5.00 for each $1,000 principal amount tendered for a total cash incentive payment of approximately $0.8 million. In February 2012, we entered into separate privately negotiated exchange agreements under which we retired an additional $10.0 million aggregate principal amount of our February 2015 Notes for $10.0 million aggregate principal amount of our Series 2012 Notes. Following settlement of the private exchanges on February 2, 2012, $1.0 million of our February 2015 Notes and $179.0 million of our Series 2012 Notes were outstanding. Like our May 2015 Notes, our Series 2012 Notes net share settle. The effect of issuing $179.0 million aggregate principal of our Series 2012 Notes with the net share settle feature in exchange for our February 2015 Notes was the reduction of 27.8 million shares of potential dilution to our stockholders.
 
Our Series 2012 Notes bear interest at a rate of 2.875% per annum, payable semiannually in arrears on February 15 and August 15 of each year, beginning on February 15, 2012. The initial conversion rate for our Series 2012 Notes is 155.396 shares of the Company’s common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $6.44 per share of common stock. Upon conversion of Series 2012 Notes, the Company will be required to pay cash and, if applicable, deliver shares of the Company’s common stock.
 
The terms of our Series 2012 Notes are governed by the Indenture, dated as of January 5, 2012, between the Company and The Bank of New York Mellon Trust Company, N.A. A summary of the terms of our Series 2012 Notes is contained in, and a copy of the governing Indenture has been filed as an exhibit to, the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 6, 2012.
 
Non-recourse Notes
 
In November 2009, we completed a $300 million securitization transaction in which we monetized 60% of the net present value of the estimated five year royalties (the Genentech Royalties) from sales of Genentech Products including Avastin, Herceptin, Lucentis, Xolair and future products, if any, under which Genentech may take a license under our related agreements with Genentech. Our Non-recourse Notes due March 15, 2015, bear interest at 10.25% per annum and were issued in a non-registered offering by QHP, a Delaware limited liability company, and a newly formed, wholly-owned subsidiary of PDL. The Genentech Royalties and other payments, if any, that QHP is entitled to receive under the agreements with Genentech, together with any funds made available from certain accounts of QHP, are the sole source of payment of principal and interest on our Non-recourse Notes, which are secured by a continuing security interest granted by QHP in its rights to receive the Genentech Royalties. Our Non-recourse Notes may be redeemed at any time prior to maturity, in whole or in part, at the option of QHP at a make-whole redemption price. The amount of quarterly repayment of the principal of our Non-recourse Notes will vary based upon the amount of future quarterly Genentech Royalties received. As of December 31, 2011, $93.4 million in aggregate principal of our Non-recourse Notes was outstanding. The anticipated final repayment date of our Non-recourse Notes is September 2012.
 
 
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2012 Notes Retirement
 
In February 2005, we issued our 2012 Notes due February 15, 2012, with a principal amount of $250.0 million. In 2009, we repurchased $22.0 million in aggregate face value of our 2012 Notes, at an average discount of 4.8% from face value in open market transactions for aggregate consideration of $21.0 million in cash, plus accrued but unpaid interest. In November 2010, we exchanged $92.0 million aggregate principal of our 2012 Notes in separate, privately negotiated transactions with the note holders. In the exchange transactions, the note holders received $92.0 million in aggregate principal of new February 2015 Notes. In December 2010, we repurchased $2.5 million of 2012 Notes in the open market at a discount of 0.5% to principal value, for aggregate consideration of $2.5 million in cash, plus accrued but unpaid interest. In June 2011, we redeemed the final $133.5 million aggregate principal outstanding for aggregate consideration of $133.9 million plus $1.0 million interest. As of December 31, 2011, our 2012 Notes were fully retired.
 
2023 Notes Retirement
 
In July 2003, we issued our 2023 Notes due August 16, 2023, with a principal amount of $250.0 million. In 2009, we repurchased an aggregate of $50.0 million principal value of our 2023 Notes, at a discount of 2.0% from principal value in open market transactions for aggregate consideration of $49.0 million in cash, plus accrued interest. During the three months ended June 30, 2010, we repurchased an aggregate of $84.2 million principal value of our 2023 Notes, in the open market at a premium of 19% to principal value for aggregate consideration of $100.4 million in cash, plus accrued interest. In August 2010, we exchanged an aggregate of $61.6 million principal value of our 2023 Notes in privately negotiated transactions with institutional holders for consideration consisting of the issuance of the number of shares of common stock convertible per the terms of our 2023 Notes plus three additional shares per $1,000 in principal for a total of 11.1 million shares. Subsequent to the exchange transaction, we issued a redemption notice for the remaining principal outstanding after the exchange transaction of $54.3 million. Under the redemption notice, $50.1 million of the outstanding principal was converted to 8.9 million shares of common stock and $4.2 million was redeemed for cash. As of December 31, 2010, our 2023 Notes were fully retired.
 
Contractual Obligations
 
As of December 31, 2011, our contractual obligations consisted primarily of our May 2015 Notes, our February 2015 Notes and our Non-recourse Notes, which in the aggregate totaled $428.6 million in principal. Our May 2015 Notes and our February 2015 Notes are not puttable by the note holders other than in the context of a fundamental change.
 
In January 2012, we completed an exchange transaction where we exchanged and subsequently retired approximately $169.0 million aggregate principal amount, representing approximately 93.9%, of our February 2015 Notes, for approximately $169.0 million aggregate principal amount of new Series 2012 Notes. Additionally, in February 2012, we entered into separate privately negotiated exchange agreements under which we retired an additional $10.0 million aggregate principal amount of our February 2015 Notes for $10.0 million aggregate principal amount of our Series 2012 Notes. Following settlement of the private exchanges on February 2, 2012, $1.0 million of our February 2015 Notes and $179.0 million of our Series 2012 Notes were outstanding. Like our May 2015 Notes, our Series 2012 Notes net share settle.
 
We expect that our debt service obligations over the next several years will consist of interest payments and repayment of our May 2015 Notes, our February 2015 Notes and our Series 2012 Notes. Also our debt service obligations in 2012 include our Non-recourse-Notes, which we expect will be fully retired in the third quarter of 2012. We may further seek to exchange, repurchase or otherwise acquire the convertible notes in the open market in the future which could adversely affect the amount or timing of any distributions to our stockholders. We would make such exchanges or repurchases only if we deemed it to be in our stockholders’ best interest. We may finance such repurchases with cash on hand and/or with public or private equity or debt financings if we deem such financings are available on favorable terms.
 
 
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Material contractual obligations including interest under lease and debt agreements for the next five years and thereafter are:
 
       
Payments Due by Period
 
       
Less Than
               
More than
       
(In thousands)
     
1 Year
   
1-3 Years
   
4-5 Years
   
5 Years
   
Total
 
Operating leases        (1)
      $ 176     $ 83     $ -     $ -     $ 259  
Convertible notes      (2)
        10,997       21,994       337,837       -       370,828  
Non-recourse notes  (3)
        98,249       -       -       -       98,249  
Total contractual obligations
    $ 109,422     $ 22,077     $ 337,837     $ -     $ 469,336  
 

(1)
Amounts represent the lease for our headquarters in Incline Village and operating leases for office equipment.
(2)
Amounts represent principal and cash interest payments due on the convertible notes.
(3)
Amounts represent principal and cash interest payments due on the Non-recourse Notes, and are based on anticipated future royalties to be received from Genentech with the anticipated final payment date in September 2012.
 
Lease Guarantee
 
In connection with the Spin-Off of Facet we entered into amendments to the leases for our former facilities in Redwood City, California, under which Facet was added as a co-tenant, and a Co-Tenancy Agreement, under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the Spin-Off date. Should Facet default under its lease obligations, we could be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities. As of December 31, 2011, the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $110.8 million. If Facet were to default, we could also be responsible for lease related costs including utilities, property taxes and common area maintenance which may be as much as the actual lease payments. In April 2010, Abbott Laboratories acquired Facet and later renamed the company Abbott Biotherapeutics Corp. We have recorded a liability of $10.7 million on our Consolidated Balance Sheets as of December 31, 2011, and 2010, related to this guarantee.
 
ITEM 7A.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Foreign Currency Risk
 
The underlying sales of our licensees’ products are conducted in multiple countries and in multiple currencies throughout the world. While foreign currency conversion terms vary by license agreement, generally most agreements require that royalties first be calculated in the currency of sale and then converted into U.S. dollars using the average daily exchange rates for that currency for a specified period at the end of the calendar quarter. Accordingly, when the U.S. dollar weakens in relation to other currencies, the converted amount is greater than it would have been had the U.S. dollar not weakened. More than 50% of our licensees’ product sales are in currencies other than U.S. dollars; as such, our revenues may fluctuate due to changes in foreign currency exchange rates and is subject to foreign currency exchange risk. For example, in a quarter in which we generate $70 million in royalty revenues, approximately $35 million is based on sales in currencies other than the U.S. dollar. If the U.S. dollar strengthens across all currencies by 10% during the conversion period for that quarter, when compared to the same amount of local currency royalties for the prior year, U.S. dollar converted royalties will be approximately $3.5 million less in that current quarter sales, assuming that the currency risk in such forecasted sales was not hedged.
 
 
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We hedge Eurodollar risk exposures related to our licensees’ product sales with Eurodollar contracts. In general, these contracts are intended to offset the underlying Eurodollar market risk in our royalty revenues. In January and May 2010, we entered into a series of Eurodollar contracts covering the quarters in which our licensees’ sales occur through December 2012. We did not have Eurodollar contracts prior to 2010. We have designated the Eurodollar contracts as cash flow hedges. At the inception of the hedging relationship and on a quarterly basis, we assess hedge effectiveness. The aggregate unrealized gain or loss on the effective component of our Eurodollar contracts, net of estimated taxes, is recorded in stockholders’ deficit as accumulated other comprehensive income (loss). Gains or losses on cash flow hedges are recognized as royalty revenue in the same period that the hedged transaction, royalty revenue, impacts earnings. The following table summarizes the notional amounts, Eurodollar exchange rates and fair values of our outstanding Eurodollar contracts designated as hedges at December 31, 2011 and 2010:
 
             
December 31, 2011
   
December 31, 2010
 
Eurodollar Forward Contracts
       
(in thousands)
   
(in thousands)
 
                                   
Currency
 
Settlement Price
($ per Eurodollar)
 
Type
 
Notional Amount
 
Fair Value
   
Notional Amount
 
Fair Value
 
Eurodollar
    1.400    
Sell Eurodollar
  $ 25,150     $ 1,837     $ 137,179     $ 6,740  
Eurodollar
    1.200    
Sell Eurodollar
    117,941       (9,783 )     117,941       (12,810 )
Total
              $ 143,091     $ (7,946 )   $ 255,120     $ (6,070 )
                                             
                                             
Eurodollar Option Contracts
                                     
                                             
Currency
 
Strike Price
($ per Eurodollar)
 
Type
 
Notional Amount
 
Fair Value
   
Notional Amount
 
Fair Value
 
Eurodollar
    1.510    
Purchased call option
  $ 27,126     $ -     $ 147,957     $ 772  
Eurodollar
    1.315    
Purchased call option
    129,244       5,001       129,244       10,251  
Total
              $ 156,370     $ 5,001     $ 277,201     $ 11,023  
 
On January, 26, 2012, we restructured our 2012 Eurodollar option contract into a forward contract, which allowed us to hedge our royalties at a rate more favorable than the rate that was insured by the option contract. With the restructure, we were able to improve the minimum rate at which we will recognize hedged Euro based royalties for 2012 by $0.03 (from $1.20 to $1.23). On the same date we executed new forward contracts to hedge our 2013 Euro based royalties. For the projected 2013 royalties hedged, we will recognize revenue at $1.30.
 
Interest Rate Risk
 
Our investment portfolio was approximately $224.8 million at December 31, 2011, and $242.5 million at December 31, 2010, and consisted of investments in Rule 2a-7 money market funds, corporate debt securities, commercial paper, U.S. government sponsored agency bonds and U.S. treasury securities. If market interest rates were to have increased by 1% in either of these years, there would have been no material impact on the fair value of our portfolio.
 
The aggregate fair value of our convertible notes was estimated to be $347.6 million at December 31, 2011 and $324.4 million at December 31, 2010, based on available pricing information. At December 31, 2011, our convertible notes consisted of our May 2015 Notes, with a fixed interest rate of 3.75% and our February 2015 Notes, with a fixed interest rate of 2.875%. At December 31, 2010, our convertible notes consisted of our 2012 Notes, with a fixed interest rate of 2.00% and our February 2015 Notes, with a fixed interest rate of 2.875%. These obligations are subject to interest rate risk because the fixed interest rates under these obligations may exceed current interest rates.
 
The aggregate fair value of our Non-recourse Notes was estimated to be $95.2 million at December 31, 2011, and $208.4 million at December 31, 2010, based on available pricing information. Our Non-recourse Notes bear interest at a fixed rate of 10.25% per annum. This obligation is subject to interest rate risk because the fixed interest rates under this obligation may exceed current interest rates.
 
 
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The following table presents information about our material debt obligations that are sensitive to changes in interest rates. The table presents principal amounts and related weighted-average interest rates by year of expected maturity for our debt obligations or the earliest year in which the note holders may put the debt to us. Our convertible notes may be converted to common stock prior to the maturity date.
 
(In thousands)
 
2012
   
2013
   
2014
   
2015
       
Thereafter
   
Total
   
Fair Value
Convertible notes
 
                                         
Fixed Rate
  $ -     $ -     $ -     $ 335,250         $ -     $ 335,250     $ 347,598   (1)
Average Interest Rate
    3.28 %     3.28 %     3.28 %     3.28 %       0.00 %                
                                                             
Non-recourse notes
                                                           
Fixed Rate
  $ 93,370     $ -     $ -     $ -         $ -     $ 93,370     $ 95,237   (2)
Average Interest Rate
    10.25 %     0.00 %     0.00 %     0.00 %       0.00 %                
 

(1)
The fair value of the remaining payments under our convertible notes was estimated based on the trading value of these notes at December 31, 2011.
 
(2)
The fair value of our Non-recourse Notes at December 31, 2011, was estimated based on the trading value of the Non-recourse notes at December 31, 2011. Repayment of our Non-recourse Notes is based on anticipated future royalties to be received from Genentech and the anticipated final payment date is September 2012.
 
 
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Table of Contents
 
ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
PDL BIOPHARMA, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
 
   
December 31,
 
   
2011
   
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 168,544     $ 211,574  
Short-term investments
    42,301       34,658  
Receivables from licensees
    600       469  
Deferred tax assets
    10,054       19,902  
Prepaid and other current assets
    12,014       18,060  
Total current assets
    233,513       284,663  
                 
Property and equipment, net
    22       80  
Long-term investments
    17,101       1,997  
Long-term deferred tax assets
    11,481       22,620  
Other assets
    7,354       7,306  
Total assets
  $ 269,471     $ 316,666  
                 
Liabilities and Stockholders' Deficit
               
Current liabilities:
               
Accounts payable
  $ 528     $ 2,540  
Accrued legal settlement
    27,500       65,000  
Accrued liabilities
    11,609       7,204  
Current portion of non-recourse notes payable
    93,370       119,247  
Total current liabilities
    133,007       193,991  
                 
Convertible notes payable
    316,615       310,428  
Non-recourse notes payable
    -       85,023  
Other long-term liabilities
    24,122       51,406  
Total liabilities
    473,744       640,848  
                 
Commitments and contingencies (Note 11)
               
                 
Stockholders' deficit:
               
Preferred stock, par value $0.01 per share, 10,000 shares authorized; no shares issued and outstanding
    -       -  
Common stock, par value $0.01 per share, 250,000 shares authorized; 139,680 and 139,640 shares issued and outstanding at December 31, 2011 and 2010, respectively
    1,397       1,396  
Additional paid-in capital
    (161,750 )     (87,373 )
Accumulated other comprehensive income (loss)
    (1,885 )     3,219  
Accumulated deficit
    (42,035 )     (241,424 )
Total stockholders' deficit
    (204,273 )     (324,182 )
Total liabilities and stockholders' deficit
  $ 269,471     $ 316,666  
 
See accompanying notes.
 
 
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PDL BIOPHARMA, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Revenues: