PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-Q, Received: 11/10/2014 16:17:01)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549  
FORM 10-Q
 
  (Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2014
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 ý
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 November 3, 2014 , there were 160,654,082 shares of the Registrant’s Common Stock outstanding.




  PDL BIOPHARMA, INC.
2014 Form 10-Q
Table of Contents
 
 
Page
GLOSSARY OF TERMS AND ABBREVIATIONS (as used in this document)
 
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
FINANCIAL STATEMENTS
 
 
 
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013
 
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2014, and December 31, 2013
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013
 
 
 
 
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 on Form 10-Q 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
Accel 300
 
Accel 300, LLC, a wholly-owned subsidiary of kaléo, Inc.
Avinger
 
Avinger, Inc.
AxoGen
 
AxoGen, Inc.
AxoGen Royalty Agreement
 
Revenue Interests Purchase Agreement between PDL and AxoGen.
Biogen Idec
 
Biogen Idec, Inc.
Chugai
 
Chugai Pharmaceutical Co., Ltd.
Depo DR Sub
 
Depo Dr Sub, LLC, a wholly owned subsidiary of Depomed
Depomed
 
Depomed, Inc.
Depomed Royalty Agreement
 
Royalty Purchase and Sale Agreement among Depomed, Depo DR Sub, LLC and PDL
Direct Flow Medical
 
Direct Flow Medical, Inc.
Durata
 
Durata Therapeutics Holding C.V., Durata Therapeutics International B.V. and Durata Therapeutics, Inc. (parent company)
Elan
 
Elan Corporation, PLC
ex-U.S.-based Manufacturing and Sales
 
Products that are both manufactured and sold outside of the United States
ex-U.S.-based Sales
 
Products that are manufactured in the United States and sold outside of the United States
EBITDA
 
Earnings before interest, taxes, depreciation and amortization
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, fully retired at September 30, 2013
February 2018 Notes
 
4.0% Convertible Senior Notes due February 1, 2018
GAAP
 
U.S. Generally Accepted Accounting Principles
Genentech
 
Genentech, Inc.
Genentech Products
 
Avastin ® , Herceptin ® , Lucentis ® , Xolair ® , Perjeta ® , and Kadcyla ®
Hyperion
 
Hyperion Catalysis International, Inc.
kaléo
 
kaléo, Inc. (formerly known as Intelliject, Inc.)
LENSAR
 
LENSAR, Inc.
Lilly
 
Eli Lilly and Company
May 2015 Notes
 
3.75% Senior Convertible Notes due May 2015
Merus Labs
 
Merus Labs International, Inc.
Michigan Royalty Agreement
 
Royalty Purchase and Sale Agreement between The Regents of the University of Michigan and PDL
Novartis
 
Novartis AG
OCI
 
Other Comprehensive Income (Loss)

3



Paradigm Spine
 
Paradigm Spine, LLC
Paradigm Spine Credit Agreement
 
Paradigm Spine Credit Agreement between Paradigm Spine and the Company, dated February 14, 2014
PDL, we, us, our, the Company
 
PDL BioPharma, Inc.
PMA
 
Premarket Approval, as such term is used by the FDA
Queen et al. patents
 
PDL's patents in the United States and elsewhere covering the humanization of antibodies
Roche
 
F. Hoffman LaRoche, Ltd.
SAB
 
Staff Accounting Bulletin
SDK
 
Showa Denka K.K.
SEC
 
Securities and Exchange Commission
Series 2012 Notes
 
2.875% Series 2012 Convertible Senior Notes due February 15, 2015
Settlement Agreement
 
Settlement Agreement amongst PDL, Genentech and Roche, dated January 31, 2014
SPCs
 
Supplementary Protection Certificates
Spin-Off
 
The spin-off by PDL of Facet
Term Loan
 
Credit Agreement among PDL, the Royal Bank of Canada and lenders thereto, dated October 28, 2013, as amended
U.S.-based Sales
 
Products sold in the United States or manufactured in the United States and used or sold anywhere in the world
VB
 
Viscogliosi Brothers, LLC
VB Royalty Agreement
 
Royalty Purchase and Sale Agreement between Viscogliosi Brothers, LLC and PDL
VWAP
 
Volume weighted average share price
Wellstat Diagnostics
 
Wellstat Diagnostics, LLC
Wellstat Diagnostics Note Receivable and Credit Agreement
 
Senior Secured Note receivable among the Company and the holders of the equity interests in Wellstat Diagnostics, as amended, and Credit Agreement between Wellstat Diagnostics and the Company, dated November 2, 2012, as amended

4



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

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
Revenues
 
 
 
 
 
 
 
 
Royalties from Queen et al. patents
 
$
123,916

 
$
96,314

 
$
355,008

 
$
331,778

Royalty rights - change in fair value
 
27,602

 

 
73,807

 

Interest revenue
 
13,076

 
2,864

 
34,760

 
11,516

License and other
 

 
1,000

 
575

 
1,000

Total revenues
 
164,594

 
100,178

 
464,150

 
344,294

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 

 
 

 
 

 
 

General and administrative
 
5,686

 
7,925

 
17,188

 
21,894

Operating income
 
158,908

 
92,253

 
446,962

 
322,400

 
 
 
 
 
 
 
 
 
Non-operating expense, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
75

 
53

 
207

 
202

Interest expense
 
(9,387
)
 
(6,118
)
 
(29,770
)
 
(18,169
)
Loss on extinguishment of debt
 

 

 
(6,143
)
 

Total non-operating expense, net
 
(9,312
)
 
(6,065
)
 
(35,706
)
 
(17,967
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
149,596

 
86,188

 
411,256

 
304,433

Income tax expense
 
47,361

 
29,963

 
144,083

 
100,995

Net income
 
$
102,235

 
$
56,225

 
$
267,173

 
$
203,438

 
 
 
 
 
 
 
 
 
Net income per share
 
 

 
 

 
 

 
 

Basic
 
$
0.64

 
$
0.40

 
$
1.70

 
$
1.45

Diluted
 
$
0.61

 
$
0.36

 
$
1.62

 
$
1.31

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
160,268

 
139,848

 
157,274

 
139,830

Diluted
 
166,894

 
154,593

 
165,141

 
155,366

 
 
 
 
 
 
 
 
 
Cash dividends declared per common share
 
$

 
$

 
$
0.60

 
$
0.60

 
 See accompanying notes.

5



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

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Net income
 
$
102,235

 
$
56,225

 
$
267,173

 
$
203,438

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 

 
 

 
 

 
 

Change in unrealized gains on investments in available-for-sale securities:
 
 
 
 
 
 
 
 
Change in fair value of investments in available-for-sale securities, net of tax
 
(258
)
 
1,091

 
(1,554
)
 
1,085

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

 

 

 

Total change in unrealized gains on investments in available-for-sale securities, net of tax (a)
 
(258
)
 
1,091

 
(1,554
)
 
1,085

Change in unrealized losses on cash flow hedges:
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedges, net of tax
 
1,974

 
(3,359
)
 
2,305

 
(1,056
)
Adjustment to royalties from Queen et al. patents for net (gains) losses realized and included in net income, net of tax
 
989

 
32

 
3,744

 
1,011

Total change in unrealized losses on cash flow hedges, net of tax (b)
 
2,963

 
(3,327
)
 
6,049

 
(45
)
Total other comprehensive income (loss), net of tax
 
2,705

 
(2,236
)
 
4,495

 
1,040

Comprehensive income
 
$
104,940

 
$
53,989

 
$
271,668

 
$
204,478

 ______________________________________________
(a) Net of tax of ($139) and $587 for the three months ended September 30, 2014 and 2013 , respectively, and ($837) and $584 for the nine months ended September 30, 2014 and 2013 , respectively.
(b) Net of tax of $1,595 and ($1,791) for the three months ended September 30, 2014 and 2013 , respectively, and $3,257 and ($24) for the nine months ended September 30, 2014 and 2013 , respectively.

See accompanying notes.

6



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
 
 
September 30,
 
December 31,
 
2014
 
2013
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
281,607

 
$
94,302

Short-term investments
2,847

 
5,238

Receivables from licensees and other
250

 
300

Deferred tax assets

 
377

Notes receivable
55,289

 
1,208

Prepaid and other current assets
1,446

 
6,272

Total current assets
341,439

 
107,697

 
 
 
 
Property and equipment, net
72

 
41

Royalty rights - at fair value
242,452

 
235,677

Notes and other receivables, long-term
363,289

 
193,840

Long-term deferred tax assets
25,096

 
6,700

Other assets
7,521

 

Total assets
$
979,869

 
$
543,955

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
1,079

 
$
287

Accrued liabilities
35,677

 
11,857

Accrued income taxes
6,494

 

Term loan payable
18,720

 
74,397

Convertible notes payable
199,669

 
320,883

Total current liabilities
261,639

 
407,424

 
 
 
 
Convertible notes payable
274,512

 

Other long-term liabilities
41,712

 
23,042

Total liabilities
577,863

 
430,466

 
 
 
 
Commitments and contingencies (Note 8)


 


 
 
 
 
Stockholders' equity:
 

 
 

Preferred stock, par value $0.01 per share, 10,000 shares authorized; no shares issued and outstanding

 

Common stock, par value $0.01 per share, 350,000 shares authorized; 160,276 and 139,935 shares issued and outstanding at September 30, 2014, and December 31, 2013, respectively
1,603

 
1,399

Additional paid-in capital
(120,180
)
 
(233,173
)
Accumulated other comprehensive loss
(393
)
 
(4,888
)
Retained earnings
520,976

 
350,151

Total stockholders' equity
402,006

 
113,489

Total liabilities and stockholders' equity
$
979,869

 
$
543,955

See accompanying notes.

7



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2014
 
2013
Cash flows from operating activities
 
 
 
Net income
$
267,173

 
$
203,438

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

 
 

Amortization of convertible notes and term loan offering costs
13,473

 
9,921

Change in fair value of royalty rights - at fair value
(72,992
)
 

Loss on extinguishment of convertible notes
6,143

 

Other amortization, depreciation and accretion of embedded derivative
(144
)
 
(360
)
Hedge ineffectiveness on foreign exchange contracts
(5
)
 
(9
)
Stock-based compensation expense
1,026

 
559

Tax expense from stock-based compensation arrangements

 
(15
)
Deferred income taxes
(6,493
)
 
(663
)
Changes in assets and liabilities:
 

 
 

Receivables from licensees and other
50

 
(534
)
Prepaid and other current assets
1,959

 
3,298

Accrued interest on notes receivable
(8,367
)
 
(6,573
)
Other assets
(29
)
 
28

Accounts payable
792

 
395

Accrued liabilities
3,325

 
1,302

Accrued income taxes
6,494

 
3,231

Other long-term liabilities
10,834

 
(5,483
)
Net cash provided by operating activities
223,239

 
208,535

Cash flows from investing activities
 

 
 

Purchases of investments

 
(9,875
)
Maturities of investments

 
42,098

Purchase of royalty rights - at fair value
(15,500
)
 

Proceeds from royalty rights - at fair value
81,717

 

Purchase of notes receivable
(215,000
)
 
(48,708
)
Repayment of notes receivable

 
59,279

Purchase of property and equipment
(49
)
 
(2
)
Net cash provided by/(used in) investing activities
(148,832
)
 
42,792

Cash flows from financing activities
 

 
 

Repurchase of convertible notes
(29,906
)
 

Proceeds from the issuance of convertible notes, net
300,000

 

Payment of debt issuance costs
(9,287
)
 

Purchase of call options
(30,951
)
 

Proceeds from the issuance of warrants
11,427

 

Repayment of term loan
(56,250
)
 

Cash dividends paid
(72,135
)
 
(62,943
)
Net cash provided by/(used in) financing activities
112,898

 
(62,943
)
Net increase in cash and cash equivalents
187,305

 
188,384

Cash and cash equivalents at beginning of the period
94,302

 
131,212

Cash and cash equivalents at end of period
$
281,607

 
$
319,596

 
 
 
 
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
134,000

 
$
101,000

Cash paid for interest (including convertible debt inducement)
$
15,217

 
$
8,086

Stock issued to settle debt
$
157,591

 
$

See accompanying notes. 

8



PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(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), except as discussed under "Correction of Immaterial Error" below, 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 our audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2013 , included in our Annual Report on Form 10-K filed with the SEC. The Condensed Consolidated Balance Sheet at December 31, 2013 , has been derived from the audited Consolidated Financial Statements at that date, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
 
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.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Notes Receivable and Other Long-Term Receivables

We account for our notes receivable at both amortized cost, net of unamortized origination fees, if any, and as collateral dependent when a loan for which repayment is expected to be provided solely by the underlying collateral. For loans accounted for at their amortized cost, related fees and costs are recorded net of any amounts reimbursed. Interest is accreted or accrued to "Interest revenue" using the interest method. When and if supplemental royalties are received from certain of these notes and other long-term receivables, an adjustment to the estimated effective interest rate is affected prospectively.

Royalty Rights - At Fair Value

We have elected to account for our investments in royalty rights at fair value with changes in fair value presented in earnings. The fair value of the investments in royalty rights is determined by using a discounted cash flow analysis related to the expected future cash flows to be received. These assets are classified as Level 3 assets within the fair value hierarchy as our valuation estimates utilize significant unobservable inputs, including estimates as to the probability and timing of future sales of the related products. Transaction related fees and costs are expensed as incurred.

Realized and unrealized gains and losses from investments in royalty rights are presented together on our Condensed Consolidated Statements of Income as a component of revenue under the caption, “Royalty rights - change in fair value.”

Correction of Immaterial Error

As disclosed in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2014, PDL was engaged in ongoing discussions with the SEC staff after receiving a comment letter regarding our Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. The comment letter requested additional information about the Company’s accounting for the Depomed Royalty Agreement. The Company was asked to support its position and explain why the transaction was accounted for as the acquisition of intangible assets as opposed to that

9



of financial assets. While significant judgment is required to account for this transaction, as either the acquisition of intangible assets or financial assets, we concluded that it is most appropriate to account for the asset as a Level 3 financial asset, which was a change to the previously reported accounting for this transaction. For the quarterly period ended June 30, 2014, PDL elected to measure this asset at fair value each reporting period. The change in the estimated fair value of this asset at each reporting period will be shown on a single caption, “Royalty rights - change in fair value” in our Condensed Consolidated Statements of Income. The purchase of this asset will be reported as an investing activity in our Condensed Consolidated Statements of Cash Flows. The revenue recognized each period related to this asset will be reported as an adjustment to net income in order to determine net cash provided by (used in) operating activities in our Condensed Consolidated Statements of Cash Flows. Actual cash received will be reported as an investing cash inflow in our Condensed Consolidated Statements of Cash Flows, separate from cash used in investing activities to purchase the asset in 2013. The Company reviewed the impact of this change in accounting on prior annual and interim periods in accordance with SAB no. 99, Materiality and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements and determined that the changes were not material for the period from October 18, 2013 (acquisition date), through March 31, 2014, and did not represent a material impact to our Condensed Consolidated Financial Statements in either our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2013, or our previously filed Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2014.

We evaluated the materiality of correcting the cumulative error in the period ended June 30, 2014. Based on such evaluation, we concluded that the correction was not material to that period. Accordingly, we corrected the cumulative error in our Condensed Consolidated Statement of Income for the nine months ended September 30, 2014 as follows: (i) $5.8 million increase in total revenues, (ii) $5.0 million increase in pre-tax income, (iii) $3.2 million increase in net income. The impacts to our Condensed Consolidated Balance Sheet and Statements of Cash Flows were not material.

We determined that a retrospective revision due to the correction of an error was not required. The prospective change is reflected in the current period as a component of “Royalty rights - change in fair value” in our Condensed Consolidated Statements of Income. Intangible assets that were presented in historical periods have been reclassified to "Royalty rights - at fair value" for all periods presented. Such reclassifications did not have an impact on our results of operations, cash flows or financial position.

Reclassifications

Certain reclassifications of previously reported amounts have been made to conform to the current year presentation. Interest income recognized from financial assets that was previously reported as a component of "Interest and other income, net" in our Condensed Consolidated Statements of Income has been reclassified to "Interest revenue" as a component of revenue in the Condensed Consolidated statements of Income.

Customer Concentration
 
The percentage of total revenue recognized, which individually accounted for 10% or more of our total revenues, was as follows:

 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Licensee
 
Product Name
 
2014
 
2013
 
2014
 
2013
Genentech
 
Avastin ®
 
24
%
 
32
%
 
25
%
 
33
%
 
 
Herceptin ®
 
24
%
 
31
%
 
25
%
 
32
%
 
 
Lucentis ®
 
10
%
 
14
%
 
11
%
 
16
%
 
 
 
 
 
 
 
 
 
 
 
Biogen Idec 1
 
Tysabri ®
 
10
%
 
12
%
 
9
%
 
11
%
 
 
 
 
 
 
 
 
 
 
 
Depomed
 
Glumetza ®
 
14
%
 
0
%
 
13
%
 
0
%
______________________
1 In April 2013, Biogen Idec completed its purchase of Elan's interest in Tysabri ® . Prior to this our licensee for Tysabri ® was identified as Elan.


10



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

We hedge certain Euro-denominated currency exposures related to royalties associated with our licensees’ product sales with Euro forward contracts. In general, these contracts are intended to offset the underlying Euro market risk in our royalty revenues. The last of these contracts expires in the fourth quarter of 2015. We designate foreign currency exchange contracts used to hedge royalty revenues based on underlying Euro-denominated licensee product sales as cash flow hedges.

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

2. Net Income per Share
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
Net Income per Basic and Diluted Share:
 
2014
 
2013
 
2014
 
2013
  (in thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
Net income used to compute net income per basic share
 
$
102,235

 
$
56,225

 
$
267,173

 
$
203,438

Add back interest expense for convertible notes, net of estimated tax of approximately $0 and $7 for the three months ended September 30, 2014 and 2013, respectively, and $0 and $13 for the nine months ended September 30, 2014 and 2013, respectively.
 

 
12

 

 
25

Net income used to compute net income per diluted share
 
$
102,235

 
$
56,237

 
$
267,173

 
$
203,463

 
 
 
 
 
 
 
 
 
Denominator
 
 

 
 

 
 
 
 
Weighted-average shares used to compute net income per basic share
 
160,268

 
139,848

 
157,274

 
139,830

Restricted stock outstanding
 
96

 
80

 
113

 
76

Effect of dilutive stock options
 
22

 
20

 
22

 
19

Assumed conversion of Series 2012 Notes
 
2,247

 
9,674

 
3,301

 
10,141

Assumed conversion of May 2015 Notes
 
4,261

 
4,910

 
4,431

 
5,160

Assumed conversion of February 2015 Notes
 

 
61

 

 
140

Weighted-average shares used to compute net income per diluted share
 
166,894

 
154,593

 
165,141

 
155,366

 
 
 
 
 
 
 
 
 
Net income per share - basic
 
$
0.64

 
$
0.40

 
$
1.70

 
$
1.45

Net income per share - diluted
 
$
0.61

 
$
0.36

 
$
1.62

 
$
1.31


We compute diluted net income per share using the sum of the weighted-average number of common and common equivalents shares outstanding. Common equivalent shares used in the computation of diluted net income per share include shares that may be issued under our stock options and restricted stock awards, our February 2018 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 the third quarter of 2013, $1.0 million aggregate principal of our February 2015 Notes was exchanged for our Series 2012 Notes, and the February 2015 Notes were retired, and in the first quarter of 2014, $131.7 million aggregate principal of our Series 2012 Notes was retired in a privately negotiated exchange and purchase agreements.

11




In May 2011, we issued our May 2015 Notes, in January and February 2012, we issued our Series 2012 Notes, and in February 2014, we issued our February 2018 Notes. The February 2018 Notes, 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 February 2018 Notes, Series 2012 Notes and May 2015 Notes, shown in the table above, include the shares issuable in respect of such excess.

May 2015 Notes Purchase Call Option and Warrant Potential Dilution

We excluded from our calculations of diluted net income per share 22.2 million and 20.8 million shares for the three months ended September 30, 2014 and 2013 , respectively, and 22.2 million and 20.8 million shares for the nine months ended September 30, 2014 and 2013, for warrants issued in 2011, because conversion of the underlying May 2015 Notes is not assumed. These securities could be dilutive in future periods. Our purchased call options, issued in 2011, will always be anti-dilutive and therefore 26.1 million and 24.4 million shares were excluded from our calculations of net income per diluted share for the three months ended September 30, 2014 and 2013 , respectively, and 26.1 million and 24.4 million shares were excluded from our calculation of diluted net income per share for the nine months ended September 30, 2014 and 2013, respectively, because they have no effect on diluted net income per share. For information related to the conversion rates on our convertible debt, see Note 9.

February 2018 Notes Purchase Call Option and Warrant Potential Dilution

We excluded from our calculation of net income per diluted share 29.0 million shares for the three months ended September 30, 2014 , 29.0 million shares for the nine months ended September 30, 2014 , for warrants issued in February 2014, because the exercise price of the warrants exceeded the VWAP of our common stock and conversion of the underlying February 2018 Notes is not assumed, no stock would be issuable upon conversion. These securities could be dilutive in future periods. Our purchased call options, issued in February 2014, will always be anti-dilutive and therefore 32.7 million shares were excluded from our calculation of net income per diluted share for the three months ended September 30, 2014 , and 32.7 million shares were excluded from our calculation of net income per diluted share for the nine months ended September 30, 2014 , because they have no effect on diluted net income per share. For information related to the conversion rates on our convertible debt, see Note 9.

Anti-Dilutive Effect of Stock Options and Restricted Stock Awards

For the three and nine months ended September 30, 2014 , we excluded approximately 4,000 and 47,000 shares underlying outstanding stock options, respectively, calculated on a weighted average basis, from our net income per diluted share calculations because their effect was anti-dilutive.

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

  3. Fair Value Measurements

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

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


12



The following tables present the fair value of our financial instruments measured at fair value on a recurring basis by level within the valuation hierarchy.
 
 
September 30, 2014
 
December 31, 2013
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
173,340

 
$

 
$

 
$
173,340

 
$
85,970

 
$

 
$

 
$
85,970

Corporate securities
 

 
2,847

 

 
2,847

 

 
5,238

 

 
5,238

Foreign currency hedge contracts
 

 
252

 
 
 
252

 

 

 

 

Royalty rights - at fair value
 

 

 
242,452

 
242,452

 

 

 
235,677

 
235,677

Total
 
$
173,340

 
$
3,099

 
$
242,452

 
$
418,891

 
$
85,970

 
$
5,238

 
$
235,677

 
$
326,885

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 

Foreign currency hedge contracts
 
$

 
$
9

 
$

 
$
9

 
$

 
$
8,871

 
$

 
$
8,871

 
There have been no transfers between levels during the three months ended September 30, 2014 , and December 31, 2013 . The Company recognizes transfers between levels on the date of the event or change in circumstances that caused the transfer.

Corporate Securities

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

Royalty Rights - At Fair Value

Depomed Royalty Agreement

On October 18, 2013, PDL entered into the Depomed Royalty Agreement, whereby the Company acquired the rights to receive royalties and milestones payable on sales of Type 2 diabetes products licensed by Depomed in exchange for a $240.5 million cash payment. Total arrangement consideration was $241.3 million , which was comprised of the $240.5 million cash payment to Depomed and $0.8 million in transaction costs.

The rights acquired include Depomed’s royalty and milestone payments accruing from and after October 1, 2013: (a) from Santarus with respect to sales of Glumetza ® (metformin HCL extended-release tablets) in the United States; (b) from Merck with respect to sales of Janumet ® XR (sitagliptin and metformin HCL extended-release tablets); (c) from Janssen Pharmaceutica with respect to potential future development milestones and sales of its investigational fixed-dose combination of Invokana® (canagliflozin) and extended-release metformin tablets; (d) from Boehringer Ingelheim with respect to potential future development milestones and sales of the investigational fixed-dose combinations of drugs and extended-release metformin subject to Depomed’s license agreement with Boehringer Ingelheim; and (e) from LG Life Sciences and Valeant Pharmaceuticals for sales of extended-release metformin tablets in Korea and Canada, respectively.

Under the terms of the Depomed Royalty Agreement, the Company will receive all royalty and milestone payments due under license agreements between Depomed and its licensees until the Company has received payments equal to two times the cash payment it made to Depomed, after which all net payments received by Depomed will be shared evenly between the Company and Depomed.

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

As of September 30, 2014, and December 31, 2013, the Company determined that its royalty purchase interest in Depo DR Sub represented a variable interest in a variable interest entity. However, the Company does not have the power to direct the

13



activities of Depo DR Sub that most significantly impact Depo DR Sub's economic performance and is not the primary beneficiary of Depo DR Sub; therefore, Depo DR Sub is not subject to consolidation by the Company.

The asset acquired represents a single unit of accounting. The fair value of the asset acquired was determined by using a discounted cash flow analysis related to the expected future cash flows to be generated by each licensed product. This asset is classified as a Level 3 asset within the fair value hierarchy, as our valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future commercialization for products not yet approved by the FDA or other regulatory agencies. The discounted cash flow is based upon expected royalties from sales of licensed products over a nine year period. The discount rates utilized range from approximately 21% to 25% . Significant judgment is required in selecting appropriate discount rates. Should these discount rates increase or decrease by 5%, the fair value of the asset could decrease by $25.6 million or increase by $21.0 million, respectively. Should the expected royalties increase or decrease by 10%, the fair value of the asset could increase by $18.1 million or decrease by $19.4 million, respectively. A third-party expert is engaged to assist management with the assessment of its estimate of the expected future cash flows, when deemed necessary. The fair value of the asset is subject to variation should cash flows vary significantly from our estimates. An evaluation of those estimates, discount rates utilized and general market conditions effecting fair market value is performed in each reporting period.

As of September 30, 2014, and December 31, 2013, the carrying value of the asset acquired and reported in our Condensed Consolidated Balance Sheets was approximately $226.6 million and $235.7 million , respectively. As of September 30, 2014, the maximum loss exposure was $226.6 million .

VB Royalty Agreement

On June 26, 2014, PDL entered into the VB Royalty Agreement, whereby VB conveyed to the Company the right to receive royalties payable on sales of a spinal implant that has received PMA, in exchange for a $15.5 million cash payment, less fees.

The royalty acquired includes royalties accruing from and after April 1, 2014. Under the terms of the VB Royalty Agreement, the Company will receive all royalty payments due to VB pursuant to certain technology transfer agreements between VB and Paradigm Spine until the Company has received payments equal to two and three tenths times the cash payment made to VB, after which all rights to receive royalties will be returned to VB. VB may repurchase the royalty right at any time on or before June 26, 2018, for a specified amount. The acting chief executive officer of Paradigm Spine is one of the owners of VB. The Paradigm Spine Credit Agreement and the VB Royalty Agreement were negotiated separately.

The fair value of the royalty right at September 30, 2014 was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as our valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of licensed product over a nine year period. The discount rate utilized was approximately 17.5% . Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $1.4 million or increase by $1.6 million, respectively. Should the expected royalties increase or decrease by 5%, the fair value of the asset could increase by $0.8 million or decrease by $0.8 million, respectively. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. The fair value of the asset is subject to variation should those cash flows vary significantly from our estimates. An evaluation of those estimates, discount rates utilized and general market conditions effecting fair market value is performed in each reporting period.

As of September 30, 2014, the carrying value of the asset acquired as reported in our Condensed Consolidated Balance Sheets was $15.8 million . As of September 30, 2014, the maximum loss exposure was $15.8 million .


14



The following tables summarize the changes in Level 3 assets and the gains and losses included in earnings for the nine months ending September 30, 2014:

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
 
 
 
 
 
 
 
(in thousands)
 
 
Royalty Rights - At Fair Value
Beginning Balance at December 31, 2013
 
 
$

 
 
 
 
 
 
 
 
Transfer into Level 3
 
 
235,677

 
Total net change in fair value for the period
 
 
 
 
 
Change in fair value of royalty rights - at fair value
$
72,992

 
 
 
Proceeds from royalty rights - at fair value
$
(81,717
)
 
 
 
 
Total net change in fair value for the period
 
 
(8,725
)
 
Purchases, issues, sales, and settlements
 
 
 
 
 
Purchases
 
 
15,500

 
 
 
 
 
 
 
Ending Balance at September 30, 2014
 
 
$
242,452


The correction of the immaterial error as described in Note 1 resulted in accounting for the Depomed Royalty Agreement as a Level 3 financial asset. That correction has been identified above as a transfer into Level 3.

Gains and losses included in earnings for each period are presented in "Royalty rights - change in fair value" as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands)
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for assets held at the end of the reporting period
 
$
26,787

 
$

 
$
72,992

 
$


Foreign Currency Hedge Contracts

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


15



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

 
 
September 30, 2014
 
December 31, 2013
 
 
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
 
$
50,191

 
$

 
$
50,191

 
$
47,694

 
$

 
$
46,042

Hyperion
 
1,200

 

 
1,200

 
1,194

 

 
1,195

AxoGen note receivable and embedded derivative
 
30,192

 

 
29,303

 
26,544

 

 
25,785

Avinger note receivable
 
20,516

 

 
19,746

 
20,250

 

 
19,061

LENSAR note receivable
 
39,645

 

 
40,000

 
39,572

 

 
39,572

Durata note receivable
 
40,000

 

 
40,000

 
24,995

 

 
24,995

Direct Flow Medical note receivable
 
35,212

 

 
36,752

 
34,799

 

 
34,799

Paradigm Spine note receivable
 
49,544

 

 
50,791

 

 

 

kaléo note receivable
 
152,078

 

 
152,140

 

 

 

Total
 
$
418,578

 
$

 
$
420,123

 
$
195,048

 
$

 
$
191,449

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Series 2012 Notes
 
$
47,564

 
$
69,172

 
$

 
$
172,630

 
$
277,650

 
$

May 2015 Notes
 
152,105

 
197,354

 

 
148,253

 
212,304

 

February 2018 Notes
 
274,512

 
292,560

 

 

 

 

Term loan
 
18,720

 
18,750

 

 
74,397

 
75,000

 

Total
 
$
492,901

 
$
577,836

 
$

 
$
395,280

 
$
564,954

 
$

 
As of September 30, 2014 , the estimated fair value of our Paradigm Spine note receivable and kaléo note receivable, as of September 30, 2014 and December 31, 2013 , the estimated fair values of our Wellstat Diagnostics note receivable, Hyperion note receivable, AxoGen note receivable and embedded derivative, Avinger note receivable, LENSAR note receivable, Durata note receivable and Direct Flow Medical note receivable, were determined using one or more discounted cash flow models, incorporating expected payments and the interest rate extended on the notes receivable with fixed interest rates and incorporating expected payments for notes receivable with a variable rate of return. In some instances the carrying values of certain notes receivable exceed their estimated fair market values. This is generally the result of discount rates used when performing a discounted cash flow for fair value valuation purposes. In all cases, the undiscounted expected future cash flows exceed the related carrying value.

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

The carrying value and estimated fair value of the AxoGen note include the value of a change of control embedded derivative valued at $1.2 million and $1.1 million at September 30, 2014 , and December 31, 2013 , respectively. We utilized discounted cash flows and probability analysis to estimate the fair value of the embedded derivative.

The Wellstat Diagnostics Note Receivable and Credit Agreement is collateralized by all assets and equity interest in Wellstat Diagnostics. The estimated fair value of the collateral was determined by using a discounted cash flow analysis related to the

16



underlying technology included in the collateral. On September 30, 2014 , the discounted cash flow was based upon expected income from estimated sales of planned products over a period of 15 years . The terminal value was estimated using selected market multiples based on sales and EBITDA. On December 31, 2013 , the estimated fair value of Wellstat Diagnostics Note Receivable and Credit Agreement was determined by using a discounted cash flow that was based upon expected income from estimated sales through December 31, 2016.

On September 30, 2014 , the carrying value of the Avinger and AxoGen notes exceeded their fair value. This is the result of discount rates used when performing a discounted cash flow for fair value valuation purposes. We determined these notes to be Level 3 assets, as our valuations utilized significant unobservable inputs, including discount rates of 22.5% and 20.0%, respectively, estimates of future revenues, expectations about settlement and required yield. To provide support for the fair value measurement, we considered forward looking performance, and current measures associated with high yield and Standard & Poor's Leveraged Commentary & Data indices, and reviewed the terms and yields of notes placed by specialty finance and venture firms both across industries and in a similar sector.

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

4. Cash Equivalents and Investments
 
As of September 30, 2014 , and December 31, 2013 , we had invested our excess cash balances primarily in money market funds, and a corporate equity security. 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 loss" in stockholders’ equity, 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
 
 Estimated Fair Value
 
 Cash and Cash Equivalents
 
Short-Term Investments
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
108,267

 
$

 
$

 
$
108,267

 
$
108,267

 
$

Money market funds
 
173,340

 

 

 
173,340

 
173,340

 

Corporate security
 
3,500

 

 
(653
)
 
2,847

 

 
2,847

Total
 
$
285,107

 
$

 
$
(653
)
 
$
284,454

 
$
281,607

 
$
2,847

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
8,332

 
$

 
$

 
$
8,332

 
$
8,332

 
$

Money market funds
 
85,970

 

 

 
85,970

 
85,970

 

Corporate security
 
3,500

 
1,738

 

 
5,238

 

 
5,238

Total
 
$
97,802

 
$
1,738

 
$

 
$
99,540

 
$
94,302

 
$
5,238


No gains or losses on sales of available-for-sale securities were recognized for the three and nine months ended September 30, 2014 and 2013 .

The unrealized gain (loss) on investments included in "Other comprehensive income (loss), net of tax" was approximately ($425) thousand and $1.1 million as of September 30, 2014, and December 31, 2013, respectively. 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 September 30, 2014, and December 31, 2013.

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

17



Balance Sheets as we have entered into a netting arrangement with the counterparty. As of September 30, 2014 , and December 31, 2013 , all outstanding Euro forward contracts were classified as cash flow hedges.

In January 2012, we modified our existing Euro forward and option contracts related to our licensees’ sales through December 2012 into Euro forward contracts with more favorable rates. Additionally, we entered into a series of Euro forward contracts covering the quarters in which our licensees’ sales occur through December 2014. In October 2014, we entered an additional series of Euro forward contracts covering the quarters in which our licensees' sales occurred through December 2015.

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

Euro Forward Contracts
 
September 30, 2014
 
December 31, 2013
 
 
 
 
 
 
(In thousands)
 
(In thousands)
Currency
 
Settlement Price
($ per Euro)
 
Type
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
Euro
 
1.240
 
Sell Euro
 
$

 
$

 
$
10,850

 
$
(1,207
)
Euro
 
1.270
 
Sell Euro
 
17,780

 
35

 
44,450

 
(3,760
)
Euro
 
1.281
 
Sell Euro
 
20,488

 
208

 
36,814

 
(2,785
)
Euro
 
1.300
 
Sell Euro
 

 

 
19,500

 
(1,119
)
Total
 
 
 
 
 
$
38,268

 
$
243

 
$
111,614

 
$
(8,871
)
 
 The location and fair values of our Euro contracts in our Condensed Consolidated Balance Sheets were as follows:

Cash Flow Hedge
 
Location
 
September 30,
2014
 
December 31,
2013
(In thousands)
 
 
 
 
 
 
Euro contracts
 
Prepaid and other current assets
 
$
252

 
$

Euro contracts
 
Accrued liabilities
 
$
9

 
$
7,355

Euro contracts
 
Other long-term liabilities
 
$

 
$
1,516


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

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
(In thousands)
 
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax (1)
 
$
1,974

 
$
(3,359
)
 
$
2,305

 
$
(1,056
)
Gain (loss) reclassified from accumulated OCI into royalty revenue, net of tax (2)
 
$
(989
)
 
$
(32
)
 
$
(3,744
)
 
$
(1,011
)
Net gain (loss) recognized in interest and other income, net -- cash flow hedges (3)
 
$
2

 
$
4

 
$
5

 
$
9

 _______________________________
(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 ($2) and ($4) for the three months ended September 30, 2014 and 2013 , respectively, and ($5) and ($9) for the nine months ended September 30, 2014 and 2013, respectively.


18



6. Notes Receivable and Other Long-term Receivables

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

Wellstat Diagnostics Note Receivable and Credit Agreement

In March 2012, the Company executed a $7.5 million two -year senior secured note receivable with the holders of the equity interests in Wellstat Diagnostics. In addition to bearing interest at 10% per annum, the note gave PDL certain rights to negotiate for certain future financing transactions. In August 2012, PDL and Wellstat Diagnostics 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, using the proceeds of the $40.0 million credit facility entered into with the Company on the same date.

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

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 agreed to refrain from exercising additional remedies for 120 days while Wellstat Diagnostics raised funds to capitalize the business and the parties attempted to negotiate a revised credit agreement. PDL agreed to provide up to $7.9 million to Wellstat Diagnostics to fund the business for the 120 -day forbearance period under the terms of the forbearance agreement. Following the conclusion of the forbearance period that ended on June 28, 2013, the Company agreed to forbear its exercise of remedies for additional periods of time to allow the owners and affiliates of Wellstat Diagnostics to complete a pending financing transaction. During such forbearance period, the Company provided approximately $1.3 million to Wellstat Diagnostics to fund ongoing operations of the business. During the year ended December 31, 2013, approximately $8.7 million was advanced pursuant to the forbearance agreement, and no further advances have been provided by the Company to Wellstat Diagnostics during the nine months ended September 30, 2014 .

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

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

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


19



In June of 2014, the Company received information from Wellstat Diagnostics that showed that it was generally unable to pay its debts as they became due. This constituted an event of default under the amended and restated credit agreement. Wellstat Diagnostics entered into a transaction involving another lender, pursuant to which Wellstat Diagnostics obtained additional short term funding for its operations. At the same time, the Company entered into the First Amendment to Amended and Restated Credit Agreement with Wellstat Diagnostics. The material terms of the amendment include the following: (1) Wellstat Diagnostics acknowledged that an event of default had occurred, (2) the Company agreed to forbear from immediately enforcing its rights for up to sixty (60) days, so long as the other lender provided agreed levels of interim funding to Wellstat Diagnostics; and (3) the Company obtained specified additional information rights with regard to Wellstat Diagnostics’ financial matters and investment banking activities.

On August 5, 2014, the Company received notice that the short term funding being provided pursuant to the agreement with the other lender entered into during June 2014, was being terminated. Wellstat Diagnostics remained in default because it was still unable to pay its debts as they became due. Accordingly, the Company delivered a notice of default to Wellstat Diagnostics, due to, inter alia, its ongoing failure to pay its debts as they become due and Wellstat Diagnostics' failure to comply with certain covenants included in the First Amendment to Amended and Restated Credit Agreement by the deadlines to which the parties had agreed ("Borrower Notice"). The Borrower Notice accelerated all obligations under the Amended and Restated Credit Agreement and demanded immediate payment in full in an amount equal to approximately $53.9 million , (which amount, in accordance with the terms of the amended and restated credit agreement, includes an amount that, together with interest and royalty payments already made to the Company, would generate a specified internal rate of return to the Company), plus accruing fees, costs and interest, and demanded that Wellstat Diagnostics protect and preserve all collateral securing its obligations. On August 7, 2014, the Company delivered a notice to each of the guarantors of Wellstat Diagnostic's obligations to the Company under the credit agreement ("the Guarantor Notice"). The Guarantor Notice included a demand that the guarantors remit payment to the Company in the amount of the outstanding obligations. The guarantors include certain affiliates and related companies of Wellstat Diagnostics, including Wellstat Therapeutics and Wellstat Diagnostics’ shareholders.

On September 24, 2014, the Company filed an Ex Parte Petition for Appointment of Receiver with the Circuit Court of Montgomery County, Maryland (the “ Petition ”), which was granted on the same day. The Order granting the Petition authorizes the receiver to take immediate possession of the physical assets of Wellstat Diagnostics, with the purpose of holding, protecting, insuring, managing and preserving the business of Wellstat Diagnostics and the value of the Company’s collateral. Wellstat Diagnostics has remained in operation during the period of the receivership with incremental additional funding from the Company. The Company continues to assess its options with respect to collecting on the loan, including determining whether and when it will foreclose on the collateral and proceed with a sale of Wellstat Diagnostics’ assets, whether providing further capital to the receiver to fund Wellstat Diagnostics’ operations for a period of time prior to sale will best position Wellstat Diagnostics’ assets for sale, and assessing the value of the guarantees obtained by the Company from Wellstat Diagnostics’ guarantors, including Wellstat Diagnostics’ shareholders and Wellstat Therapeutics.

On November 4, 2014, the Company entered into the Third Amendment to the Amended and Restated Credit Agreement with Wellstat Diagnostics.  The amendment provides that additional funding, if any, to be made by the Company are conditioned upon agreement by Wellstat Diagnostics to effecting certain operational changes within Wellstat Diagnostics, which the Company believes will allow the receiver to more efficiently optimize the value of the collateral.

While the Company believes the value of the collateral securing Wellstat Diagnostics’ obligations exceeds the carrying value of the asset and is sufficient to enable the Company to recoup the full amount owed under the credit agreement. There can be no assurances that this in fact will be the case in the event of the Company’s foreclosure on the collateral or the timing in realizing on the value of such collateral.

As of September 30, 2014 , the Company determined that its interest in Wellstat Diagnostics represented a variable interest in a variable interest entity since Wellstat Diagnostics' equity was not sufficient to finance its operations without amounts advanced to it under the Company's note and forbearance agreement. However, the Company does not have the power to direct the activities of Wellstat Diagnostics that most significantly impacts Wellstat Diagnostic's economic performance and is not the primary beneficiary of Wellstat Diagnostics; therefore, Wellstat Diagnostics is not subject to consolidation.

Hyperion Agreement

On January 27, 2012, PDL and Hyperion entered into an agreement whereby Hyperion sold to PDL the royalty streams due from SDK related to a certain patent license agreement between Hyperion and SDK dated December 31, 2008. The agreement assigned the patent license agreement royalty stream accruing from January 1, 2012 through December 31, 2013 to PDL in exchange for the lump sum payment to Hyperion of $2.3 million . In exchange for the lump sum payment, PDL was to receive

20



two equal payments of $1.2 million on both March 5, 2013 and March 5, 2014. The first payment of $1.2 million was paid on March 5, 2013. The second and final payment of $1.2 million was due on March 5, 2014. Hyperion has not made the payment due on March 5, 2014. The inability to make this payment constitutes a breach of the purchase agreement. The Company completed an impairment analysis as of September 30, 2014. The estimated fair value of the collateral was determined to be in excess of that of the carrying value. Hyperion is considering other sources of financing and strategic alternatives, including selling the company. Depending on the outcome of its efforts and PDL's assessment of Hyperion's financial viability, we may recognize an impairment in a future period.

Merus Labs Note Receivable and Credit Agreement

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

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

In September 2013, Merus Labs prepaid in full its obligations under the credit agreement, including accrued interest through the payment date and a prepayment fee of 1% of the aggregate principal amount outstanding at the time of repayment. There was no outstanding balance owed as of September 30, 2014 .

AxoGen Note Receivable and AxoGen Royalty Agreement

In October 2012, PDL entered into the AxoGen Royalty Agreement with AxoGen pursuant to which the Company will receive specified royalties on AxoGen’s net revenues (as defined in the AxoGen Royalty Agreement) generated by the sale, distribution or other use of AxoGen’s products. The AxoGen Royalty Agreement has an eight year term and provides PDL with royalties of 9.95% based on AxoGen's net revenues, subject to agreed-upon guaranteed quarterly minimum payments of approximately $1.3 to $2.5 million beginning in the fourth quarter of 2014, and the right to require AxoGen to repurchase the royalties under the AxoGen 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 an interim funding of $1.8 million in August 2012. AxoGen was required to use a portion of the proceeds from the AxoGen 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 AxoGen Royalty Agreement, beginning on October 1, 2016, or in the event of the occurrence of a material adverse event, AxoGen's bankruptcy or material breach of the AxoGen 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 that should be bifurcated and separately accounted for at fair value.

In the event of a change of control, AxoGen must repurchase the assigned interests from the Company for a repurchase price equal to an amount that, together with payments already made by AxoGen, would generate a 32.5% internal rate of return to the Company. The Company has concluded that the change of control provision is an embedded derivative that should be bifurcated and separately recorded at its estimated fair value. The estimated fair value of the change of control provision was approximately $1.2 million and $1.1 million as of September 30, 2014 , and December 31, 2013 , respectively. The estimated fair value of this embedded derivative is included in the carrying value of the AxoGen note receivable. The Company recognized gains of approximately $0.1 million and $0.0 million related to the change in the estimated fair value of the embedded derivative during the three month periods ended September 30, 2014 and 2013, respectively. The Company recognized gains of approximately $0.2 million and $0.4 million related to the change in the estimated fair value of the embedded derivative during the nine month periods ended September 30, 2014 and 2013, respectively.


21



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

During the term of the AxoGen Royalty Agreement, the Company was entitled to designate an individual to be a member of AxoGen's board of directors. The Company exercised this right and on October 5, 2012, upon the close of the transactions contemplated by the AxoGen Royalty Agreement, the Company's President and Chief Executive Officer was elected to AxoGen's board of directors. On August 20, 2014, the Company's President and Chief Executive Officer resigned as a member of the board of directors of AxoGen. The resignation was not the result of any disagreement with AxoGen relating to its operations, policies or practices. PDL informed AxoGen that it does not intend to appoint a replacement board member at this time.

On August 14, 2013, PDL purchased 1,166,666 shares of AXGN at $3.00 per share, totaling $3.5 million . The shares are classified as available for sale and recorded as short term investments on the balance sheet. As of September 30, 2014 , the shares were valued at $2.8 million , which resulted in an unrealized loss of $0.7 million and is recorded in "Other comprehensive loss, net of tax."

As of September 30, 2014, and December 31, 2013, the Company determined that its royalty purchase interest in AxoGen represented a variable interest in a variable interest entity. However, the Company does not have the power to direct the activities of AxoGen that most significantly impact AxoGen's economic performance and is not the primary beneficiary of AxoGen; therefore, AxoGen is not subject to consolidation by the Company.

Avinger Note Receivable and Royalty Agreement

On April 18, 2013, PDL entered into a credit agreement with Avinger, under which we made available to Avinger up to $40.0 million to be used by Avinger in connection with the commercialization of its lumivascular catheter devices and the development of Avinger's lumivascular atherectomy device. Of the $40.0 million initially available to Avinger, we funded an initial $20.0 million , net of fees, at the close of the transaction. The additional $20.0 million in the form of a second tranche is no longer available to Avinger. Outstanding borrowings under the initial loan bear interest at a stated rate of 12% per annum.

Avinger is required to make quarterly interest and principal payments. Principal repayment will commence on the eleventh interest payment date. The principal amount outstanding at commencement of repayment, after taking into account any payment-in-kind, will be repaid in equal installments until final maturity of the loan. The loan will mature in April 2018.

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

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

LENSAR Credit Agreement

On October 1, 2013, PDL entered into a credit agreement with LENSAR, under which PDL made available to LENSAR up to $60.0 million to be used by LENSAR in connection with the commercialization of its currently marketed LENSAR™ Laser System. Of the $60.0 million available to LENSAR, an initial $40.0 million , net of fees, was funded by the Company at the close of the transaction. The additional $20.0 million in the form of a second tranche is no longer available to LENSAR under the terms of the credit agreement. Outstanding borrowings under the loans bear interest at the rate of 15.5% per annum, payable quarterly in arrears.

Principal repayment will commence on the thirteenth interest payment date or December 31, 2016 . The principal amount outstanding at the commencement of repayment will be repaid in equal installments until final maturity of the loans. The loans will mature on October 1, 2018. LENSAR may elect to prepay the loans at any time, subject to a prepayment penalty that decreases over the life of the loans. The loans are secured by all of the assets of LENSAR.


22



Durata Credit Agreement

On October 31, 2013, PDL entered into a credit agreement with Durata, under which the Company made available to Durata up to $70.0 million . Of the $70.0 million available to Durata, an initial $25.0 million (tranche one), net of fees, was funded by the Company at the close of the transaction. On May 27, 2014, the Company funded Durata an additional $15.0 million (tranche two) as a result of Durata's marketing approval of dalbavancin in the United States, which occurred on May 23, 2014, and was the milestone needed to receive the tranche two funding. Within nine months after the occurrence of the tranche two milestone, Durata may request up to a single additional $30.0 million borrowing. Until the occurrence of the tranche two milestone, outstanding borrowings under tranche one bore interest at the rate of 14.0% per annum, payable quarterly in arrears. Upon occurrence of the tranche two milestone, the interest rate of the loans decreased to 12.75% .

Principal repayment will commence on the fifth interest payment date, March 31, 2015. The principal amount outstanding will be repaid quarterly over the remainder of the loans in an increasing percentage of the principal outstanding at commencement of repayment. The loans will mature on October 31, 2018. Durata may elect to prepay the loans at any time, subject to a prepayment penalty that decreases over the life of the loans. The Company is entitled to receive a fee in addition to the prepayment penalty in the event that Durata undergoes a change of control. The obligations under the credit agreement are secured by a pledge of substantially all of the assets of Durata.

On October 5, 2014, Durata entered into an agreement to be acquired by a wholly-owned subsidiary of Actavis plc pursuant to a tender offer. In connection with the acquisition, Durata has informed PDL that they expect to terminate the credit agreement and pay-off the loans (plus any accrued and unpaid interest, applicable fees or premiums). There can be no assurance that the acquisition will be consummated or that the credit agreement will be paid-off.

Direct Flow Credit Agreement

On November 5, 2013, PDL entered into a credit agreement with Direct Flow Medical, under which PDL will provide up to $50.0 million to Direct Flow Medical. Of the $50.0 million available to Direct Flow Medical, an initial $35.0 million (tranche one), net of fees, was funded by the Company at the close of the transaction. Upon the attainment of a specified revenue milestone to be accomplished no later than December 31, 2014 (the tranche two milestone), the Company will fund Direct Flow Medical an additional $15.0 million , net of fees. Until the occurrence of the tranche two milestone, outstanding borrowings under tranche one bear interest at the rate of 15.5% per annum, payable quarterly in arrears.

On November 10, 2014, PDL and Direct Flow Medical agreed to an amendment to the credit agreement to permit Direct Flow Medical to borrow the $15.0 million second tranche upon receipt by Direct Flow Medical of a specified minimum amount of proceeds from a contemporaneous equity offering prior to December 31, 2014. In exchange, Direct Flow Medical agreed to amend the Credit Agreement to provide for additional fees associated with certain liquidity events, such as a change of control or the consummation of an initial public offering, and granted PDL certain board of director observation rights. Upon occurrence of the borrowing of the second tranche, the interest rate applicable to all loans under the credit agreement will be 13.5% per annum.

Principal repayment will commence on the twelfth interest payment date, September 30, 2016. The principal amount outstanding at commencement of repayment will be repaid in equal installments until final maturity of the loans. The loans will mature on November 5, 2018. Direct Flow Medical may elect to prepay the loans at any time, subject to a prepayment penalty that decreases over the life of the loans. The obligations under the credit agreement are secured by a pledge of substantially all of the assets of Direct Flow Medical and any of its subsidiaries.

Paradigm Spine Credit Agreement

On February 14, 2014, the Company entered into a credit agreement with Paradigm Spine, under which it made available to Paradigm Spine up to $75.0 million to be used by Paradigm Spine to refinance its existing credit facility and expand its domestic commercial operations. Of the $75.0 million available to Paradigm Spine, an initial $50.0 million , net of fees, was funded by the Company at the close of the transaction. Upon the attainment of specified sales and other milestones before December 31, 2014, the Company will fund Paradigm Spine between an additional $6.25 million and $12.5 million , at Paradigm Spine’s discretion. Upon the attainment of specified sales and other milestones before June 30, 2015, the Company will fund Paradigm Spine up to an additional $12.5 million , also at Paradigm Spine’s discretion. Borrowings under the credit agreement bear interest at the rate of 13.0% per annum, payable quarterly in arrears.

Principal repayment will commence on the twelfth interest payment date, December 31, 2016. The principal amount outstanding at commencement of repayment will be repaid in equal installments until final maturity of the loans. The loans will

23



mature on February 14, 2019, or, if Paradigm Spine has achieved the first milestone and the additional loan amount is provided to Paradigm, the loans will mature on August 14, 2019. Paradigm Spine may elect to prepay the loans at any time, subject to a prepayment penalty that decreases over the life of the loans. The obligations under the credit agreement are secured by a pledge of substantially all of the assets of Paradigm Spine and its domestic subsidiaries and, initially, certain assets of Paradigm Spine’s German subsidiaries.

kaléo Note Purchase Agreement

On April 1, 2014, PDL entered into a note purchase agreement with Accel 300, a wholly-owned subsidiary of kaléo, pursuant to which the Company acquired $150.0 million of secured notes due 2029. The secured notes were issued pursuant to an indenture between Accel 300 and U.S. Bank, National Association, as trustee, and are secured by 100% of the royalties from kaléo’s first approved product, Auvi-Q™ (epinephrine auto-injection, USP) (known as Allerject in Canada), 10% of net sales of kaléo’s second proprietary auto-injector based product, EVZIO (naloxone hydrochloride injection) (collectively, the "Revenue Interests"), and by a pledge of kaléo’s equity ownership in Accel 300.

The secured notes bear interest at 13% per annum, paid quarterly in arrears on principal outstanding. The principal balance of the secured notes is repaid to the extent that the Revenue Interests exceed the quarterly interest payment, as limited by a quarterly payment cap. The final maturity of the secured notes is March 2029. Kaléo may redeem the secured notes at any time, subject to a redemption premium.

As of September 30, 2014, the Company determined that its royalty purchase interest in Accel 300 represented a variable interest in a variable interest entity. However, the Company does not have the power to direct the activities of Accel 300 that most significantly impact Accel 300's economic performance and is not the primary beneficiary of Accel 300; therefore, Accel 300 is not subject to consolidation by the Company.

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

7. Accrued Liabilities

 
 
September 30,
2014
 
December 31,
2013
(In thousands)
 
 
 
 
Compensation
 
$
2,409

 
$
768

Interest
 
4,603

 
2,925

Deferred tax liability
 
2,576

 

Deferred revenue
 
1,052

 

Foreign currency hedge
 
9

 
7,355

Dividend payable
 
24,272

 
59

Legal
 
535

 
324

Other
 
221

 
426

Total
 
$
35,677

 
$
11,857


8. Commitments and Contingencies

Legal Proceedings

Resolution of Past Challenges to the Queen et al. Patents in the United States and Europe

Settlement with Novartis

On February 25, 2011, we reached a settlement with Novartis. Under the settlement agreement, PDL agreed to dismiss its claims against Novartis in its action in Nevada state court which also includes Genentech and Roche as defendants. Novartis agreed to withdraw its opposition appeal in the European Patent Office challenging the validity of the ‘216B Patent. Under the settlement agreement with Novartis, we will pay Novartis certain amounts based on net sales of Lucentis ® made by Novartis during calendar year 2011 and beyond. The settlement does not affect our claims against Genentech and Roche in the Nevada state court action. We do not currently expect such amount to materially impact our total annual revenues.

24




Genentech / Roche Matter

Settlement Agreement

On January 31, 2014, we entered into the Settlement Agreement with Genentech and Roche that resolves all outstanding legal disputes between the parties, including our Nevada litigation with Genentech relating to an August 2010 facsimile sent by Genentech on behalf of Roche and Novartis asserting its products do not infringe on PDL’s SPC’s, and our arbitration proceedings with Genentech related to the audit of royalties on sales.

Under the terms of the Settlement Agreement, effective retroactively to August 15, 2013, Genentech will pay a fixed royalty rate of 2.125% on worldwide sales of Avastin ® , Herceptin ® , Xolair ® , Perjeta ® and Kadcyla ® occurring on or before December 31, 2015, as compared to the previous tiered royalty rate in the United States and the fixed rate on all ex-U.S.-based Manufacturing and Sales. Pursuant to the agreement, Genentech and Roche confirmed that Avastin ® , Herceptin ® , Lucentis ® , Xolair ® and Perjeta ® are licensed products as defined in the relevant license agreements between the parties, and further agreed that Kadcyla ® and Gazyva are licensed products. With respect to Lucentis ® , Genentech owes no royalties on U.S. sales occurring after June 30, 2013, and will pay a royalty of 2.125% on all ex-U.S.-based Sales occurring on or before December 28, 2014. The royalty term for Gazyva remains unchanged from the existing license agreement pertaining thereto.

The agreement precludes Genentech and Roche from challenging the validity of PDL’s patents, including its SPCs in Europe, from contesting their obligation to pay royalties, from contesting patent coverage for Avastin ® , Herceptin ® , Lucentis ® , Xolair ® , Perjeta ® , Kadcyla ® and Gazyva and from assisting or encouraging any third party in challenging PDL’s patents and SPCs. The agreement further outlines the conduct of any audits initiated by PDL of the books and records of Genentech in an effort to ensure a full and fair audit procedure. Finally, the agreement clarifies that the sales amounts from which the royalties are calculated does not include certain taxes and discounts.

Other Legal Proceedings

In addition, from time to time, we are subject to various other legal proceedings and claims that arise in the ordinary course of business and that we do not expect to materially impact our financial statements.

The Company, its directors, and certain of its officers are parties to two related lawsuits filed by shareholders of the Company in federal court in Nevada. The first lawsuit, which purports to be brought on behalf of a class of purchasers of the Company’s securities from November 6, 2013 to September 16, 2014, alleges that the Company and certain of its officers violated federal securities laws by allegedly making misstatements or omissions concerning, among other things, the Company’s financial condition.  This action is entitled Hampe v. PDL Biopharma, Inc., et al. , No. 2:14-cv-01526 (D. Nev. filed Sept. 18, 2014). The second lawsuit, which purports to be brought derivatively on behalf of the Company, seeks to assert claims on behalf of the Company against the Company’s directors for, among other things, breach of fiduciary duty (for disseminating allegedly false and misleading information). This action is entitled Freely v. Lindell, et al. , No. 2:14-cv-01738 (D. Nev. filed Oct. 20, 2014).

Lease Guarantee

In connection with the Spin-Off, we entered into amendments to the leases for our former facilities in Redwood City, California, under which Facet was added as a co-tenant, and a Co-Tenancy Agreement, under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the Spin-Off date. Should Facet default under its lease obligations, we could be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities. As of September 30, 2014 , the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $81.8 million . In April 2010, Abbott acquired Facet and later renamed the entity AbbVie Biotherapeutics, Inc. If AbbVie Biotherapeutics, Inc.were to default, we could also be responsible for lease related costs including utilities, property taxes and common area maintenance, which may be as much as the actual lease payments.

We have recorded a liability of $10.7 million on our Condensed Consolidated Balance Sheets as of September 30, 2014 , and December 31, 2013 , related to this guarantee. In future periods, we may adjust this liability for any changes in the ultimate outcome of this matter that are both probable and estimable.


25



9. Convertible Notes and Term Loans
  
 
 
 
 
Principal Balance Outstanding
 
Carrying Value
 
 
 
 
September 30,
 
September 30,
 
December 31,
Description
 
Maturity Date
 
2014
 
2014
 
2013
(In thousands)
 
 
 
 
 
 
 
 
Convertible Notes
 
 
 
 
 
 
 
 
Series 2012 Notes
 
February 15, 2015
 
$
48,311

 
$
47,564

 
$
172,630

May 2015 Notes
 
May 1, 2015
 
$
155,250

 
152,105

 
148,253

February 2018 Notes
 
February 1, 2018
 
$
300,000

 
274,512

 

Term Loan
 
October 28, 2014
 
$
18,750

 
18,720

 
74,397

Total
 
 
 
 

 
$
492,901

 
$
395,280


As of September 30, 2014 , PDL was in compliance with all applicable debt covenants, and embedded features of all debt agreements were evaluated and did not need to be accounted for separately.
 
Series 2012 Notes

In January 2012, we exchanged $169.0 million aggregate principal of new Series 2012 Notes for an identical principal amount of our February 2015 Notes, plus a cash payment of $5.00 for each $1,000 principal amount tendered, totaling approximately $845,000 . The cash incentive payment was allocated to deferred issue costs of $765,000 , additional paid-in capital of $52,000 and deferred tax assets of $28,000 . The deferred issue costs will be recognized over the life of the Series 2012 Notes as interest expense. In February 2012, we entered into separate privately negotiated exchange agreements under which we exchanged an additional $10.0 million aggregate principal amount of the new Series 2012 Notes for an identical principal amount of our February 2015 Notes. In August 2013, the Company entered into a separate privately negotiated exchange agreement under which it retired the final $1.0 million aggregate principal amount of the Company's outstanding February 2015 Notes. Pursuant to the exchange agreement, the holder of the February 2015 Notes received $1.0 million aggregate principal amount of the Company's Series 2012 Notes. Immediately following the exchange, no principal amount of the February 2015 Notes remained outstanding and $180.0 million principal amount of the Series 2012 Notes was outstanding.

On February 6, 2014, the Company entered into exchange and purchase agreements with certain holders of approximately $131.7 million aggregate principal amount of outstanding Series 2012 Notes. The exchange agreement provided for the issuance by the Company of shares of common stock and a cash payment for the Series 2012 Notes being exchanged, and the purchase agreement provided for a cash payment for the Series 2012 Notes being repurchased. The total consideration given was approximately $191.8 million . The Company issued to the participating holders of the February 2015 Notes, a total of approximately 20.3 million shares of its common stock with a fair value of approximately $157.6 million and made an aggregate cash payment of approximately $34.2 million pursuant to the exchange and purchase agreements. Of the $34.2 million cash payment, $2.5 million is attributable to an inducement fee, $1.8 million is attributable to interest accrued through the date of settlement and $29.9 million is attributable to the repurchase of the Series 2012 Notes. It was determined that the exchange and purchase agreement represented an extinguishment of the related notes. As a result, a loss on extinguishment of $6.1 million was recorded. The $6.1 million loss on extinguishment included the derecognition of the original issuance discount of $5.8 million and a $0.3 million charge resulting from the difference of the face value of the notes and the fair value of the notes. Immediately following the exchange, $48.3 million principal amount of the Series 2012 Notes was outstanding with approximately $2.1 million of remaining original issuance discount to be amortized over the remaining life of the Series 2012 Notes.

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

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

26




During any fiscal quarter commencing after the fiscal quarter ending December 31, 2011, if the closing price of the Company’s common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price for the Series 2012 Notes on the last day of such preceding fiscal quarter;
During the five business-day period immediately after any five consecutive trading-day period in which the trading price per $1,000 principal amount of the Series 2012 Notes for each trading day of that measurement period was less than 98% of the product of the closing price of the Company’s common stock and the conversion rate for the Series 2012 Notes for that trading day;
Upon the occurrence of certain corporate transactions as provided in the indenture; or
Anytime, at the holder’s option, beginning on August 15, 2014.

Holders of our Series 2012 Notes who convert their Series 2012 Notes in connection with a fundamental change resulting in the
reclassification, conversion, exchange or cancellation of our common stock may be entitled to a make-whole premium in the form of an increase in the conversion rate. Such fundamental change is generally defined to include a merger involving PDL, an acquisition of a majority of PDL’s outstanding common stock and a change of a majority of PDL’s board of directors without the approval of the board of directors.

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

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

(In thousands)
 
September 30, 2014
 
December 31, 2013
Principal amount of the Series 2012 Notes
 
$
48,311

 
$
180,000

Unamortized discount of liability component
 
(747
)
 
(7,370
)
Total
 
$
47,564

 
$
172,630


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

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2014
 
2013
 
2014
 
2013
Contractual coupon interest
 
$
347

 
$
1,290

 
$
1,455

 
$
3,864

Amortization of debt issuance costs
 
64

 
289

 
996

 
860

Amortization of debt discount
 
404

 
1,538

 
1,783

 
4,538