PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-Q, Received: 11/06/2013 16:04:25)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549  
FORM 10-Q
 
  (Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2013
OR
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For transition period from               to            
Commission File Number: 000-19756
 
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 Number)
932 Southwood Boulevard
Incline Village, Nevada 89451
(Address of principal executive offices and Zip Code)
(775) 832-8500
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   ý     No   ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes   ý     No   ¨
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.
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 Exchange Act)    Yes   ¨     No   ý
As of October 29, 2013 , there were 140,048,451 sha res of the Registrant’s Common Stock outstanding.




  PDL BIOPHARMA, INC.
2013 Form 10-Q
Table of Contents
 
 
Page
GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
 
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
FINANCIAL STATEMENTS
 
 
 
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2013 and 2012
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2013 and 2012
 
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2013, and December 31, 2012
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012
 
 
 
 
Notes to the Condensed Consolidated Financial Statements
 
 
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 
 
ITEM 4.
CONTROLS AND PROCEDURES
 
PART II - OTHER INFORMATION
 
 
 
ITEM 1.
LEGAL PROCEEDINGS
 
 
 
ITEM 1A.
RISK FACTORS
 
 
 
ITEM 6.
EXHIBITS
 
 
SIGNATURES
 
We own or have rights to certain trademarks, trade names, copyrights and other intellectual property used in our business, including PDL BioPharma and the PDL logo, each of which is considered a trademark. All other company names, product names, trade names and trademarks included in this Quarterly Report are trademarks, registered trademarks or trade names of their respective owners.

2



GLOSSARY OF TERMS AND ABBREVIATIONS
Abbreviation/term
 
Definition
 
 
 
'216B Patent
 
European Patent No. 0 451 216B
'761 Patent
 
U.S. Patent No. 5,693,761
2012 Notes
 
2.0% Convertible Senior Notes due February 15, 2012, fully retired at June 30, 2011
ASC
 
Accounting Standards Codification
ASU
 
Accounting Standards Update
Avinger
 
Avinger, Inc.
AxoGen
 
AxoGen, Inc.
Biogen Idec
 
Biogen Idec, Inc.
Chugai
 
Chugai Pharmaceutical Co., Ltd.
Depomed
 
Depomed, Inc.
Direct Flow Medical
 
Direct Flow Medical, Inc.
Durata
 
Durata Therapeutics Holding C.V. and Durata Therapeutics International B.V. and Durata Therapeutics, Inc. (parent company)
Elan
 
Elan Corporation, PLC
ex-U.S.-based Manufacturing and Sales
 
Products that are both manufactured and sold outside of the United States
ex-U.S.-based Sales
 
Products that are manufactured in the United States and sold outside of the United States
EBITDA
 
Earnings before interest, taxes, depreciation and amortization
EMA
 
European Medicines Agency
Facet
 
Facet Biotech Corporation. In April 2010, Abbott Laboratories acquired Facet and later renamed the company Abbott Biotherapeutics Corp., and in January 2013, Abbott Biotherapeutics Corp. was renamed AbbVie Biotherapeutics, Inc. and spun off from Abbott Laboratories as a subsidiary of AbbVie Inc.
FASB
 
Financial Accounting Standards Board
FDA
 
U.S. Food and Drug Administration
February 2015 Notes
 
2.875% Convertible Senior Notes due February 15, 2015, fully retired at September 30, 2013
GAAP
 
U.S. Generally Accepted Accounting Principles
Genentech
 
Genentech, Inc.
Genentech Products
 
Avastin ® , Herceptin ® , Lucentis ® , Xolair ® , Perjeta ® , Kadcyla ®
KMPG
 
KPMG, LLP
LENSAR
 
LENSAR, Inc.
Lilly
 
Eli Lilly and Company
May 2015 Notes
 
3.75% Senior Convertible Notes due May 2015
Merus Labs
 
Merus Labs International, Inc.
Non-Recourse Notes
 
QHP PhaRMA SM  Senior Secured Notes due March 15, 2015, issued through our wholly-owned subsidiary, QHP Royalty Sub LLC, in November 2009, fully repaid in September 2012
Novartis
 
Novartis AG
OCI
 
Other Comprehensive Income (Loss)
PDL, we, us, our, the Company
 
PDL BioPharma, Inc.
Queen et al. patents
 
PDL's patents in the United States and elsewhere covering the humanization of antibodies
Roche
 
F. Hoffman LaRoche, Ltd.
Royalty Agreement
 
Revenue Interests Purchase Agreement between PDL and AxoGen.
SEC
 
Securities and Exchange Commission
Series 2012 Notes
 
2.875% Series 2012 Convertible Senior Notes due February 15, 2015
SPCs
 
Supplementary Protection Certificates
SPC Products
 
Avastin ® , Herceptin ® , Lucentis ® , Xolair ®  and Tysabri ®

3



Spin-Off
 
The spin-off by PDL of Facet
U.S.-based Sales
 
Products sold in the United States or manufactured in the United States and used or sold anywhere in the world
VWAP
 
Volume weighted average share price
Wellstat Diagnostics
 
Wellstat Diagnostics, LLC

4



PART I. FINANCIAL INFORMATION
 
ITEM  1.         FINANCIAL STATEMENTS
 
PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
2013
 
2012
Revenues
 
 
 
 
 
 
 
 
Royalties
 
$
96,314

 
$
85,231

 
$
331,778

 
$
288,479

License and other
 
1,000

 

 
1,000

 

Total revenues
 
97,314

 
85,231

 
332,778

 
288,479

 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 

 
 

General and administrative
 
7,925

 
5,647

 
21,894

 
17,737

Operating income
 
89,389

 
79,584

 
310,884

 
270,742

 
 
 
 
 
 
 
 
 
Non-operating expense, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
2,917

 
1,867

 
11,718

 
2,385

Interest expense
 
(6,118
)
 
(6,514
)
 
(18,169
)
 
(23,087
)
Total non-operating expense, net
 
(3,201
)
 
(4,647
)
 
(6,451
)
 
(20,702
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
86,188

 
74,937

 
304,433

 
250,040

Income tax expense
 
29,963

 
26,362

 
100,995

 
87,779

Net income
 
$
56,225

 
$
48,575

 
$
203,438

 
$
162,261

 
 
 
 
 
 
 
 
 
Net income per share
 
 

 
 

 
 

 
 

Basic
 
$
0.40

 
$
0.35

 
$
1.45

 
$
1.16

Diluted
 
$
0.36

 
$
0.32

 
$
1.31

 
$
1.08

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
139,848

 
139,715

 
139,830

 
139,693

Diluted
 
154,593

 
149,626

 
155,366

 
150,678

 
 
 
 
 
 
 
 
 
Cash dividends declared per common share
 
$

 
$

 
$
0.60

 
$
0.60

 
 See accompanying notes.

5



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

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
2013
 
2012
Net income
 
$
56,225

 
$
48,575

 
$
203,438

 
$
162,261

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 

 
 

 
 

 
 

Unrealized gains (losses) on investments in available-for-sale securities (a)
 
1,091

 
(14
)
 
1,085

 
(1
)
Unrealized gains (losses) on cash flow hedges (b)
 
(3,327
)
 
(3,126
)
 
(46
)
 
(853
)
Total other comprehensive income (loss), net of tax
 
(2,236
)
 
(3,140
)
 
1,039

 
(854
)
Comprehensive income
 
$
53,989

 
$
45,435

 
$
204,477

 
$
161,407

 ______________________________________________
(a) Net of tax of $587 and ($8) for the three months ended September 30, 2013 and 2012 , respectively, and $584 and ($1) for the nine months ended September 30, 2013 and 2012 , respectively.
(b) Net of tax of ($1,791) and ($1,683) for the three months ended September 30, 2013 and 2012 , respectively, and ($25) and ($459) for the nine months ended September 30, 2013 and 2012 , respectively.

See accompanying notes.

6



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
 
 
September 30,
 
December 31,
 
2013
 
2012
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
319,596

 
$
131,212

Restricted investment

 
20,000

Short-term investments
6,862

 
17,477

Receivables from licensees
900

 
366

Deferred tax assets
2,416

 
1,613

Notes receivable

 
7,504

Prepaid and other current assets
3,180

 
4,813

Total current assets
332,954

 
182,985

 
 
 
 
Property and equipment, net
47

 
59

Notes and other receivables, long-term
90,815

 
85,704

Long-term deferred tax assets
3,835

 
4,552

Other assets
2,021

 
6,666

Total assets
$
429,672

 
$
279,966

 
 
 
 
Liabilities and Stockholders' Equity (Deficit)
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
1,469

 
$
1,074

Accrued liabilities
33,524

 
9,400

Accrued income taxes
3,231

 

Convertible notes payable
171,066

 

Total current liabilities
209,290

 
10,474

 
 
 
 
Convertible notes payable
147,015

 
309,952

Other long-term liabilities
20,480

 
27,662

Total liabilities
376,785

 
348,088

 
 
 
 
Commitments and contingencies (Note 8)


 


 
 
 
 
Stockholders' equity (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, 350,000 shares authorized; 139,848 and 139,816 shares issued and outstanding at September 30, 2013, and December 31, 2012, respectively
1,399

 
1,398

Additional paid-in capital
(233,523
)
 
(234,066
)
Accumulated other comprehensive loss
(4,049
)
 
(5,088
)
Retained earnings
289,060

 
169,634

Total stockholders' equity (deficit)
52,887

 
(68,122
)
Total liabilities and stockholders' equity (deficit)
$
429,672

 
$
279,966


See accompanying notes.

7



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from operating activities
 
 
 
Net income
$
203,438

 
$
162,261

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Amortization of convertible notes offering costs
9,921

 
10,507

Other amortization, depreciation and accretion of embedded derivative
(360
)
 
804

Hedge ineffectiveness on foreign exchange contracts
(9
)
 
(372
)
Stock-based compensation expense
559

 
675

Tax expense from stock-based compensation arrangements
(15
)
 
(42
)
Deferred taxes
(663
)
 
6,523

Changes in assets and liabilities:
 

 
 

Receivables from licensees
(534
)
 
600

Prepaid and other current assets
3,312

 
5,266

Accrued interest on notes receivable
(6,587
)
 

Other assets
1,173

 
(1,163
)
Accounts payable
395

 
285

Accrued legal settlement

 
(27,500
)
Accrued liabilities
1,302

 
2,028

Accrued income taxes
3,231

 

Other long-term liabilities
(5,483
)
 
(1,250
)
Net cash provided by operating activities
209,680

 
158,622

Cash flows from investing activities
 

 
 

Purchases of investments
(9,875
)
 
(25,992
)
Maturities of investments
42,098

 
36,799

Issuance of notes receivable
(48,708
)
 
(48,264
)
Repayment of notes receivable
58,134

 

Acquisition of property and equipment
(2
)
 
(18
)
Net cash provided by/(used in) investing activities
41,647

 
(37,475
)
Cash flows from financing activities
 

 
 

Repayment of non-recourse notes

 
(93,370
)
Payment of debt issuance costs

 
(845
)
Cash dividends paid
(62,943
)
 
(62,886
)
Net cash used in financing activities
(62,943
)
 
(157,101
)
Net increase/(decrease) in cash and cash equivalents
188,384

 
(35,954
)
Cash and cash equivalents at beginning of the period
131,212

 
168,544

Cash and cash equivalents at end of period
$
319,596

 
$
132,590

 
 
 
 
 
 
 
 
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
101,000

 
$
76,000

Cash paid for interest
$
8,086

 
$
12,843

See accompanying notes. 

8



PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)

1. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. GAAP for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments) that management of PDL believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year or for any subsequent interim period.
 
The accompanying Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2012 , included in our Annual Report on Form 10-K filed with the SEC. The Condensed Consolidated Balance Sheet at December 31, 2012 , has been derived from the audited Consolidated Financial Statements at that date.
 
Principles of Consolidation
 
The Condensed Consolidated Financial Statements include the accounts of PDL and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Our condensed consolidated financial statements are prepared in accordance with GAAP and the rules and regulations of the SEC.
 
Notes Receivable and Other Long-Term Receivables

We account for our notes receivable at amortized cost, net of unamortized origination fees, if any.  Related fees and costs are recorded net of any amounts reimbursed.  Interest is accreted or accrued to interest income using the interest method.

Customer Concentration
 
The percentage of total revenue earned from our licensees’ net product sales, which individually accounted for ten percent or more of our total revenues, was as follows:
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Licensee
 
Product Name
 
2013
 
2012
 
2013
 
2012
Genentech
 
Avastin ®
 
33
%
 
30
%
 
34
%
 
31
%
 
 
Herceptin ®
 
32
%
 
36
%
 
33
%
 
35
%
 
 
Lucentis ®
 
14
%
 
15
%
 
17
%
 
18
%
 
 
 
 
 
 
 
 
 
 
 
Biogen Idec 1
 
Tysabri ®
 
12
%
 
14
%
 
11
%
 
12
%
______________________
1 In April 2013, Biogen Idec completed its purchase of Elan's interest in Tysabri. Prior to this our licensee for Tysabri was identified as Elan.

Foreign Currency Hedging
 
We enter into foreign currency hedges to manage exposures arising in the normal course of business and not for speculative purposes.

We hedge certain Euro-denominated currency exposures related to royalties associated with our licensees’ product sales with Euro forward contracts. In general, these contracts are intended to offset the underlying Euro market risk in our royalty revenues. These contracts currently extend through the fourth quarter of 2014. We designate foreign currency exchange contracts used to hedge royalty revenues based on underlying Euro-denominated licensee product sales as cash flow hedges.


9



At the inception of each hedging relationship and on a quarterly basis, we assess hedge effectiveness. The fair value of the Euro contracts is estimated using pricing models with readily observable inputs from actively quoted markets and is disclosed on a gross basis. The aggregate unrealized gain or loss, net of tax, on the effective component of the hedge is recorded in stockholders’ equity (deficit) as accumulated other comprehensive income (loss). Gains or losses on cash flow hedges are recognized as an adjustment to royalty revenue in the same period that the hedged transaction impacts earnings as royalty revenue. Any gain or loss on the ineffective portion of our hedge contracts is reported in interests and other income, net in the period the ineffectiveness occurs.

Comprehensive Income
 
In the first quarter of 2012, we adopted FASB ASU 2011-05, and have presented the components of other comprehensive income (loss) in the Condensed Consolidated Statements of Comprehensive Income. Also in accordance with this ASU, we have applied this guidance retrospectively to all periods presented. The adoption of the guidance was a change to the presentation of other comprehensive income (loss) and had no effect on our condensed consolidated financial statements. See Note 14 for our discussion of accumulated other comprehensive income (loss).

New Accounting Pronouncements

In January 2013, we adopted the provisions of ASU 2013-01, issued by the FASB, which requires new asset and liability offsetting disclosures for derivatives, repurchase agreements and security lending transactions to the extent that they are: (1) offset in the financial statements or (2) subject to an enforceable master netting arrangement or similar agreement. We do not have any repurchase agreements and do not participate in securities lending transactions. Our derivative instruments are not offset in the financial statements and are not subject to any right of offset provisions with our counterparties. Accordingly, this amendment did not have a material impact on our Condensed Consolidated Financial Statements. Additional information about derivative instruments can be found in Note 5.

In February 2013, FASB amended ASC 220, “Comprehensive Income.” This amendment requires companies to report, in one place, information about reclassifications (by component) out of accumulated other comprehensive income (loss). In addition, this amendment requires companies to present the related line item effect of significant reclassifications on the statement where income is presented. We adopted the provisions of this amendment during the first quarter of 2013, which affects only the display of information and does not change existing recognition and measurement requirements in our Condensed Consolidated Financial Statements.


10



2. Net Income per Share
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
Net Income per Basic and Diluted Share:
 
2013
 
2012
 
2013
 
2012
  (in thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
Net income used to compute net income per basic share
 
$
56,225

 
$
48,575

 
$
203,438

 
$
162,261

Add back interest expense for convertible notes, net of estimated tax of approximately $7 and $4 for the three months ended September 30, 2013 and 2012, respectively, and $13 and $21 for the nine months ended September 30, 2013 and 2012, respectively (see Note 9)
 
12

 
6

 
25

 
40

Net income used to compute net income per diluted share
 
$
56,237

 
$
48,581

 
$
203,463

 
$
162,301

 
 
 
 
 
 
 
 
 
Denominator
 
 

 
 

 
 
 
 
Total weighted-average shares used to compute net income per basic share
 
139,848

 
139,715

 
139,830

 
139,693

Restricted stock outstanding
 
80

 
110

 
76

 
93

Effect of dilutive stock options
 
20

 
18

 
19

 
16

Assumed conversion of Series 2012 Notes
 
9,674

 
7,008

 
10,141

 
7,427

Assumed conversion of May 2015 Notes
 
4,910

 
2,609

 
5,160

 
2,825

Assumed conversion of February 2015 Notes
 
61

 
166

 
140

 
624

Weighted-average shares used to compute net income per diluted share
 
154,593

 
149,626

 
155,366

 
150,678

 
 
 
 
 
 
 
 
 
Net income per basic share
 
$
0.40

 
$
0.35

 
$
1.45

 
$
1.16

Net income per diluted share
 
$
0.36

 
$
0.32

 
$
1.31

 
$
1.08


We compute net income per basic share using the weighted-average number of shares of common stock outstanding during the period less the weighted-average number of restricted stock shares that are subject to repurchase by the Company.

We compute net income per diluted share using the sum of the weighted-average number of common and common equivalent shares outstanding. Common equivalent shares used in the computation of net income per diluted share include shares that may be issued under our stock options and restricted stock awards, our February 2015 Notes, our Series 2012 Notes and our May 2015 Notes on a weighted average basis for the period that the notes were outstanding, including the effect of adding back interest expense and the underlying shares using the if-converted method. In the first quarter of 2012, $179.0 million aggregate principal of our February 2015 Notes was exchanged for our Series 2012 Notes, and in the third quarter of 2013, $1.0 million aggregate principal of our February 2015 Notes was exchanged for our Series 2012 Notes, and the February 2015 Notes were retired.

In May 2011, we issued our May 2015 Notes, and in January and February 2012, we issued our Series 2012 Notes. The Series 2012 Notes and May 2015 Notes are net share settled, with the principal amount settled in cash and the excess settled in our common stock. The weighted average share adjustments related to our Series 2012 Notes and May 2015 Notes, shown in the table above, include the shares issuable in respect of such excess.

We excluded from our calculations of net income per diluted share 20.8 million and 19.2 million shares for our warrants for the three months ended September 30, 2013 and 2012 , respectively, and 20.8 million and 19.2 million shares for the nine months ended September 30, 2013 and 2012 , respectively, for warrants issued in 2011, because the exercise price of the warrants exceeded the VWAP of our common stock and thus, for the periods presented, no stock was issuable upon conversion. These securities could be dilutive in future periods. Our purchased call options, issued in 2011, will always be anti-dilutive and therefore 24.4 million and 22.6 million shares were excluded from our calculations of net income per diluted share for the three months ended September 30, 2013 and 2012 , respectively, and 24.4 million and 22.6 million shares were excluded for the nine months ended September 30, 2013 and 2012 , respectively, because they have no effect on diluted net income per share. For information related to the conversion rates on our convertible debt, see Note 9.


11



For the three months ended September 30, 2013 , we excluded approximately 121,000 and 10,000 shares underlying outstanding stock options and restricted stock awards, respectively, and for the nine months ended September 30, 2013 , we excluded approximately 133,000 and zero shares underlying outstanding stock options and restricted stock awards, respectively, calculated on a weighted average basis, from our net income per diluted share calculations because their effect was anti-dilutive.

For the three and nine months ended September 30, 2012 , we excluded approximately 144,000 and 164,000 shares underlying outstanding stock options, calculated on a weighted average basis, from our net income per diluted share calculations because their effect was anti-dilutive.

  3. Fair Value Measurements

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

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

The following tables present the fair value of our financial instruments measured at fair value on a recurring basis by level within the valuation hierarchy.
 
 
September 30, 2013
 
December 31, 2012
 
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
269,806

 
$

 
$
269,806

 
$
121,095

 
$

 
$
121,095

Certificates of deposit
 

 
1,682

 
1,682

 

 
26,128

 
26,128

Corporate securities
 

 
5,180

 
5,180

 

 

 

Corporate debt securities
 

 

 

 

 
13,572

 
13,572

Total
 
$
269,806

 
$
6,862

 
$
276,668

 
$
121,095

 
$
39,700

 
$
160,795

 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Foreign currency hedge contracts
 
$

 
$
7,508

 
$
7,508

 
$

 
$
7,581

 
$
7,581

 
The fair value of the certificates of deposit is determined using quoted market prices for similar instruments and non-binding market prices that are corroborated by observable market data. At December 31, 2012, the certificates of deposit included a $20.0 million certificate of deposit that was restricted as it was purchased to collateralize the line of credit for Merus Labs; see Note 6.

The fair value of the foreign currency hedge contracts is estimated based on pricing models using readily observable inputs from actively quoted markets and are disclosed on a gross basis.

Corporate securities consist primarily of U.S. corporate equity holdings. The fair value of corporate securities is estimated using recently executed transactions or market quoted prices, where observable. Independent pricing sources are also used for valuation.

Corporate debt securities consisted primarily of U.S. corporate bonds. The fair value of corporate debt securities was estimated using recently executed transactions or market quoted prices, where observable. Independent pricing sources are also used for valuation.


12



There have been no transfers between levels during the three and nine months ended September 30, 2013 , and December 31, 2012 . The Company recognizes transfers between levels on the date of the event or change in circumstances that caused the transfer.

The following tables present the fair value of assets and liabilities not subject to fair value recognition by level within the valuation hierarchy:

 
 
September 30, 2013
 
December 31, 2012
 
 
Carrying Value
 
Fair Value
Level 2
 
Fair Value
Level 3
 
Carrying Value
 
Fair Value
Level 2
 
Fair Value
Level 3
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics note receivable
 
$
45,269

 
$

 
$
45,269

 
$
41,098

 
$

 
$
41,098

Merus Labs note receivable
 

 

 

 
30,000

 
30,000

 

AxoGen note receivable and embedded derivative
 
25,404

 

 
25,404

 
22,110

 

 
22,110

Avinger note receivable
 
20,142

 

 
20,142

 

 

 

Total
 
$
90,815

 
$

 
$
90,815

 
$
93,208

 
$
30,000

 
$
63,208

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Series 2012 Notes
 
$
171,066

 
$
258,984

 
$

 
$
165,528

 
$
227,187

 
$

May 2015 Notes
 
147,015

 
198,138

 

 
143,433

 
182,031

 

February 2015 Notes
 

 

 

 
991

 
1,269

 

Total
 
$
318,081

 
$
457,122

 
$

 
$
309,952

 
$
410,487

 
$

 
As of September 30, 2013 , the estimated fair value of our Avinger note receivable, as of September 30, 2013 and December 31, 2012 , the estimated fair values of our Wellstat Diagnostics note receivable and AxoGen note receivable and derivative, and as of December 31, 2012 , the estimated fair value of our Merus Labs note receivable, were determined using one or more discounted cash flow models, incorporating expected principal payments and the interest rate extended for notes with fixed interest rates and incorporating expected payments for notes with a variable rate of return.

On September 30, 2013 , and December 31, 2012 , the carrying value of the AxoGen note and derivative approximated its estimated fair value. We determined this note to be a Level 3 asset, as our valuation utilized significant unobservable inputs, including estimates of AxoGen's future revenues, expectations about settlement and required yield. To provide support for the estimated fair value measurement, we considered forward looking performance related to AxoGen and current measures associated with high yield indices, and reviewed the terms and yields of notes placed by specialty finance and venture firms both across industries and in a similar sector. Additionally, we reviewed market yield indices for changes since the issuance of the note. We observed no material events with AxoGen or in the market in which it participates since the placement. The carrying value and estimated fair value of the AxoGen note include the value of a change of control embedded derivative valued at $1.0 million and $0.6 million at September 30, 2013 , and December 31, 2012 , respectively. We utilized discounted cash flows and probability analysis to determine the fair value of the embedded derivative.
 
On September 30, 2013 , and December 31, 2012 , the carrying value of the note receivable from Wellstat Diagnostics approximates its fair value. We determined this note to be a Level 3 asset, as our valuation utilized significant unobservable inputs. Due to the breach of the credit agreement as of December 31, 2012, as discussed in Note 6, we considered the fair value of the underlying collateral when estimating fair value of the note. The note is collateralized by all assets and equity interest in Wellstat Diagnostics. The fair value of the collateral was determined by using a discounted cash flow analysis related to the underlying technology included in the collateral. The discounted cash flow was based upon expected income from sales of planned products over a 15-year period. The terminal value was estimated using selected market multiples based on sales and EBITDA. Our valuation of the collateral utilized significant unobservable inputs including a discount rate of 35% , terminal value EBITDA multiple of 17.5 , terminal value sales multiple of 3.0 and future revenue and expenses related to commercialization of the borrower's technology.


13



On September 30, 2013 , the carrying value of the Avinger note approximates its fair value. We determined this note to be a Level 3 asset, as our valuation utilized significant unobservable inputs, including a discount rate of 18.5% , estimates of Avinger's future revenues, expectations about settlement and required yield. To provide support for the fair value measurement, we considered forward looking performance related to Avinger, current measures associated with high yield and Standard & Poor's Leveraged Commentary & Data indices, and reviewed the terms and yields of notes placed by specialty finance and venture firms both across industries and in a similar sector.

The fair values of our convertible notes were determined using quoted market pricing or dealer quotes.

4. Cash Equivalents and Investments
 
As of September 30, 2013 , and December 31, 2012 , we had invested our excess cash balances primarily in money market funds, certificates of deposit, corporate securities and corporate debt securities. Our securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss) in stockholders’ equity (deficit), net of estimated taxes. The cost of securities sold is based on the specific identification method. To date, we have not experienced credit losses on investments in these instruments and we do not require collateral for our investment activities.

Summary of Cash and Available-For-Sale Securities
 
 Adjusted Cost
 
 Unrealized Gains
 
 Unrealized Losses
 
 Estimated Fair Value
 
 Cash and Cash Equivalents
 
 Restricted Investment
 
Short-Term Marketable Securities
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
49,790

 
$

 
$

 
$
49,790

 
$
49,790

 
$

 
$

Money market funds
 
269,806

 

 

 
269,806

 
269,806

 

 

Certificates of deposit
 
1,682

 

 

 
1,682

 

 

 
1,682

Corporate securities
 
3,500

 
1,680

 

 
5,180

 

 

 
5,180

Total
 
$
324,778

 
$
1,680

 
$

 
$
326,458

 
$
319,596

 
$

 
$
6,862

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
7,894

 
$

 
$

 
$
7,894

 
$
7,894

 
$

 
$

Money market funds
 
121,095

 

 

 
121,095

 
121,095

 

 

Certificates of deposit
 
26,128

 

 

 
26,128

 
2,223

 
20,000

 
3,905

Corporate debt securities
 
13,562

 
10

 

 
13,572

 

 

 
13,572

Total
 
$
168,679

 
$
10

 
$

 
$
168,689

 
$
131,212

 
$
20,000

 
$
17,477


No gains or losses on sales of available-for-sale securities were recognized for the three and nine months ended September 30, 2013 and 2012 .

Cash and Available-For-Sale Securities by Contractual Maturity
 
September 30, 2013
 
December 31, 2012
(In thousands)
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Less than one year
 
$
324,778

 
$
326,458

 
$
168,679

 
$
168,689

Greater than one year but less than five years
 

 

 

 

Total
 
$
324,778

 
$
326,458

 
$
168,679

 
$
168,689

 
No significant facts or circumstances have arisen to indicate that there has been any deterioration in the creditworthiness of the issuers of these securities. Based on our review of these securities, we believe that we had no other-than-temporary impairments on these securities as of September 30, 2013 , and December 31, 2012 .


14



5. Foreign Currency Hedging

We designate the foreign currency exchange contracts used to hedge our royalty revenues based on underlying Euro-denominated sales as cash flow hedges. Euro forward contracts are presented on a net basis on our Condensed Consolidated Balance Sheets as we have entered into a netting arrangement with the counterparty. As of September 30, 2013 , and December 31, 2012 , all outstanding Euro forward contracts and option contracts were classified as cash flow hedges.

In January 2012, we modified our existing Euro forward and option contracts related to our licensees’ sales through December 2012 into Euro forward contracts with more favorable rates. Additionally, we entered into a series of Euro forward contracts covering the quarters in which our licensees’ sales occur through December 2013.

During the third quarter of 2012, we reduced our forecasted exposure to the Euro for 2013 royalties. We de-designated and terminated certain forward contracts, due to our determination that certain cash flows under the de-designated contracts were probable to not occur, and recorded a gain of approximately $391,000 to interest and other income, net, which was reclassified from other comprehensive income (loss) net of tax effects. The termination of these contracts was effected through a reduction in the notional amount of the original hedge contracts.

The notional amounts, Euro exchange rates and fair values of our Euro forward contracts designated as cash flow hedges were as follows:

Euro Forward Contracts
 
September 30, 2013
 
December 31, 2012
 
 
 
 
 
 
(In thousands)
 
(In thousands)
Currency
 
Settlement Price
($ per Euro)
 
Type
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
Euro
 
1.230
 
Sell Euro
 
$

 
$

 
$
27,553

 
$
(2,036
)
Euro
 
1.240
 
Sell Euro
 
10,850

 
(982
)
 
10,850

 
(726
)
Euro
 
1.270
 
Sell Euro
 
44,450

 
(2,887
)
 
44,450

 
(1,950
)
Euro
 
1.281
 
Sell Euro
 
36,814

 
(2,076
)
 
36,814

 
(1,331
)
Euro
 
1.300
 
Sell Euro
 
39,000

 
(1,563
)
 
91,000

 
(1,538
)
Total
 
 
 
 
 
$
131,114

 
$
(7,508
)
 
$
210,667

 
$
(7,581
)
 
 The location and fair values of our Euro contracts in our Condensed Consolidated Balance Sheets were as follows: 
 
Cash Flow Hedge
 
Location
 
September 30,
2013
 
December 31,
2012
(In thousands)
 
 
 
 
 
 
Euro contracts
 
Accrued liabilities
 
$
5,199

 
$
3,574

Euro contracts
 
Other long-term liabilities
 
$
2,309

 
$
4,007



15



The effect of our derivative instruments in our Condensed Consolidated Statements of Income and our Condensed Consolidated Statements of Comprehensive Income was as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
2013
 
2012
(In thousands)
 
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax (1)
 
$
(3,359
)
 
$
(3,454
)
 
$
(1,056
)
 
$
(1,851
)
Gain (loss) reclassified from accumulated OCI into royalty revenue, net of tax (2)
 
$
(32
)
 
$
(328
)
 
$
(1,011
)
 
$
(998
)
Net gain (loss) recognized in interest and other income, net -- cash flow hedges (3)
 
$
4

 
$
(27
)
 
$
9

 
$
(54
)
Net gain recognized in interest and other income, net -- non-designated contracts (4)
 
$

 
$
391

 
$

 
$
391

Amount excluded from effectiveness testing
 
$

 
$

 
$

 
$

 _______________________________
(1) Net change in the fair value of the effective portion of cash flow hedges classified in OCI.
(2) Effective portion classified as royalty revenue.
(3) Ineffectiveness from excess hedge was approximately ($4) and $27 for the three months ended September 30, 2013 and 2012 , respectively, and ($9) and $27 for the nine months ended September 30, 2013 and 2012 , respectively. Net loss from restructuring hedges was zero for the three months ended September 30, 2013 and 2012 , and zero and $27 for the nine months ended September 30, 2013 and 2012 , respectively.

6. Notes Receivable and Other Long-term Receivables

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

Wellstat Diagnostics Note Receivable and Credit Agreement

In March 2012, the Company executed a $7.5 million two -year senior secured note receivable with the holders of the equity interests in Wellstat Diagnostics. In addition to bearing interest at 10% per annum, the note gave PDL certain rights to negotiate for certain future financing transactions. In August 2012, PDL and the borrowers amended the note receivable, providing a senior secured note receivable of $10.0 million , bearing interest at 12% per annum, to replace the original $7.5 million note. This $10.0 million note was repaid on November 2, 2012.

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

In January 2013, the Company was informed that, as of November 2012, Wellstat Diagnostics had used funds contrary to the terms of the credit agreement and breached Sections 2.1.2 and 7 of the credit agreement. PDL sent Wellstat Diagnostics a notice of default on January 22, 2013, and accelerated the amounts owed under the credit agreement. In connection with the notice of default, PDL exercised one of its available remedies and transferred approximately $8.1 million of available cash from a bank account of Wellstat Diagnostics to PDL and applied the funds to amounts due under the credit agreement. On February 28, 2013, the parties entered into a forbearance agreement whereby PDL agreed to refrain from exercising additional remedies for 120 days while Wellstat Diagnostics raised funds to capitalize the business and the parties attempted to negotiate a revised credit agreement. PDL agreed to provide up to $7.9 million to Wellstat Diagnostics to fund the business for the 120 -day forbearance period under the terms of the forbearance agreement. Following the conclusion of the June 28 forbearance period, the Company agreed to forbear in its exercise of remedies for additional periods of time to allow the owners and affiliates of Wellstat Diagnostics to complete a pending financing transaction. During such forbearance period, the Company provided approximately $1.3 million to Wellstat Diagnostics to fund ongoing operations of the business. During the nine months ended September 30, 2013 , approximately $8.7 million was advanced pursuant to the forbearance agreement.


16



On August 15, 2013, the owners and affiliates of Wellstat Diagnostics completed a financing transaction to fulfill its obligations under the forbearance agreement. On August 15, 2013, the Company entered into an amended and restated credit agreement with Wellstat Diagnostics. The Company determined that the new agreement should be accounted for as a modification of the existing agreement.

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

When the principal amount was reset it resulted in a $2.5 million reduction of the carrying value and was recorded as a financing cost as a component of interest and other income, net. The new carrying value is lower as a function of the variable nature of the internal rate of return to be realized by the Company based on when the note is repaid. The internal rate of return calculation, although increased, was reset when the credit agreement was amended and restated.

Wellstat Diagnostics may prepay the amended credit agreement at a price that, together with interest and royalty payments already made to the Company, would generate a specified internal rate of return to the Company. In the event of a change of control, bankruptcy or certain other customary events of defaults, or Wellstat Diagnostics' failure to achieve a specified annual revenue threshold in 2017, Wellstat Diagnostics will be required to prepay the credit agreement at a price that, together with interest and royalty payments already made to the Company, would generate a specified internal rate of return to the Company. The amended credit agreement is secured by a pledge of all of the assets of Wellstat Diagnostics, a pledge of all of Wellstat Diagnostics’ equity interests by the holders thereof, and a second lien on the assets of the affiliates of Wellstat Diagnostics. The Company believes the fair value of the collateral is not less than $76.6 million .

At September 30, 2013 , and December 31, 2012, the carrying value of the note was included in non-current assets.

As of September 30, 2013 , the Company determined that its interest in Wellstat Diagnostics represented a variable interest in a Variable Interest Entity since Wellstat Diagnostics' equity was not sufficient to finance its operations without amounts advanced to it under the Company's note and forbearance agreement. However, the Company does not have the power to unilaterally direct operational activities of Wellstat Diagnostics and is not the primary beneficiary of Wellstat Diagnostics; therefore, Wellstat Diagnostics is not subject to consolidation.

As of September 30, 2013 , the carrying value of all amounts advanced to Wellstat Diagnostics was $45.3 million , which was recorded in notes receivable. As of September 30, 2013 , the maximum loss exposure was $45.3 million .

Merus Labs Note Receivable and Credit Agreement

In July 2012, PDL loaned $35.0 million to Merus Labs in connection with its acquisition of a commercial-stage pharmaceutical product and related assets. In addition, PDL agreed to provide a $20.0 million letter of credit on behalf of Merus Labs for the seller of the assets to draw upon to satisfy the remaining $20.0 million purchase price obligation. The seller made this draw on the letter of credit in July 2013 and an additional loan to Merus Labs for $20.0 million was recorded for an aggregate of $55.0 million in total borrowings.

Outstanding borrowings under the July 2012 loan bore interest at the rate of 13.5% per annum and outstanding borrowings as a result of the draw on the letter of credit bore interest at the rate of 14.0% per annum. Merus Labs was required to make four periodic principal payments in respect of the July 2012 loan, with repayment of the remaining principal balance of all loans due on March 31, 2015. The borrowings were subject to mandatory prepayments upon certain asset dispositions or debt issuances as set forth in the credit agreement. Merus Labs made the first of these payments in December 2012 in the amount of $5.0 million , and made the second payment in June 2013 in the amount of $7.5 million . In September 2013, Merus Labs made two additional payments totaling $43.3 million , including the prepayment fee, in order to pay its remaining outstanding balance.


17



In September 2013, Merus Labs prepaid in full its obligations under the credit agreement , including accrued interest through the payment date and a prepayment fee of 1% of the aggregate principal amount outstanding at the time of repayment. There was no outstanding balance owed as of September 30, 2013 .

AxoGen Note Receivable and Royalty Agreement

In October 2012, PDL entered into the Royalty Agreement with AxoGen pursuant to which the Company will receive specified royalties on AxoGen’s net revenues (as defined in the Royalty Agreement) generated by the sale, distribution or other use of AxoGen’s products. The Royalty Agreement has an eight years term and provides PDL with royalties of 9.95% based on AxoGen Net Revenues, subject to agreed-upon guaranteed quarterly minimum payments of approximately $1.3 to $2.3 million beginning in the fourth quarter of 2014, and the right to require AxoGen to repurchase the Royalty Agreement at the end of the fourth year. AxoGen has been granted certain rights to call the contract in years five through eight . The total consideration PDL paid to AxoGen for the royalty rights was $20.8 million , including the termination of an interim funding of $1.8 million in August 2012. AxoGen was required to use a portion of the proceeds from the Royalty Agreement to pay the outstanding balance under its existing credit facility. AxoGen plans to use the remainder of the proceeds to support the business plan for its products. The royalty rights are secured by the cash and accounts receivable of AxoGen.

Under the Royalty Agreement, beginning on October 1, 2016, or in the event of the occurrence of a material adverse event or AxoGen's bankruptcy or material breach of the Royalty Agreement, the Company may require AxoGen to repurchase the royalty rights at a price that, together with payments already made by AxoGen, would generate a specified internal rate of return to the Company. The Company has concluded that the repurchase option is an embedded derivative which should be bifurcated and separately accounted for at fair value.

In the event of a change of control, AxoGen must repurchase the assigned interests from the Company for a repurchase price equal to an amount that, together with payments already made by AxoGen, would generate a 32.5% internal rate of return to the Company. The Company has concluded that the change of control provision is an embedded derivative that should be bifurcated and separately recorded at its estimated fair value. The estimated fair value of the change of control provision was approximately $1.0 million and $0.6 million as of September 30, 2013 , and December 31, 2012 , respectively. The estimated fair value of this embedded derivative is included in the carrying value of the AxoGen Note Receivable. The Company recognized approximately $0.0 million and $0.4 million related to the change in the estimated fair value of embedded derivative during the three and nine month periods ended September 30, 2013 , respectively.

At any time after September 30, 2016, AxoGen, at its option, can repurchase the assigned interests under the Royalty Agreement for a price applicable in a change of control.

During the term of the Royalty Agreement, the Company is entitled to designate an individual to be a member of AxoGen's board of directors. The Company has exercised this right and on October 5, 2012, upon close of the transaction, the Company's President and Chief Executive Officer was elected to AxoGen's board of directors.

On August 14, 2013, PDL purchased 1,166,666 shares of AXGN at $3.00 per share, totaling $3.5 million . The shares are classified as available for sale and recorded as short term investments on the balance sheet. As of September 30, 2013 , the shares were valued at $5.2 million , which results in an unrealized gain of $1.7 million and is recorded in other comprehensive income.

Avinger Note Receivable and Royalty Agreement

On April 18, 2013, PDL entered into a credit agreement with Avinger, under which we made available to Avinger up to $40.0 million to be used by Avinger in connection with the commercialization of its currently marketed lumivascular catheter devices and in the development of Avinger's lumivascular atherectomy device. Of the $40.0 million available to Avinger, we funded an initial $20.0 million , net of fees, at close of the transaction. Upon the attainment by Avinger of a certain revenue milestone to be accomplished no later than the end of the first half of 2014, we will fund them an additional amount between $10.0 million and $20.0 million (net of fees) at Avinger's election. Outstanding borrowings under the initial loan bear interest at a stated rate of 12% per annum, and any future outstanding borrowings as a result of an additional amount funded upon reaching the revenue milestone will bear interest at the rate of 14% per annum.

Avinger is required to make quarterly interest and principal payments. Principal repayment will commence on: (i) the eleventh interest payment date if the revenue milestone is not achieved or (ii) the thirteenth interest payment date if the revenue milestone is achieved. The principal amount outstanding at commencement of repayment, after taking into account any payment-in-kind, will be repaid in equal installments until final maturity of the loans. The loans will mature in April 2018.

18




In connection with entering into the credit agreement, the Company will receive a low, single-digit royalty on Avinger's net revenues through April 2018. Avinger may prepay the outstanding principal and accrued interest on the notes receivable at any time. If Avinger repays the notes receivable prior to April 2018, the royalty on Avinger's net revenues will be reduced by 50% and will be subject to certain minimum payments from the prepayment date through April 2018.

The obligations under the credit agreement are secured by a pledge of substantially all of the assets of Avinger and any of its subsidiaries (other than controlled foreign corporations, if any). The credit agreement provides for a number of standard events of default, including payment, bankruptcy, covenant, representation and warranty and judgment defaults.

For carrying value and fair value information related to our notes receivable and other long-term receivables, see Note 3.

7. Accrued Liabilities

 
 
September 30,
2013
 
December 31,
2012
(In thousands)
 
 
 
 
Compensation
 
$
1,908

 
$
594

Interest
 
3,087

 
2,925

Foreign currency hedge
 
5,199

 
3,574

Dividend payable
 
21,124

 
53

Legal
 
1,921

 
2,020

Other
 
285

 
234

Total
 
$
33,524

 
$
9,400


8. Commitments and Contingencies
 
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 Avastin, Herceptin, Lucentis and Xolair do not infringe the SPCs granted to PDL by various countries in Europe for covering those 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 Avastin, Herceptin, Lucentis and Xolair. The SPCs covering Avastin, Herceptin, Lucentis and Xolair 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 any of 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 Avastin, Herceptin, Lucentis and Xolair that are both manufactured and sold outside of the United States. Royalties on sales of Avastin, Herceptin, Lucentis and Xolair that are ex-U.S.-based Manufacturing and Sales accounted for approximately 42% of our royalty revenues for the nine months ended September 30, 2013 .

We believe that the SPCs are enforceable, 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.
 

19



Nevada Litigation with Genentech, Roche and Novartis in Nevada State Court and Arbitration with Genentech
 
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 Avastin, Herceptin, Lucentis and Xolair.

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.

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 parties have been engaged in discovery motion practice. On March 29, 2013, the court affirmed an order of the discovery commissioner requiring the production of certain documents in the possession of Roche and Genentech to PDL. Roche and Genentech have communicated to us that they have requested review of the court's order from the Nevada Supreme Court. The parties have agreed to a stay in the proceedings pending the decision of the Nevada Supreme Court regarding whether they will review the court's order. In the event that the Nevada Supreme Court agrees to consider Roche and Genentech's request and review the court's order, we expect a lengthy delay in the case schedule for a period that may extend for a number of months, and, while no trial date is currently scheduled with the District Court, the likelihood is that a trial date will be at some point between mid-2014 to mid-2015. The outcome of this litigation is uncertain and we may not be successful in our allegations.

On June 7, 2013, the Company filed a Notice of Arbitration against Genentech with the American Arbitration Association in Voorhees, New Jersey, alleging, inter alia , that Genentech underpaid royalties going back to at least 2007 and impeded PDL's attempts to have Genentech's books and records inspected to determine whether Genentech's past payments to PDL were accurately calculated.

In 2009, PDL retained KPMG to conduct an independent inspection and analysis of the books and records of Genentech and its sublicensees for the three year period covering January 1, 2007 to December 31, 2009, a right granted to PDL under PDL's Patent License Master Agreement and license agreements with Genentech. KPMG reported to PDL that, due to limitations on its inspection imposed by Genentech, it was unable to assess the completeness or accuracy of Genentech's reporting of royalties. KPMG concluded that, based on the limited information it was able to review, Genentech appears to have underpaid PDL in an amount that, if substantiated, PDL believes would be material. Genentech has informed PDL that it disagrees with KPMG's conclusions and that it believes that it has correctly calculated royalties due.

In the arbitration, PDL: (i) requests a declaration of the parties' rights and obligations with respect to reporting and payment of royalties under the license agreements; (ii) alleges that Genentech has breached the license agreements due to its obstruction of KPMG's inspection and underpayment of royalties; and (iii) alleges that Genentech breached the implied covenant of good faith and fair dealing by depriving PDL of the benefits of the license agreements through its obstruction of the inspection, which we further assert concealed the nature and extent of its underpayment.

On July 3, 2013, Genentech filed its Response and Counterclaim in which Genentech requests that the arbitrator (i) reject PDL's claims that Genentech breached the license agreements by underpaying royalties owed to PDL, obstructing KPMG's inspection, or violating the covenant of good faith and fair dealing; (ii) reject PDL's claim that Genentech owed any royalties to PDL on Herceptin, Avastin and Xolair manufactured and sold outside of the United States prior to December 27, 2009 on the ground that those products did not infringe the '216B patent prior to its expiration; (iii) offset any royalties underpaid during the audit period by the amount Genentech claims to have overpaid in royalties attributable to the sale of Herceptin, Avastin and Xolair manufactured and sold outside of the United States prior to December 27, 2009; and (iv) award damages to Genentech in the amount of $428,751 , representing royalties Genentech overpaid during the audit period, as well as costs and reasonable attorney's fees. Genentech's counterclaim does not challenge whether Herceptin, Avastin and Xolair manufactured and sold outside of the United States after December 27, 2009, are Licensed Products (and subject to a royalty under PDL's SPCs issued to such products in Europe) as Genentech's ability to contest infringement of PDL's SPCs is the subject of pending litigation in Nevada.

20




The parties have mutually agreed to stay the arbitration proceedings and to extend the deadline for responses in the Nevada litigation to allow time for discussions to occur to determine if a settlement of certain issues is possible. The parties may not reach agreement regarding settlement terms and PDL expects that it will renew its litigation efforts if settlement is unsuccessful.

The outcome of this arbitration is uncertain, and PDL may not be successful in its 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 that we do not expect to materially impact our financial statements.

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, 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 September 30, 2013 , the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $92.7 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.

We have recorded a liability of $10.7 million on our Condensed Consolidated Balance Sheets as of September 30, 2013 , and December 31, 2012 , related to this guarantee. In future periods, we may adjust this liability for any changes in the ultimate outcome of this matter that are both probable and estimable.

9. Convertible Notes
  
 
 
 
 
Principal Balance Outstanding
 
Carrying Value
 
 
 
 
September 30,
 
September 30,
 
December 31,
Description
 
Maturity Date
 
2013
 
2013
 
2012
(In thousands)
 
 
 
 
 
 
 
 
Convertible Notes
 
 
 
 
 
 
 
 
Series 2012 Notes
 
February 15, 2015
 
$
180,000

 
$
171,066

 
$
165,528

May 2015 Notes
 
May 1, 2015
 
$
155,250

 
147,015

 
143,433

February 2015 Notes
 
February 15, 2015
 
$

 

 
991

Total
 
 
 
 

 
$
318,081

 
$
309,952


As of September 30, 2013 , PDL was in compliance with all applicable debt covenants, and embedded features of all debt agreements were evaluated and did not need to be accounted for separately.
 
Series 2012 Notes

In January 2012, we exchanged $169.0 million aggregate principal of new Series 2012 Notes for an identical principal amount of our February 2015 Notes, plus a cash payment of $5.00 for each $1,000 principal amount tendered, totaling approximately $845,000 . The cash incentive payment was allocated to deferred issue costs of $765,000 , additional paid-in capital of $52,000 and deferred tax assets of $28,000 . The deferred issue costs will be recognized over the life of the Series 2012 Notes as interest expense. In February 2012, we entered into separate privately negotiated exchange agreements under which we exchanged an additional $10.0 million aggregate principal amount of the new Series 2012 Notes for an identical principal amount of our February 2015 Notes. In August 2013, the Company entered into a separate privately negotiated exchange agreement under which it retired the final $1.0 million aggregate principal amount of the Company's outstanding February 2015 Notes. Pursuant to the exchange agreement, the holder of the February 2015 Notes received $1.0 million aggregate principal amount of the

21



Company's Series 2012 Notes. Immediately following the exchange, no principal amount of the February 2015 Notes remained outstanding and $180.0 million principal amount of the Series 2012 Notes is outstanding.

The terms of the Series 2012 Notes are governed by the indenture dated as of January 5, 2012, and include a net share settlement feature, meaning that if a conversion occurs, the principal amount will be settled in cash and the excess, if any, will be settled in the Company’s common stock. The Series 2012 Notes may not be redeemed by the Company prior to their stated maturity date. Our Series 2012 Notes are due February 15, 2015, and bear interest at a rate of 2.875% per annum, payable semi-annually in arrears on February 15 and August 15 of each year.

Holders may convert their Series 2012 Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the stated maturity date of the Series 2012 Notes under the following circumstances:

During any fiscal quarter commencing after the fiscal quarter ending December 31, 2011, if the closing price of the Company’s 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 Series 2012 Notes on the last day of such preceding fiscal quarter;
During the five business-day period immediately after any five consecutive trading-day period in which the trading price per $1,000 principal amount of the Series 2012 Notes for each trading day of that measurement period was less than 98% of the product of the closing price of the Company’s common stock and the conversion rate for the Series 2012 Notes for that trading day;
Upon the occurrence of certain corporate transactions as provided in the indenture; or
Anytime, at the holder’s option, beginning on August 15, 2014.

Holders of our Series 2012 Notes who convert their Series 2012 Notes in connection with a fundamental change resulting in the
reclassification, conversion, exchange or cancellation of our common stock may be entitled to a make-whole premium in the form of an increase in the conversion rate. Such 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.

We allocated $2.3 million of the remaining deferred February 2015 Notes original issue discount as of the date of the exchange to the Series 2012 Notes based on the percentage of the February 2015 Notes exchanged. In accordance with the accounting guidance for convertible debt instruments that may be settled in cash or other assets on conversion, we were required 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 the Series 2012 Notes, net of the allocated original issue discount, between the fair value of the debt component and the common stock conversion feature. Using an assumed borrowing rate of 7.3% , which represents the estimated market interest rate for a similar nonconvertible instrument available to us during the period of the exchange transactions, we recorded a total debt discount of $16.8 million , allocated $10.9 million to additional paid-in capital and $5.9 million to deferred tax liability. The discount is being amortized to interest expense over the term of the Series 2012 Notes and increases interest expense during the term of the Series 2012 Notes from the 2.875% cash coupon interest rate to an effective interest rate of 7.3% . The common stock conversion feature is recorded as a component of stockholders’ deficit.

The principal amount, carrying value and unamortized discount of our Series 2012 Notes were as follows:

(In thousands)
 
September 30, 2013
 
December 31, 2012
Principal amount of the Series 2012 Notes
 
$
180,000

 
$
179,000

Unamortized discount of liability component
 
(8,934
)
 
(13,472
)
Total
 
$
171,066

 
$
165,528



22



Interest expense for our Series 2012 Notes on the Condensed Consolidated Statements of Income was as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2013
 
2012
 
2013
 
2012
Contractual coupon interest
 
$
1,290

 
$
1,287

 
$
3,864

 
$
3,836

Amortization of debt issuance costs
 
289

 
279

 
860

 
826

Amortization of debt discount
 
1,538

 
1,439

 
4,538

 
4,219

Total
 
$
3,117

 
$
3,005

 
$
9,262

 
$
8,881


As of September 30, 2013 , our Series 2012 Notes are convertible into 179.777 shares of the Company’s common stock per $1,000 of principal amount, or approximately $5.56 per common share, subject to further adjustment upon certain events including dividend payments. As of September 30, 2013 , the remaining discount amortization period was 1.4 years .

Our common stock exceeded the conversion threshold price of $7.37 for at least 20 days during the 30 consecutive trading days ended June 30, 2013; accordingly, the Series 2012 Notes were convertible at the option of the holder during the quarter ended September 30, 2013 . Our common stock price exceeded the conversion threshold price of $7.23 per common share for at least 20 days during the 30 consecutive trading days ended September 30, 2013 ; accordingly, the Series 2012 Notes are convertible at the option of the holder during the quarter ending December 31, 2013. The Series 2012 Notes have been classified as current as the notes will be due upon demand within one year of the quarter ended September 30, 2013 . At September 30, 2013 , the if-converted value of our Series 2012 Notes exceeded their principal amount by approximately $77.9 million .

May 2015 Notes
 
On May 16, 2011, we issued $155.3 million in aggregate principal amount, at par, of our May 2015 Notes in an underwritten public offering, for net proceeds of $149.7 million . Our May 2015 Notes are due May 1, 2015, and 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. Proceeds from our May 2015 Notes, net of amounts used for purchased call option transactions and provided by the warrant transactions described below, were used to redeem our 2012 Notes. 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.

In accordance with the accounting guidance for convertible debt instruments that may be settled in cash or other assets on conversion, we were required 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 fair value of 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 allocated $6.6 million to deferred tax liability. The discount is being amortized to interest expense over the term of our May 2015 Notes and increases interest expense during the term of our May 2015 Notes from the 3.75% cash coupon interest rate to an effective interest rate of 7.5% . As of September 30, 2013 , the remaining discount amortization period is 1.6 years .

23




The carrying value and unamortized discount of our May 2015 Notes were as follows:

(In thousands)
 
September 30, 2013
 
December 31, 2012
Principal amount of the May 2015 Notes
 
$
155,250

 
$
155,250

Unamortized discount of liability component
 
(8,235
)
 
(11,817
)
Total
 
$
147,015

 
$
143,433


Interest expense for our May 2015 Notes on the Condensed Consolidated Statements of Income was as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2013
 
2012
 
2013
 
2012
Contractual coupon interest
 
$
1,456

 
$
1,455

 
$
4,366

 
$
4,366

Amortization of debt issuance costs
 
309

 
299

 
920

 
891

Amortization of debt discount
 
1,215

 
1,130

 
3,582

 
3,330

Total
 
$
2,980

 
$
2,884

 
$
8,868

 
$
8,587


As of September 30, 2013 , our May 2015 Notes are convertible into 157.37 shares of the Company’s common stock per $1,000 of principal amount, or approximately $6.35 per common share, subject to further adjustment upon certain events including dividend payments.

Our common stock did not exceed the conversion threshold price of $8.42 for at least 20 days during the 30 consecutive trading days ended June 30, 2013; accordingly, the May 2015 Notes were not convertible at the option of the holder during the quarter ended September 30, 2013 . Our common stock price did not exceed the conversion threshold price of $8.26 per common share for at least 20 days during the 30 consecutive trading days ended September 30, 2013 ; accordingly, the May 2015 Notes are not convertible at the option of the holder during the quarter ending December 31, 2013. At September 30, 2013 , the if-converted value of our May 2015 exceeded their principal amount by approximately $39.5 million .

Purchased Call Options and Warrants

In connection with the issuance of our May 2015 Notes, we entered into purchased call option transactions with two hedge counterparties. We paid an aggregate amount of $20.8 million , 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 24.0 million shares of our common stock. 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.

In addition, we sold to the hedge counterparties warrants exercisable, on a cashless basis, for the sale of rights to receive up to 27.5 million shares of common stock underlying our May 2015 Notes. We received an aggregate amount of $10.9 million for the sale from the two counterparties. 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 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.

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 $6.35 and $7.48 , subject to further adjustment upon certain events including dividend payments, for the purchased call options and warrants, respectively.

If the share price is above $6.35 , but below $7.48 , 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

24



that the Company must deliver to the note holders. If the share price is above $7.48 , 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 $7.48 . For example, a 10% increase in the share price above $7.48 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 September 30, 2013 , and December 31, 2012 , the market price condition for convertibility of our May 2015 Notes was not met and there were no related purchased call options or warrants exercised.

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 September 30, 2013 , and December 31, 2012 . 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, was 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.

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, and we recorded a net gain of $1.1 million . As part of the transaction, we placed an additional $88.0 million in aggregate principal of our February 2015 Notes. In January 2012, we completed an exchange transaction where we exchanged and subsequently retired approximately $169.0 million aggregate principal amount 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. In August 2013, the Company entered into a separate privately negotiated exchange agreement under which it retired the final $1.0 million aggregate principal amount of the Company's outstanding February 2015 Notes. Pursuant to the exchange agreement, the holder of the February 2015 Notes received $1.0 million aggregate principal amount of the Company's Series 2012 Notes. Immediately following the exchange, no principal amount of the February 2015 Notes remained outstanding. Our February 2015 Notes bore interest at 2.875% per annum.

10. Other Long-Term Liabilities

 
 
September 30,
 
December 31,
 
 
2013
 
2012
(In thousands)
 
 
 
 
Accrued lease liability
 
$
10,700

 
$
10,700

Long term incentive accrual
 
425

 

Uncertain tax positions
 
7,046

 
12,955

Foreign currency hedge
 
2,309

 
4,007

Total
 
$
20,480

 
$
27,662

 

11. Stock-Based Compensation
 
The Company grants stock options and restricted stock awards pursuant to a stockholder approved stock-based incentive plan. This incentive plan is described in further detail in Note 14, Stock-Based Compensation, of Notes to Consolidated Financial Statements in the 2012 Form 10-K.


25



The following table summarizes the Company’s stock option and restricted stock award activity during the nine months ended September 30, 2013 :

 
 
 
 
Stock Options
 
Restricted Stock Awards
(In thousands except per share amounts)
 
Shares Available for Grant
 
Number of Shares Outstanding
 
Weighted Average Exercise Price
 
Number of Shares Outstanding
 
Weighted Average Grant-date Fair Value Per Share
Balance December 31, 2012
 
4,589

 
196

 
$
16.22

 
120

 
$
6.51

Granted
 
(127
)
 

 
 

 
127

 
$
7.50

Shares released
 

 

 
 

 
(32
)
 
$
6.69

Forfeited or canceled
 
37

 
(22
)
 
$
14.23

 
(15
)
 
$
7.07

Plan shares expired
 
(22
)
 

 
 
 

 
 
Balance at September 30, 2013
 
4,477

 
174

 
$
16.47

 
200

 
$
7.12


12. Cash Dividends
 
On January 23, 2013 , our board of directors declared that the regular quarterly dividends to be paid to our stockholders in 2013  will be  $0.15 per share of common stock, payable on March 12 , June 12 , September 12 and December 12 of 2013 to stockholders of record on March 5 , June 5 September 5 and December 5 of 2013 , the record dates for each of the dividend payments, respectively.
 
In connection with the September 12, 2013 , dividend payment, the conversion rates for our convertible notes adjusted as follows:
 
Convertible Notes
 
Conversion Rate per $1,000 Principal Amount
 
Approximate Conversion Price Per Common Share
 
Effective Date
Series 2012 Notes
 
179.777

 
$
5.56

 
September 3, 2013
May 2015 Notes
 
157.3700

 
$
6.35

 
September 3, 2013

13. Income Taxes
 
For the three and nine months ended September 30, 2013 and 2012 , income tax expense was primarily derived by applying the federal statutory rate of 35% to operating income before income taxes.

During the second and third quarters of 2013, the Company released tax liabilities for the federal tax credits taken on the 2009 income tax return, in the amount of $5.7 million and $0.4 million , respectively. This resulted in a reduction to income tax expense for the second and third quarters of 2013. We expect to release additional tax liabilities in the third quarter of 2014 of approximately $7.0 million .

In general, our income tax returns are subject to examination by tax authorities for tax years 1996 forward. The California Franchise Tax Board is currently examining the Company’s 2008, 2009 and 2010 tax returns. 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 benefits over the next 12 months, except as described above.

14. Accumulated Other Comprehensive Income (Loss)

Comprehensive income is comprised of net income and other comprehensive income (loss). We include unrealized net gains on investments held in our available-for-sale securities and unrealized gains (losses) on our cash flow hedges in other comprehensive income (loss), and present the amounts net of tax. Our other comprehensive income (loss) is included in our Condensed Consolidated Statements of Comprehensive Income.

26




The balance of accumulated other comprehensive income (loss), net of tax, was as follows:
 
 
 
Unrealized gains (losses) on available-for-sale securities
 
Unrealized gains (losses) on cash flow hedges
 
Total Accumulated Other Comprehensive Income (Loss)
(In thousands)
 
 
 
 
 
 
Beginning Balance at December 31, 2012
 
$
7

 
$
(5,095
)
 
$
(5,088
)
Activity for the nine months ended September 30, 2013
 
1,085

 
(46
)
 
1,039

Ending Balance at September 30, 2013
 
$