PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-Q, Received: 05/09/2013 16:05:42)


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 March 31, 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 April 30, 2013 , there were 139,996,257 s hares 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 Months Ended March 31, 2013 and 2012
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2013 and 2012
 
 
 
 
Condensed Consolidated Balance Sheets at March 31, 2013, and December 31, 2012
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 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
Abbott
 
Abbott Laboratories
APIC
 
Additional paid-in-capital
ASC
 
Accounting Standards Codification
ASU
 
Accounting Standards Update
Avinger
 
Avinger, Inc.
AxoGen
 
AxoGen, Inc.
Chugai
 
Chugai Pharmaceutical Co., Ltd.
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 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 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
FTB
 
California Franchise Tax Board
GAAP
 
U.S. Generally Accepted Accounting Principles
Genentech
 
Genentech, Inc.
Genentech Products
 
Avastin ® , Herceptin ® , Lucentis ® , Xolair ® , Perjeta ® , Kadcyla TM
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 ®
Spin-Off
 
The spin-off by PDL of Facet
T-DM1
 
Trastuzumab-DM1
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


3



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
March 31,
 
 
2013
 
2012
Revenues
 
 
 
 
Royalties
 
$
91,847

 
$
77,344

Total revenues
 
91,847

 
77,344

 
 
 
 
 
Operating expenses
 
 

 
 

General and administrative
 
7,186

 
6,945

Operating income
 
84,661

 
70,399

 
 
 
 
 
Non-operating expense, net
 
 

 
 

Interest and other income, net
 
3,838

 
90

Interest expense
 
(6,000
)
 
(8,700
)
Total non-operating expense, net
 
(2,162
)
 
(8,610
)
 
 
 
 
 
Income before income taxes
 
82,499

 
61,789

Income tax expense
 
29,028

 
21,605

Net income
 
$
53,471

 
$
40,184

 
 
 
 
 
Net income per share
 
 

 
 

Basic
 
$
0.38

 
$
0.29

Diluted
 
$
0.36

 
$
0.29

 
 
 
 
 
Weighted average shares outstanding
 
 

 
 

Basic
 
139,816

 
139,680

Diluted
 
149,101

 
140,204

 
 
 
 
 
Cash dividends declared per common share
 
$
0.60

 
$
0.60

 
 See accompanying notes.

4



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

 
 
Three Months Ended
March 31,
 
 
2013
 
2012
Net income
 
$
53,471

 
$
40,184

 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 

 
 

Unrealized gains (losses) on investments in available-for-sale securities (a)
 
(3
)
 
29

Unrealized gains (losses) on cash flow hedges (b)
 
4,814

 
(6,677
)
Total other comprehensive income (loss), net of tax
 
4,811

 
(6,648
)
Comprehensive income
 
$
58,282

 
$
33,536

 ______________________________________________
(a) Net of tax of ($2) and $16 for the three months ended March 31, 2013 and 2012 , respectively.
(b) Net of tax of $2,592 and ($3,595) for the three months ended March 31, 2013 and 2012 , respectively.

See accompanying notes.

5



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
 
 
March 31,
2013
 
December 31,
2012
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
182,192

 
$
131,212

Restricted investment
20,000

 
20,000

Short-term investments
5,021

 
17,477

Receivables from licensees
150

 
366

Deferred tax assets
235

 
1,613

Notes receivable
44,682

 
7,504

Prepaid and other current assets
6,427

 
4,813

Total current assets
258,707

 
182,985

 
 
 
 
Property and equipment, net
56

 
59

Notes receivable and other long-term receivables
45,502

 
85,704

Long-term deferred tax assets
3,614

 
4,552

Other assets
4,931

 
6,666

Total assets
$
312,810

 
$
279,966

 
 
 
 
Liabilities and Stockholders' Deficit
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
504

 
$
1,074

Accrued liabilities
68,281

 
9,400

Total current liabilities
68,785

 
10,474

 
 
 
 
Convertible notes payable
312,613

 
309,952

Other long-term liabilities
25,083

 
27,662

Total liabilities
406,481

 
348,088

 
 
 
 
Commitments and contingencies (Note 8)
 

 
 

 
 
 
 
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; 139,816 and 139,816 shares issued and outstanding at March 31, 2013, and December 31, 2012, respectively
1,398

 
1,398

Additional paid-in capital
(233,910
)
 
(234,066
)
Accumulated other comprehensive loss
(277
)
 
(5,088
)
Retained earnings
139,118

 
169,634

Total stockholders' deficit
(93,671
)
 
(68,122
)
Total liabilities and stockholders' deficit
$
312,810

 
$
279,966


See accompanying notes.

6



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
Three Months Ended
March 31,
 
2013
 
2012
Cash flows from operating activities
 
 
 
Net income
$
53,471

 
$
40,184

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

 
 

Amortization of convertible notes offering costs
3,251

 
3,668

Other amortization and depreciation
50

 
298

Hedge ineffectiveness on foreign exchange contracts
(3
)
 
84

Stock-based compensation expense
156

 
204

Deferred taxes
(276
)
 
1,961

Changes in assets and liabilities:
 

 
 

Receivables from licensees
216

 
600

Prepaid and other current assets
(438
)
 
1,468

Accrued interest on notes receivable
(2,531
)
 

Other assets
1,145

 
(2,288
)
Accounts payable
(570
)
 
(57
)
Accrued legal settlement

 
(27,500
)
Accrued liabilities
(669
)
 
985

Other long-term liabilities
198

 
(1,711
)
Net cash provided by operating activities
54,000

 
17,896

Cash flows from investing activities
 

 
 

Purchases of investments

 
(5,993
)
Maturities of investments
12,405

 
14,000

Issuance of notes receivable
(2,579
)
 
(7,425
)
Repayment of notes receivable
8,134

 

Acquisition of property and equipment

 
(8
)
Net cash provided by investing activities
17,960

 
574

Cash flows from financing activities
 

 
 

Repayment of non-recourse notes

 
(23,839
)
Payment of debt issuance costs

 
(845
)
Cash dividends paid
(20,980
)
 
(20,962
)
Net cash used in financing activities
(20,980
)
 
(45,646
)
Net increase (decrease) in cash and cash equivalents
50,980

 
(27,176
)
Cash and cash equivalents at beginning of the year
131,212

 
168,544

Cash and cash equivalents at end of period
$
182,192

 
$
141,368

 
 
 
 
 
 
 
 
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
28,000

 
$
18,000

Cash paid for interest
$
2,588

 
$
4,980

See accompanying notes. 

7



PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2013
(Unaudited)

1. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with 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 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:
 
 
 
 
Three Months Ended March 31,
Licensee
 
Product Name
 
2013
 
2012
Genentech
 
Avastin ®
 
36
%
 
30
%
 
 
Herceptin ®
 
33
%
 
33
%
 
 
Lucentis ®
 
13
%
 
14
%
 
 
 
 
 
 
 
Elan
 
Tysabri ®
 
14
%
 
15
%

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 our licensees’ product sales with Euro forward contracts and, in 2011, Euro forward and option contracts. In general, these contracts are intended to offset the underlying Euro market risk in our royalty revenues. These contracts extend through the fourth quarter of 2014. We designate foreign currency exchange contracts used to hedge royalty revenues based on underlying Euro-denominated sales 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 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’ deficit as accumulated other comprehensive income (loss). Gains or losses on cash flow hedges are recognized as

8



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 portions is reported in other income 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 No. 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 Consolidated Condensed Financial Statements. Additional information about derivative instruments can be found in Note 5 of the Notes to the Consolidated Condensed Financial Statements.

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. 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 2013, which affects only the display of information and does not change existing recognition and measurement requirements in our Consolidated Condensed Financial Statements.

2. Net Income per Share
 
 
 
Three Months Ended March 31,
Net Income per Basic and Diluted Share:
 
2013
 
2012
  (in thousands except per share amounts)
 
 
Numerator
 
 
 
 
Net income used to compute net income per basic share
 
$
53,471

 
$
40,184

Add back interest expense for convertible notes, net of estimated tax of approximately $3 and $15 for the three months ended March 31, 2013 and 2012, respectively. (see Note 9)
 
6

 
27

Net income used to compute net income per diluted share
 
$
53,477

 
$
40,211

 
 
 
 
 
Denominator
 
 

 
 

Total weighted-average shares used to compute net income per basic share
 
139,816

 
139,680

Restricted stock outstanding
 
61

 
68

Effect of dilutive stock options
 
18

 
15

Assumed conversion of Series 2012 Notes
 
6,688

 
315

Assumed conversion of May 2015 Notes
 
2,345

 

Assumed conversion of February 2015 Notes
 
173

 
126

Weighted-average shares used to compute net income per diluted share
 
149,101

 
140,204

 
 
 
 
 
Net income per basic share
 
$
0.38

 
$
0.29

Net income per diluted share
 
$
0.36

 
$
0.29



9



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.

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.

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 include the shares issuable in respect of such excess.

We excluded 20.0 million and 18.4 million shares of potential dilution for our warrants for the three months ended March 31, 2013 and 2012 , respectively, for our warrants issued in 2011, because the exercise price of the warrants exceeded the average market price 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 23.5 million and 21.6 million shares were excluded for the three months ended March 31, 2013 and 2012 , respectively, because they have no effect on diluted net income per share under GAAP. For information related to the conversion rates on our convertible debt, see Note 9.

For the three months ended March 31, 2013 , we excluded approximately 139,000 and 20,000 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.

  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 paid 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.
 
 
March 31, 2013
 
December 31, 2012
 
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
173,532

 
$

 
$
173,532

 
$
121,095

 
$

 
$
121,095

Certificates of deposit
 

 
20,988

 
20,988

 

 
26,128

 
26,128

Corporate debt securities
 

 
5,021

 
5,021

 

 
13,572

 
13,572

Foreign currency hedge contracts
 

 
1,176

 
1,176

 

 

 

Total
 
$
173,532

 
$
27,185

 
$
200,717

 
$
121,095

 
$
39,700

 
$
160,795

 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Foreign currency hedge contracts
 
$

 
$
1,229

 
$
1,229

 
$

 
$
7,581

 
$
7,581

 

10



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. The certificates of deposit include a $20.0 million certificate of deposit that is restricted as it was purchased to collateralize the line of credit for Merus Labs; see Note 6.

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

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

There have been no transfers between levels during the three months ended March 31, 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:

 
 
March 31, 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
 
$
37,157

 
$

 
$
37,157

 
$
41,098

 
$

 
$
41,098

Merus Labs note receivable
 
30,000

 
30,000

 

 
30,000

 
30,000

 

AxoGen note receivable
 
23,027

 

 
23,027

 
22,110

 

 
22,110

Total
 
$
90,184

 
$
30,000

 
$
60,184

 
$
93,208

 
$
30,000

 
$
63,208

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Series 2012 Notes
 
$
167,015

 
$
235,940

 
$

 
$
165,528

 
$
227,187

 
$

May 2015 Notes
 
144,606

 
188,489

 

 
143,433

 
182,031

 

February 2015 Notes
 
992

 
1,318

 

 
991

 
1,269

 

Total
 
$
312,613

 
$
425,747

 
$

 
$
309,952

 
$
410,487

 
$

 
As of March 31, 2013 , the fair values of our Wellstat Diagnostic note receivable, Merus Labs note receivable, and AxoGen note receivable were determined using one or more discounted cash flow models, incorporating expected payments and the interest rate extended on the notes with fixed interest rates and incorporating expected payments for notes with a variable rate of return.

On March 31, 2013 , the carrying value of the AxoGen note approximates its fair value. We determined the estimated fair value of the note to be Level 3, 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 fair value measurement, we considered forward looking performance related to AxoGen, 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.

On March 31, 2013 , the carrying value of the note receivable from Wellstat Diagnostics approximates its fair value. 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 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. We determined that this note is a Level 3 asset, as our valuation of collateral utilized significant unobservable inputs including estimates of 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.

11




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

4. Cash Equivalents and Investments
 
As of March 31, 2013 , and December 31, 2012 , we had invested our excess cash balances primarily in money market funds, certificates of deposit, 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’ deficit, net of estimated taxes. See Note 3 for fair value measurement information. 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
 
 Fair Value
 
 Cash and Cash Equivalents
 
 Restricted Investment
 
Short-Term Marketable Securities
 
Long-Term Marketable Securities
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
7,672

 
$

 
$

 
$
7,672

 
$
7,672

 
$

 
$

 
$

Money market funds
 
173,532

 

 

 
173,532

 
173,532

 

 

 

Certificates of deposit
 
20,988

 

 

 
20,988

 
988

 
$
20,000

 

 

Corporate debt securities
 
5,015

 
6

 

 
5,021

 

 

 
5,021

 

Total
 
$
207,207

 
$
6

 
$

 
$
207,213

 
$
182,192

 
$
20,000

 
$
5,021

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 months ended March 31, 2013 and 2012 .

Cash and Available-For-Sale Securities by Contractual Maturity
 
March 31, 2013
 
December 31, 2012
(In thousands)
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Less than one year
 
$
207,207

 
$
207,213

 
$
168,679

 
$
168,689

Greater than one year but less than five years
 

 

 

 

Total
 
$
207,207

 
$
207,213

 
$
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 we had no other-than-temporary impairments on these securities as of March 31, 2013 , and December 31, 2012 .

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 March 31, 2013 , and December 31, 2012 , all outstanding Euro forward contracts and option contracts were classified as cash flow hedges.


12



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, fair values of our Euro forward contracts designated as cash flow hedges were as follows:

Euro Forward Contracts
 
March 31, 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

 
(392
)
 
10,850

 
(726
)
Euro
 
1.270
 
Sell Euro
 
44,450

 
(609
)
 
44,450

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

 
(228
)
 
36,814

 
(1,331
)
Euro
 
1.300
 
Sell Euro
 
91,000

 
1,176

 
91,000

 
(1,538
)
Total
 
 
 
 
 
$
183,114

 
$
(53
)
 
$
210,667

 
$
(7,581
)
 
 The location and fair values of our Euro contracts in our Condensed Consolidated Balance Sheets were: 
 
Cash Flow Hedge
 
Location
 
March 31,
2013
 
December 31,
2012
(In thousands)
 
 
 
 
 
 
Euro contracts
 
Prepaid and other current assets
 
$
1,176

 
$

Euro contracts
 
Accrued liabilities
 
$

 
$
3,574

Euro contracts
 
Other long-term liabilities
 
$
1,229

 
$
4,007


The effect of our derivative instruments in our Condensed Consolidated Statements of Income and our Condensed Consolidated Statements of Comprehensive Income were:

 
 
Three Months Ended March 31,
 
 
2013
 
2012
(In thousands)
 
 
 
 
Net gain (loss) recognized in OCI, net of tax (1)
 
$
3,568

 
$
(5,482
)
Gain (loss) reclassified from accumulated OCI into royalty revenue, net of tax (2)
 
$
(1,247
)
 
$
1,195

Net gain (loss) recognized in interest and other income, net -- cash flow hedges (3)
 
$
3

 
$
(84
)
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 ($3,000) and $57,000 for the three months ended March 31, 2013 and 2012 , respectively. Net loss from restructuring hedges was approximately zero and $27,000 for the three months ended March 31, 2013 and 2012 , respectively.

6. Notes Receivable and Other Long-term Receivables

13




Notes 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%, 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.

Under the credit agreement, Wellstat Diagnostics may 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. In the event of a change of control, bankruptcy or certain other customary events of defaults, or Wellstat Diagnostics' failure to achieve specified annual revenue threshold in 2017, Wellstat Diagnostics shall 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 credit agreement is secured by a pledge of all of the assets of Wellstat Diagnostics and a pledge of all of Wellstat Diagnostics’ equity interests by the holders thereof.

In January 2013, the Company was informed that, as of December 31, 2012, Wellstat Diagnostics had used funds contrary to the terms of the credit agreement and breached Sections 2.1.2 and 7 of the credit agreement. 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 has agreed to refrain from exercising additional remedies for 120 days while Wellstat Diagnostics raises funds to capitalize the business and the parties attempt to negotiate a revised credit agreement. PDL has 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 credit agreement. During the quarter ended March 31, 2013, approximately $2.6 million was advanced pursuant to the forbearance agreement.

At December 31, 2012 the carrying value of the note was included in non-current assets. At March 31, 2013 , the note is subject to the forbearance agreement and we believe the note will be settled within twelve months. Therefore, the carrying value is included in current assets. The note is collateralized by all assets and equity interest in Wellstat Diagnostics.

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 that the seller of the assets may draw upon on July 11, 2013, to satisfy the remaining $20.0 million purchase price obligation on July 11, 2013. Draws on the letter of credit will be funded from the proceeds of an additional loan to Merus Labs. Outstanding borrowings under the July 2012 loan bear interest at the rate of 13.5% per annum and outstanding borrowings as a result of draws on the letter of credit bear interest at the rate of 14.0% per annum. Merus Labs is 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 are subject to mandatory prepayments upon certain asset dispositions or debt issuances upon the terms set forth in the credit agreement.

The credit agreement provides for a number of standard events of default, including payment, bankruptcy, covenant, judgment and cross-defaults.

AxoGen Note Receivable and Revenue Interest Purchase 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

14



AxoGen’s products. The Royalty Agreement has an eight year term and provides PDL with high single digit royalties based on AxoGen Net Revenues, subject to agreed-upon minimum payments 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. The fair value of the repurchase option was not material on March 31, 2013 .

In the event of a change of control of AxoGen, it 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 specified internal rate of return to the Company. The Company has concluded that the change of control provision is an embedded derivative which should be bifurcated and separately accounted for at fair value. The fair value of the change of control provision was not material on March 31, 2013 .

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

Under the Royalty Agreement, during its term 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.

For carrying value and fair value information related to our Notes Receivable and Other Long-term Receivables, see Note 3.

7. Accrued Liabilities

 
 
March 31,
2013
 
December 31,
2012
(In thousands)
 
 
 
 
Compensation
 
$
928

 
$
594

Interest
 
3,087

 
2,925

Foreign currency hedge
 

 
3,574

Dividend payable
 
63,060

 
53

Legal
 
705

 
2,020

Other
 
501

 
234

Total
 
$
68,281

 
$
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 the 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 the Avastin, Herceptin, Lucentis and Xolair effectively extend our

15



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 54% of our royalty revenues for the three months ended March 31, 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.
 
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 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 intend to request 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 up to eighteen months. Accordingly, while the court has scheduled trial to commence on October 7, 2013, the likelihood that a trial date will be pushed out to as late as mid-2014 to mid-2015 is significant. Even in the event that the Nevada Supreme Court does not accept review of Roche and Genentech's request, due to the stay of proceedings in the interim period, the possibility exists that the parties will have insufficient time to complete discovery and other pre-trial activities, necessitating a delay in the currently scheduled October 2013 trial. In that instance, it is unclear at this time whether such a delay would occur or how long such a delay would be. 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.

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

16



under the lease agreements for the Redwood City facilities. As of March 31, 2013 , the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $97.6 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 March 31, 2013 and December 31, 2012 , related to this guarantee. 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.

9. Convertible Notes
  
 
 
 
 
Principal Balance Outstanding
 
Carrying Value
Description
 
Maturity Date
 
March 31, 2013
 
March 31, 2013
 
December 31, 2012
(In thousands)
 
 
 
 
 
 
 
 
Convertible Notes
 
 
 
 
 
 
 
 
Series 2012 Notes
 
February 15, 2015
 
$
179,000

 
$
167,015

 
$
165,528

May 2015 Notes
 
May 1, 2015
 
$
155,250

 
144,606

 
143,433

February 2015 Notes
 
February 15, 2015
 
$
1,000

 
992

 
991

Total
 
 
 
 

 
$
312,613

 
$
309,952


As of March 31, 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. For fair value information on our convertible notes, see Note 3.
 
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. At the conclusion of these transactions, $1.0 million of our February 2015 Notes remained 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. This is the same interest rate that we pay on the February 2015 Notes.

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

17



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:

(In thousands)
 
March 31, 2013
 
December 31, 2012
Principal amount of the Series 2012 Notes
 
$
179,000

 
$
179,000

Unamortized discount of liability component
 
(11,985
)
 
(13,472
)
Total
 
$
167,015

 
$
165,528


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

 
 
Three Months Ended March 31,
(In thousands)
 
2013
 
2012
Contractual coupon interest
 
$
1,287

 
$
1,263

Amortization of debt issuance costs
 
284

 
271

Amortization of debt discount
 
1,487

 
1,365

Total
 
$
3,058

 
$
2,899


As of March 31, 2013 , our Series 2012 Notes are convertible into 173.200 shares of the Company’s common stock per $1,000 of principal amount, or approximately $5.77 per common share, subject to further adjustment upon certain events including dividend payments. As of March 31, 2013 , the remaining discount amortization period was 1.9 years.

Our common stock did not exceed the conversion threshold price of $7.67 for at least 20 days during 30 consecutive trading days ended December 31, 2012; accordingly, the Series 2012 Notes were not convertible at the option of the holder during the quarter ended March 31, 2013 . Our common stock price did not exceed the conversion threshold price of $7.51 per common share for at least 20 days during the 30 consecutive trading days ended March 31, 2013 ; accordingly, the Series 2012 Notes are not convertible at the option of the holder during the quarter ending June 30, 2013. At March 31, 2013 , the if-converted value of our Series 2012 Notes exceeded their principal amount by approximately $47.3 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

18



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 $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 March 31, 2013 , the remaining discount amortization period is 2.1 years.

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

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

 
$
155,250

Unamortized discount of liability component
 
(10,644
)
 
(11,817
)
Total
 
$
144,606

 
$
143,433


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

 
 
Three Months Ended March 31,
(In thousands)
 
2013
 
2012
Contractual coupon interest
 
$
1,455

 
$
1,455

Amortization of debt issuance costs
 
304

 
295

Amortization of debt discount
 
1,173

 
1,090

Total
 
$
2,932

 
$
2,840


As of March 31, 2013 , our May 2015 Notes are convertible into 151.6248 shares of the Company’s common stock per $1,000 of principal amount, or approximately $6.60 per common share, subject to further adjustment upon certain events including dividend payments.

Our common stock did not exceed the conversion threshold price of $8.76 for at least 20 days during 30 consecutive trading days ended December 31, 2012; accordingly, the May 2015 Notes were not convertible at the option of the holder during the quarter ended March 31, 2013 . Our common stock price did not exceed the conversion threshold price of $8.57 per common share for at least 20 days during the 30 consecutive trading days ended March 31, 2013 ; accordingly, the May 2015 Notes are

19



not convertible at the option of the holder during the quarter ending June 30, 2013. At March 31, 2013 , the if-converted value of our May 2015 exceeded their principal amount by approximately $16.6 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 23.5 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 $6.60 and $7.76 , subject to further adjustment upon certain events including dividend payments, for the purchased call options and warrants, respectively.

If the share price is above $6.60 , but below $7.76 , 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 $7.76 , 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 $7.76 . For example, a 10% increase in the share price above $7.76 would result in the issuance of 2.1 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 March 31, 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 March 31, 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 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.

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. Following settlement of the exchanges on February 2, 2012, $1.0 million of our February 2015 Notes and $179.0 million of our Series 2012 Notes were outstanding.


20



Our February 2015 Notes bear interest at 2.875% per annum, are due February 15, 2015, and are convertible at any time, at the holders’ option, into our common stock at a conversion price of 173.200 shares of common stock per $1,000 principal amount, or $5.77 per share, subject to further adjustment in certain events including dividend payments. We pay interest on our February 2015 Notes 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. Our February 2015 Notes issuance was not registered under the Securities Act of 1933, as amended, in reliance on exemption from registration thereunder. As of March 31, 2013 , and December 31, 2012 , our February 2015 Notes aggregate principal outstanding was $1.0 million .

As of March 31, 2013 , and December 31, 2012 , our February 2015 Notes unamortized issuance costs, included as a component of Other Assets on the Condensed Consolidated Balance Sheets, were approximately $11,000 and $12,000 , respectively. As of March 31, 2013 , and December 31, 2012 , the unamortized discount on our February 2015 Notes was approximately $8,000 and $9,000 , respectively. The issuance cost and discount are being amortized to interest expense over the term of our February 2015 Notes, with a remaining amortization period as of March 31, 2013 , of approximately 1.9 years.
 
10. Other Long-Term Liabilities

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

 
$
10,700

Long term incentive accrual
 
103

 

Uncertain tax positions
 
13,051

 
12,955

Foreign currency hedge
 
1,229

 
4,007

Total
 
$
25,083

 
$
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.

The following table summarizes the Company’s stock option and restricted stock award activity during the three months ended March 31, 2013 :

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

 
196

 
$
16.22

 
120

 
$
6.51

Granted
 
(51
)
 

 
 

 
51

 
$
6.72

Forfeited or canceled
 
5

 

 
 
 
(5
)
 
$
6.29

Balance at March 31, 2013
 
4,543

 
196

 
$
16.22

 
166

 
$
6.58


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

21



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 March 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
 
173.200

 
$
5.77

 
March 1, 2013
May 2015 Notes
 
151.6248

 
$
6.60

 
March 1, 2013
February 2015 Notes
 
173.200

 
$
5.77

 
March 6, 2013

13. Income Taxes
 
For the three months ended March 31, 2013 and 2012 , income tax expense was primarily derived by applying the federal statutory rate of 35% to operating income before income taxes.
 
In general, our income tax returns are subject to examination by tax authorities for tax years 1996 forward. The FTB 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.

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.

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 Loss
(In thousands)
 
 
 
 
 
 
Beginning Balance at December 31, 2012
 
$
7

 
$
(5,095
)
 
$
(5,088
)
Activity for the three months ended March 31, 2013
 
(3
)
 
4,814

 
4,811

Ending Balance at March 31, 2013
 
$
4

 
$
(281
)
 
$
(277
)

15. Subsequent Events

On April 18, 2013, PDL entered into a credit agreement with Avinger, under which we made available to Avinger up to $40 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 million available to Avinger, we funded an initial $20 million, net of fees, at close of the transaction. Upon the attainment of certain revenue milestones to be accomplished no later than the end of the first half of 2014, we will fund Avinger an additional amount between $10 million and $20 million (net of fees) at Avinger's election. Outstanding borrowings under the initial loan bear interest at the rate of 12% per annum, and outstanding borrowings as a result of additional amounts funded upon reaching the revenue milestones 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 milestones are not achieved or (ii) the thirteenth interest payment date if the revenue

22



milestones are achieved. The principal amount outstanding at commencement of repayment, after taking in account any payment-in-kind, will be repaid in equal installments until final maturity of the loans. The loans will mature in April 2018.

Under the credit agreement, Avinger may prepay the outstanding principal and accrued interest on the note receivable at any time. However, if Avinger repays the note receivable prior to April 2018, the Company will receive certain minimum payments from Avinger from the prepayment date through the maturity date of the note receivable.

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. 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.

23



ITEM 2.             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Quarterly 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 they were made, 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 or incorporated by reference herein, and for the reasons described elsewhere in this Quarterly Report. All forward-looking statements and reasons why results may differ included in this Quarterly 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.
 
OVERVIEW
 
PDL pioneered the humanization of monoclonal antibodies and, by doing so, enabled the discovery of a new generation of targeted treatments for cancer, immunologic diseases and other medical conditions. Today, PDL is focused on intellectual property asset management, investing in income generating 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 that are manufactured or launched before final patent expiry in December 2014 or which are otherwise subject to a royalty for licensed know-how under our 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.

We continuously evaluate alternatives to increase return for our stockholders, for example, purchasing income generating assets, buying back or redeeming our convertible notes, repurchasing our common stock, paying dividends or selling the Company. 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.

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. Our business previously included a biotechnology operation that was focused on the discovery and development of novel antibodies. We spun-off the operation to our stockholders as Facet in December 2008.

Recent Developments
 
March 12, 2013, Dividend Payment and Effect on Conversion Rates for the Convertible Notes
 
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. On March 12, 2013 , we paid the regular quarterly dividend to our stockholders totaling $21.0 million using earnings generated in the three months ended March 31, 2013 .


24



In connection with the March 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
 
173.200

 
$
5.77

 
March 1, 2013
May 2015 Notes
 
151.6248

 
$
6.60

 
March 1, 2013
February 2015 Notes
 
173.200

 
$
5.77

 
March 6, 2013

The adjustments were based on the amount of the dividend and the trading price of our stock under the terms of the applicable indenture.

Wellstat Diagnostics Forbearance Agreement

In January 2013 , the Company was informed that, as of December 31, 2012 , Wellstat Diagnostics had used funds contrary to the terms of the credit agreement and breached Sections 2.1.2 and 7 of the credit agreement. 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 has agreed to refrain from exercising additional remedies for 120 days while Wellstat Diagnostics raises funds to capitalize the business and the parties attempt to negotiate a revised credit agreement. PDL has 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 credit agreement.

Subsequent Events
 
On April 18, 2013, PDL entered into a credit agreement with Avinger, under which we made available to Avinger up to $40 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 million available to Avinger, we funded an initial $20 million, net of fees, at close of the transaction. Upon the attainment of certain revenue milestones to be accomplished no later than the end of the first half of 2014, we will fund Avinger an additional amount between $10 million and $20 million (net of fees) at Avinger's election. Outstanding borrowings under the initial loan bear interest at the rate of 12% per annum, and outstanding borrowings as a result of additional amounts funded upon reaching the revenue milestones 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 milestones are not achieved or (ii) the thirteenth interest payment date if the revenue milestones are achieved. The principal amount outstanding at commencement of repayment, after taking in account any payment-in-kind, will be repaid in equal installments until final maturity of the loans. The loans will mature in April 2018.

Under the credit agreement, Avinger may prepay the outstanding principal and accrued interest on the note receivable at any time. However, if Avinger repays the note receivable, the Company will receive certain minimum payments from Avinger from the prepayment date through the maturity date of the note receivable.

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. 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). The Credit Agreement provides for a number of standard events of default, including payment, bankruptcy, covenant, representation and warranty and judgment defaults.

 
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

25



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
 
6/7/1995
 
5,585,089
 
12/17/1996
 
6/25/2013
08/474,040
 
6/7/1995
 
5,693,761
 
12/2/1997
 
12/2/2014
08/487,200
 
6/7/1995
 
5,693,762
 
12/2/1997
 
6/25/2013
08/484,537
 
6/7/1995
 
6,180,370
 
1/30/2001
 
6/25/2013

Our U.S. '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. Genentech has advised us that they believe Lucentis ® is not covered by the claims of the '761 patent. We have requested clarification from Genentech on the bases of their belief. However, Genentech may elect to stop royalty payments on Lucentis that is manufactured and sold in the United States after June 25, 2013. Genentech has not suggested that Lucentis that is manufactured in the United States prior to June 25, 2013 and sold after that date will not be subject to a royalty payment to us. In addition, our SPCs covering manufacture and/or sale of Lucentis in Europe do not expire until in December 2014.

Our '216B patent expired in Europe in December 2009. We have been granted 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. The SPCs effectively extend our patent protection with respect to SPC 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.
 
Licensing Agreements
 
We have entered into licensing agreements under our Queen et al. patents with numerous entities that are independently developing or have developed humanized antibodies. We receive royalties on net sales of products that are made, used and/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. We also expect to receive 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.
 
Licensing Agreements for Marketed Products
 
In the three months ended March 31, 2013 , we received royalties on sales of the seven humanized antibody products listed below, all of which are currently approved for use by the FDA and other regulatory agencies outside the United States.
 
Licensee
 
Product Names
Genentech
 
Avastin ®
 
 
Herceptin ®
 
 
Xolair ®
 
 
Lucentis ®
 
 
Perjeta ®
 
 
 
Elan
 
Tysabri ®
 
 
 
Chugai
 
Actemra ®

26




For the three months ended March 31, 2013 and 2012 , we received royalty revenues under license agreements of $91.8 million and $77.3 million , respectively.

On February 22, 2013, Genentech announced that the FDA had approved Kadcyla TM for second line treatment of HER2-positive metastatic breast cancer and first line treatment for those patients who relapse within six months following adjuvant therapy. Roche has submitted a Marketing Authorization Application to other regulatory authorities around the world, including the EMA, for Kadcyla for the treatment of people with HER2-positive metastatic breast cancer. This application is currently under review by the EMA. On March 4, 2013, Genentech notified PDL in writing that Kadcyla is a licensed product for which a royalty is payable to PDL on sales thereof. PDL expects to begin receiving royalties in the second quarter of 2013 for the sales that occurred in the first quarter of 2013. Because Kadcyla is an antibody drug conjugate, i.e., made up of the antibody, trastuzumab, and the chemotherapy, DM1, joined together using a stable linker, it is a “combination product” under the terms of the license agreement and PDL will not receive royalties on that portion of the sales of the drug attributable to the DM1.

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 license agreement with Genentech entitles us to royalties following the expiration of our patents with respect to sales of licensed product manufactured prior to patent expiry in jurisdictions providing patent protection. 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 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:

Genentech Products Made or Sold in the U.S.
 
Royalty Rate
Net sales up to $1.5 billion
 
3.0%
Net sales between $1.5 billion and up to $2.5 billion
 
2.5%
Net sales between $2.5 billion and up to $4.0 billion
 
2.0%
Net sales exceeding $4.0 billion
 
1.0%
 
 
 
Genentech Products Made and Sold ex-U.S.
 
 
Net sales
 
3.0%
 
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.
 

27



With respect to 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 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. 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:

 
Three Months Ended March 31,
 
2013
 
2012
Avastin
 
 
 
Ex-U.S.-based Sales
60
%
 
57
%
Ex-U.S.-based Manufacturing and Sales
50
%
 
27
%
Herceptin
 

 
 

Ex-U.S.-based Sales
69
%
 
70
%
Ex-U.S.-based Manufacturing and Sales
41
%
 
35
%
Lucentis
 

 
 

Ex-U.S.-based Sales
67
%
 
60
%
Ex-U.S.-based Manufacturing and Sales
0
%
 
0
%
Perjeta
 
 
 
Ex-U.S.-based Sales
5
%
 
0
%
Ex-U.S.-based Manufacturing and Sales
0
%
 
0
%
Xolair
 

 
 

Ex-U.S.-based Sales
39
%
 
40
%
Ex-U.S.-based Manufacturing and Sales
39
%
 
40
%
 
The information in the table above is based on information provided to us by Genentech. We were not provided the reasons for the fluctuations in the manufacturing split between U.S.-based Sales and ex-U.S.-based Manufacturing and Sales.
 
In the three months ended March 31, 2013 and 2012 , PDL received royalties from ex-U.S. based Manufacturing and Sales of three of Genentech’s licensed products: Herceptin, Avastin and Xolair. Roche, Genentech's parent company, produces Avastin and Herceptin in plants in Basel, Switzerland and Penzberg, Germany, respectively. Roche has announced that there are new plants in Singapore for the potential production of Avastin and Lucentis.

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.

On June 8, 2012, Genentech announced that the U.S. Food and Drug Administration approved Perjeta (pertuzumab). Perjeta is approved in combination with Herceptin and docetaxel chemotherapy for the treatment of people with HER2-postive metastatic breast cancer who have not received prior anti-HER2 therapy or chemotherapy for metastatic disease. PDL began receiving royalties generated from Perjeta during the quarter ended September 30, 2012.

On March 5, 2013, Genentech announced that Perjeta was approved by the EMA in combination with Herceptin and docetaxel chemotherapy for the treatment of people with HER2-postive metastatic breast cancer who have not received prior anti-HER2 therapy or chemotherapy for metastatic disease.

On February 22, 2013, Genentech announced that the FDA had approved Kadcyla for second line treatment of HER2-positive metastatic breast cancer and first line treatment for those patients who relapse within six months following adjuvant therapy. Roche has submitted a Marketing Authorization Application to other regulatory authorities around the world, including the EMA, for Kadcyla for the treatment of people with HER2-positive metastatic breast cancer. This application is currently under review by the EMA. On March 4, 2013, Genentech notified PDL in writing that Kadcyla is a licensed product for which a royalty is payable to PDL on sales thereof. PDL expects to begin receiving royalties in the second quarter of 2013 for the sales that occurred in the first quarter of 2013. Because Kadcyla is an antibody drug conjugate, i.e., made up of the antibody,

28



trastuzumab, and the chemotherapy, DM1, joined together using a stable linker, it is a “combination product” under the terms of the license agreement and PDL will not receive royalties on that portion of the sales of the drug attributable to the DM1.

In 2010 we initiated an audit of Genentech related to its payment of royalties for the period 2007-2009.  KPMG, who Genentech and PDL agreed would be the independent auditor for this purpose, concluded that, based on the information available to it, Genentech may have underpaid royalties during the audited period.  Genentech disagrees with KPMG's conclusions.  We are in discussions with Genentech in an attempt to resolve the matter.

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 α4 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. Our license agreement with Elan entitles us to royalties following the expiration of our patents with respect to sales of licensed product manufactured prior to patent expiry in jurisdictions providing patent protection. 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.
 
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 manufactured in the U.S. prior to patent expiry. 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 that are not currently marketed. 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, solanezumab is the Lilly licensed antibody for the treatment of Alzheimer's disease. If Lilly’s antibody for Alzheimer’s disease is approved, we would receive royalties on sales of solanezumab manufactured before patent expiration, as well as 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 two percent royalty payable for "know-how" runs for 12.5 years after the product's initial commercialization.

Economic and Industry-wide Factors
 
Various economic and industry-wide factors are relevant to us and could affect our business, including changes to laws and interpretation of those laws that protect our intellectual property rights, our licensees ability to obtain or retain regulatory approval for products licensed under our patents, fluctuations in foreign currency exchange rates, the ability to attract, retain and integrate qualified personnel, as well as overall global economic conditions. We actively monitor economic, industry and market factors affecting our business, however, we cannot predict the impact such factors may have on our future results of operations, liquidity and cash flows. See also the “Risk Factors” section of this quarterly report for additional factors that may impact our business and results of operations.

Critical Accounting Policies and Uses of Estimates

During the three months ended March 31, 2013 , there have been no significant changes to our critical accounting policies since those presented in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2012 .


29



  Operating Results
 
Three Months Ended March 31, 2013 , compared to three months ended March 31, 2012

Revenues

 
 
Three Months Ended March 31,
 
Change from Prior
 
 
2013
 
2012
 
Year %
(Dollars in thousands)
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
Royalties
 
$
91,847

 
$
77,344

 
19
%
Total revenues
 
$
91,847

 
$
77,344

 
19
%
 
Total royalty revenues were $91.8 million and $77.3 million for the three months ended March 31, 2013 and 2012 , respectively, and consisted of royalties and maintenance fees earned on sales of products under license agreements associated with our Queen et al. patents. Royalty revenue is net of the payments 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. The amount paid is less than we receive in royalties on such sales.

Royalty revenues increased nineteen percent for the three months ended March 31, 2013 , when compared to the same period in 2012 . The growth is primarily driven by increased royalties in the fourth quarter of 2012 of Avastin, Herceptin, Lucentis, Tysabri, and Actemra by our licensees. Net sales of Avastin, Herceptin, Lucentis, Xolair and Perjeta, are subject to a tiered royalty rate except in the case when the product is ex-U.S. Manufactured and Sold, in which case it is subject to a flat three percent royalty rate.
 
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 three months ended March 31, 2013 and 2012 :
 
 
 
 
 
Three Months Ended March 31,
Licensee
 
Product Name
 
2013
 
2012
Genentech
 
Avastin
 
36
%
 
30
%
 
 
Herceptin
 
33
%
 
33
%
 
 
Lucentis
 
13
%
 
14
%
 
 
 
 
 
 
 
Elan
 
Tysabri
 
14
%
 
15
%

Foreign currency exchange rates also impact our reported revenues. 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, and when 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. 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.

As a result of our Euro forward contracts, recognized royalty revenues decreased $1.9 million for the three months ended March 31, 2013 , and increased $1.8 million for the three months ended March 31, 2012 .
 

30



Operating Expenses
 
 
 
Three Months Ended March 31,
 
Change from Prior
 
 
2013
 
2012
 
Year %
(In thousands)
 
 
 
 
 
 
General and administrative
 
$
7,186

 
$
6,945

 
3
%
Percentage of total revenues
 
8
%
 
9
%
 
 

The 3% increase in operating expenses was a result of increased legal expenses related to litigation.

Non-operating Expense, Net
 
For the three months ended March 31, 2013 , compared to the three months ended March 31, 2012 , non-operating expense, net, decreased primarily due to a $3.7 million increase in interest income from the notes receivables entered into during 2012 and $2.9 million lower interest expense as a result of our repayment of the principal balance of our Non-recourse Notes.

Income Taxes

Income tax expense for the three months ended March 31, 2013 and 2012 , was $29.0 million and $21.6 million , respectively, which resulted primarily from applying the federal statutory income tax rate to income before income taxes.

Net Income per Share
 
Net income per share for the three months ended March 31, 2013 and 2012 , was:

 
Three Months Ended March 31,
 
2013
 
2012
Net income per basic share
$
0.38

 
$
0.29

Net income per diluted share
$
0.36

 
$
0.29


The increase in the net income per diluted share is due to the 19% increase in royalty revenues and the resulting 33% increase in net income.

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 $187.2 million and $148.7 million , excluding restricted investments, at March 31, 2013 , and December 31, 2012 , respectively. The increase was primarily attributable to net cash provided by operating activities of $54.0 million and repayment of notes receivable of $8.1 million , offset in part by payment of dividends of $21.0 million and cash advanced on notes receivable of $2.6 million . 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 expires 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.

We continuously evaluate alternatives to increase return for our stockholders by, for example, purchasing income generating assets, buying back our convertible notes, repurchasing our common stock, selling the Company and paying dividends. On January 23, 2013 , our board of directors declared regular quarterly dividends of $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.

31




Notes and Other Long-term Receivables

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%, 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 to replace the original $7.5 million note, which bore interest at 12% per annum. 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.

Under the credit agreement, Wellstat Diagnostics may 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. In the event of a change of control, bankruptcy or certain other customary events of defaults, or Wellstat Diagnostics' failure to achieve specified annual revenue threshold in 2017, Wellstat Diagnostics shall 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 credit agreement is secured by a pledge of all of the assets of Wellstat Diagnostics and a pledge of all of Wellstat Diagnostics’ equity interests by the holders thereof.

In January 2013, the Company was informed that, as of December 31, 2012, Wellstat Diagnostics had used funds contrary to the terms of the credit agreement and breached Sections 2.1.2 and 7 of the credit agreement. 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 has agreed to refrain from exercising additional remedies for 120 days while Wellstat Diagnostics raises funds to capitalize the business and the parties attempt to negotiate a revised credit agreement. PDL has 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 credit agreement. During the q