PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-Q, Received: 08/04/2016 16:15:54)


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 June 30, 2016
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 No.)
932 Southwood Boulevard
Incline Village, Nevada 89451
(Address of principal executive offices and Zip Code)
(775) 832-8500
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   ý     No   ¨
 
Indicate by check mark whether the registrant has submitted electronically 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 July 25, 2016 , there were 165,540,749 shares of the registrant’s Common Stock outstanding.




  PDL BIOPHARMA, INC.
2016 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 Six Months Ended June 30, 2016 and 2015
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2016 and 2015
 
 
 
 
Condensed Consolidated Balance Sheets at June 30, 2016, and December 31, 2015
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2016 and 2015
 
 
 
 
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 5.
OTHER INFORMATION
 
 
 
ITEM 6.
EXHIBITS
 
 
SIGNATURES
 
We own or have rights to certain trademarks, trade names, copyrights and other intellectual property used in our business, including PDL BioPharma and the PDL logo, each of which is considered a trademark. All other company names, product names, trade names and trademarks included in this Quarterly Report on Form 10-Q are trademarks, registered trademarks or trade names of their respective owners.

2



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
AbbVie
 
AbbVie Biotherapeutics, Inc.
Accel 300
 
Accel 300, LLC, a wholly-owned subsidiary of kaléo
AcelRx
 
AcelRx Pharmaceuticals, Inc.
AcelRx Royalty Agreement
 
Royalty Interest Assignment Agreement, dated September 18, 2015, between PDL and AcelRx
Alphaeon
 
ALPHAEON Corporation
APIC
 
Additional paid-in-capital
ARIAD
 
ARIAD Pharmaceuticals, Inc.
ARIAD Royalty Agreement
 
Royalty Interest Assignment Agreement, dated July 28, 2015, between PDL and ARIAD
ARIAD Royalty Rights
 
The right to receive specified royalties on ARIAD’s Net Revenues (as defined in the ARIAD Royalty Agreement) generated by the sale, distribution or other use of ARIAD’s product Iclusig ®  (ponatinib)
ASC
 
Accounting Standards Codification
ASU
 
Accounting Standards Update
Avinger
 
Avinger, Inc.
Avinger Credit and Royalty Agreement
 
Credit Agreement, dated April 18, 2013, between PDL and Avinger
AxoGen
 
AxoGen, Inc.
AxoGen Royalty Agreement
 
Revenue Interests Purchase Agreement, dated as of October 5, 2012, between PDL and AxoGen
Biogen
 
Biogen, Inc.
CareView
 
CareView Communications, 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, dated as of October 18, 2013, among Depomed, Depo DR Sub and PDL
Direct Flow Medical
 
Direct Flow Medical, Inc.
Durata
 
Collectively, Durata Therapeutics Holding C.V., Durata Therapeutics International B.V. and Durata Therapeutics, Inc. (parent company)
EBITDA
 
Earnings before interest, taxes, depreciation and amortization
Elan
 
Elan Corporation, PLC
EPO
 
European Patent Office
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
Facet
 
Facet Biotech Corporation. In April 2010, Abbott Laboratories acquired Facet and later renamed the company Abbott Biotherapeutics Corp., and in January 2013, Abbott Biotherapeutics Corp. was renamed AbbVie and spun off from Abbott Laboratories as a subsidiary of AbbVie Inc.
FASB
 
Financial Accounting Standards Board
FDA
 
U.S. Food and Drug Administration
February 2015 Notes
 
2.875% Convertible Senior Notes due February 15, 2015, fully retired at September 30, 2013
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 ®
Genzyme
 
Genzyme Corporation (a Sanofi company)
Hyperion
 
Hyperion Catalysis International, Inc.
Incyte
 
Incyte Corporation
IRS
 
Internal Revenue Service

3



kaléo
 
kaléo, Inc. (formerly known as Intelliject, Inc.)
kaléo Revenue Interests
 
100% of the royalties from kaléo’s first approved product, Auvi-Q™ (epinephrine auto-injection, USP) (known as Allerject in Canada) and 10% of net sales of kaléo’s second proprietary auto-injector based product, EVZIO (naloxone hydrochloride injection), collectively
KMPG
 
KPMG, LLP
Kythera
 
Kythera Biopharmaceuticals, Inc., a Delaware corporation.
LENSAR
 
LENSAR, Inc.
Lilly
 
Eli Lilly and Company
March 2015 Term Loan
 
Term Loan borrowed under the Credit Agreement, dated as of March 30, 2015, among PDL, the Royal Bank of Canada and lenders thereto, fully retired on February 12, 2016
May 2015 Notes
 
3.75% Senior Convertible Notes due May 2015, fully retired on May 1, 2015
Merck
 
Merck & Co., Inc.
Michigan Royalty Agreement
 
Royalty Purchase and Sale Agreement, dated as of November 6, 2014, between The Regents of the University of Michigan and PDL
New LENSAR
 
LENSAR, LLC a wholly-owned subsidiary of Alphaeon (formerly known as Lion Buyer LLC)
Noden
 
Noden Pharma DAC
Noden Purchase Agreement
 
Asset Purchase Agreement, dated as of May 24, 2016, by and among Novartis AG, a company organized under the laws of Switzerland, Novartis Pharma AG, company organized under the laws of Switzerland, Speedel Holding AG, a company organized under the laws of Switzerland, collectively referred to as "Novartis") and Noden.
Novartis
 
Novartis AG
OCI
 
Other Comprehensive Income (Loss)
Paradigm Spine
 
Paradigm Spine, LLC
Paradigm Spine Credit Agreement
 
Paradigm Spine Credit Agreement, dated February 14, 2014, between Paradigm Spine and the Company
PDL, we, us, our, the Company
 
PDL BioPharma, Inc.
Queen et al. patents
 
PDL's patents in the United States and elsewhere covering the humanization of antibodies
Roche
 
F. Hoffman LaRoche, Ltd.
Salix
 
Salix Pharmaceuticals, Inc.
Santarus
 
Santarus, Inc.
SDK
 
Showa Denka K.K.
SEC
 
Securities and Exchange Commission
Series 2012 Notes
 
2.875% Series 2012 Convertible Senior Notes, fully retired on February 15, 2015
Settlement Agreement
 
Settlement Agreement between and among PDL, Genentech and Roche, dated January 31, 2014
SPCs
 
Supplementary Protection Certificates
SPC Products
 
Avastin, Herceptin, Lucentis, Xolair and Tysabri
Spin-Off
 
The spin-off by PDL of Facet
Takeda
 
Takeda Pharmaceuticals America, Inc.
U-M
 
University of Michigan
Valeant Pharmaceuticals
 
Valeant Pharmaceuticals International, Inc.
VB
 
Viscogliosi Brothers, LLC
VB Royalty Agreement
 
Royalty Purchase and Sale Agreement, dated as of June 26, 2014, between VB and PDL
VWAP
 
Volume-weighted average share price
Wellstat Diagnostics
 
Wellstat Diagnostics, LLC a/k/a Defined Diagnostics, LLC
Wellstat Diagnostics Borrower Notice
 
A notice of default to Wellstat Diagnostics, due to, inter alia, its ongoing failure to pay its debts as they became 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
Wellstat Diagnostics Guarantor Notice
 
A notice to each of the guarantors of Wellstat Diagnostics' obligations to the Company under the credit agreement

4



Wellstat Diagnostics Guarantors
 
Some or all of: Samuel J. Wohlstadter; Nadine H. Wohlstadter; Duck Farm, Inc.; Hebron Valley Farms, Inc.; HVF, Inc.; Hyperion Catalysis EU Limited; Hyperion; NHW, LLC; Wellstat AVT Investment, LLC; Wellstat Biocatalysis, LLC; Wellstat Biologics Corporation; Wellstat Diagnostics; Wellstat Immunotherapeutics, LLC; Wellstat Management Company, LLC; Wellstate Opthalmics Corporation; Wellstat Therapeutics Corporation; Wellstat Therapeutics EU Limited; Wellstat Vaccines, LLC; and SJW Properties, Inc.
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
Wellstat Diagnostics Petition
 
An Ex Parte Petition for Appointment of Receiver with the Circuit Court of Montgomery County, Maryland

5



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
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues
 
 
 
 
 
 
 
 
Royalties from Queen et al. patents
 
$
14,232

 
$
116,884

 
$
135,687

 
$
244,694

Royalty rights - change in fair value
 
(855
)
 
12,216

 
(27,957
)
 
23,578

Interest revenue
 
7,343

 
8,966

 
16,307

 
19,500

License and other
 
327

 

 
134

 

Total revenues
 
21,047

 
138,066

 
124,171

 
287,772

 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 

 
 

General and administrative
 
6,951

 
7,429

 
16,797

 
15,095

Acquisition-related costs
 
2,959

 

 
2,959

 

Total operating expenses
 
9,910

 
7,429

 
19,756

 
15,095

Operating income
 
11,137

 
130,637

 
104,415

 
272,677

 
 
 
 
 
 
 
 
 
Non-operating expense, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
129

 
121

 
242

 
207

Interest expense
 
(4,461
)
 
(7,199
)
 
(9,011
)
 
(15,809
)
Total non-operating expense, net
 
(4,332
)
 
(7,078
)
 
(8,769
)
 
(15,602
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
6,805

 
123,559

 
95,646

 
257,075

Income tax expense
 
2,657

 
45,295

 
35,611

 
94,313

Net income
 
$
4,148

 
$
78,264

 
$
60,035

 
$
162,762

 
 
 
 
 
 
 
 
 
Net income per share
 
 

 
 

 
 

 
 

Basic
 
$
0.03

 
$
0.48

 
$
0.37

 
$
1.00

Diluted
 
$
0.03

 
$
0.47

 
$
0.37

 
$
0.97

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
163,791

 
163,544

 
163,729

 
163,188

Diluted
 
164,029

 
165,384

 
163,920

 
167,376

 
 
 
 
 
 
 
 
 
Cash dividends declared per common share
 
$
0.05

 
$

 
$
0.10

 
$
0.60

 
See accompanying notes.

6



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

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Net income
 
$
4,148

 
$
78,264

 
$
60,035

 
$
162,762

 
 
 
 
 
 
 
 
 
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
 
15

 
(151
)
 
122

 
(189
)
Adjustment for net (gains) losses realized and included in net income, net of tax
 
(433
)
 

 
(557
)
 

Total change in unrealized gains on investments in available-for-sale securities, net of tax (a)
 
(418
)
 
(151
)
 
(435
)
 
(189
)
Change in unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedges, net of tax
 

 
(1,305
)
 

 
4,363

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

 
(1,739
)
 
(1,821
)
 
(2,408
)
Total change in unrealized losses on cash flow hedges, net of tax (b)
 

 
(3,044
)
 
(1,821
)
 
1,955

Total other comprehensive income (loss), net of tax
 
(418
)
 
(3,195
)
 
(2,256
)
 
1,766

Comprehensive income
 
$
3,730

 
$
75,069

 
$
57,779

 
$
164,528

 ______________________________________________
(a) Net of tax of ($225) and ($82) for the three months ended June 30, 2016 and 2015 , respectively, and ($234) and ($102) for the six months ended June 30, 2016 and 2015, respectively.
(b) Net of tax of zero and ($1,639) for the three months ended June 30, 2016 and 2015 , respectively, and ($981) and $1,053 for the six months ended June 30, 2016 and 2015, respectively.

See accompanying notes.

7



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
 
 
June 30,
 
December 31,
 
2016
 
2015
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
115,854

 
$
218,883

Short-term restricted cash
105,938

 

Short-term investments

 
1,469

Receivables from licensees and other
2,881

 

Deferred tax assets

 
981

Notes receivable
95,359

 
58,398

Prepaid and other current assets
673

 
2,979

Total current assets
320,705

 
282,710

 
 
 
 
Property and equipment, net
18

 
31

Investments-other
75,000

 

Royalty rights - at fair value
339,338

 
399,204

Notes and other receivables, long-term
276,823

 
306,507

Long-term deferred tax assets
25,707

 
16,172

Other assets
11,600

 
7,581

Total assets
$
1,049,191

 
$
1,012,205

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
1,073

 
$
394

Accrued liabilities
11,738

 
8,009

Accrued income taxes
9,793

 
3,372

Term loan payable

 
24,966

Total current liabilities
22,604

 
36,741

 
 
 
 
Convertible notes payable
232,847

 
228,862

Other long-term liabilities
55,088

 
50,650

Total liabilities
310,539

 
316,253

 
 
 
 
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; 165,541 and 164,287 shares issued and outstanding at June 30, 2016, and December 31, 2015, respectively
1,655

 
1,643

Additional paid-in capital
(116,542
)
 
(117,983
)
Accumulated other comprehensive income

 
2,256

Retained earnings
853,539

 
810,036

Total stockholders' equity
738,652

 
695,952

Total liabilities and stockholders' equity
$
1,049,191

 
$
1,012,205

See accompanying notes.

8



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Six Months Ended June 30,
 
2016
 
2015
Cash flows from operating activities
 
 
 
Net income
$
60,035

 
$
162,762

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

 
 

Amortization of convertible notes and term loan offering costs
4,019

 
7,210

Change in fair value of royalty rights - at fair value
27,957

 
(23,578
)
Change in fair value of derivative asset
747

 

Other amortization, depreciation and accretion of embedded derivative
13

 
20

Gain on sale of available-for-sale securities
(881
)
 

Stock-based compensation expense
1,599

 
727

Deferred income taxes
(7,485
)
 
8,358

Changes in assets and liabilities:
 

 
 

Receivables from licensees and other
(2,881
)
 
(100
)
Prepaid and other current assets
(496
)
 
(695
)
Accrued interest on notes receivable
(2,277
)
 
(2,527
)
Other assets
31

 
23

Accounts payable
679

 
383

Accrued liabilities
3,746

 
(102
)
Accrued income taxes
6,421

 
(3,293
)
Other long-term liabilities
3,525

 
6,712

Net cash provided by operating activities
94,752

 
155,900

Cash flows from investing activities
 

 
 

Purchase consideration paid in advance
(4,000
)
 

Purchase of investments-other
(75,000
)
 

Proceeds from sales of available-for-sale securities
1,681

 

Restricted cash
(105,938
)
 

Proceeds from royalty rights - at fair value
31,909

 
2,091

Purchase of notes receivable
(5,000
)
 
(5,226
)
Net cash used in investing activities
(156,348
)
 
(3,135
)
Cash flows from financing activities
 

 
 

Proceeds from term loan

 
100,000

Repurchase of convertible notes

 
(177,387
)
Payment of debt issuance costs

 
(607
)
Repayment of term loan
(25,000
)
 
(25,000
)
Cash dividends paid
(16,433
)
 
(49,083
)
Net cash used in financing activities
(41,433
)
 
(152,077
)
Net increase (decrease) in cash and cash equivalents
(103,029
)
 
688

Cash and cash equivalents at beginning of the period
218,883

 
291,377

Cash and cash equivalents at end of period
$
115,854

 
$
292,065

 
 
 
 
 
 
 
 
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
34,000

 
$
84,000

Cash paid for interest
$
5,001

 
$
9,655

 
 
 
 
Supplemental schedule of non-cash investing and financing activities
 
 
 
Stock issued to settle debt
$

 
$
9,794

Warrants received for notes receivable
$
797

 
$
(1,258
)
See accompanying notes.

9



PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

1. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments), that management of PDL believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year or for any subsequent interim period.
 
The accompanying unaudited 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, 2015 , included in our Annual Report on Form 10-K, filed with the SEC. The Condensed Consolidated Balance Sheet at December 31, 2015 , has been derived from the audited Consolidated Financial Statements at that date, but does not include all disclosures required by GAAP.
 
Principles of Consolidation
 
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of PDL and its subsidiaries. All significant intercompany balances and transactions have been eliminated upon consolidation. Our accompanying unaudited Condensed Consolidated Financial Statements are prepared in accordance with GAAP and the rules and regulations of the SEC.

Management 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 dependent on collateral when the 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 effective interest method. When and if supplemental payments are received from certain of these notes and other long-term receivables, an adjustment to the estimated effective interest rate is affected prospectively.

We evaluate the collectability of both interest and principal for each note receivable and loan to determine whether it is impaired. A note receivable or loan is considered to be impaired when, based on current information and events, we determine it is probable that we will be unable to collect amounts due according to the existing contractual terms. When a note receivable or loan is considered to be impaired, the amount of loss is calculated by comparing the carrying value of the financial asset to the value determined by discounting the expected future cash flows at the loan's effective interest rate or to the estimated fair value of the underlying collateral, less costs to sell, if the loan is collateralized and we expect repayment to be provided solely by the collateral. Impairment assessments require significant judgments and are based on significant assumptions related to the borrower's credit risk, financial performance, expected sales, and estimated fair value of the collateral.

Convertible Notes

We issued our Series 2012 Notes, May 2015 Notes and February 2018 Notes with a net share settlement feature, meaning that upon any conversion, the principal amount will be settled in cash and the remaining amount, if any, will be settled in shares of our common stock. In accordance with accounting guidance for convertible debt instruments that may be settled in cash or other assets upon conversion, we separated the principal balance between the fair value of the liability component and the common stock conversion feature using a market interest rate for a similar nonconvertible instrument at the date of issuance.


10



Queen et al. Royalty Revenues

Under our Queen Patent license agreements, the Company receives royalty payments based upon our licensees’ net sales of covered products. Generally, under these agreements we receive royalty reports from our licensees approximately one quarter in arrears, that is, generally in the second month of the quarter after the licensee has sold the royalty-bearing product. We recognize royalty revenues when we can reliably estimate such amounts and collectability is reasonably assured. Under this accounting policy, the royalty revenues we report are not based upon our estimates and such royalty revenues are typically reported in the same period in which we receive payment from our licensees.

The Company also received annual maintenance fees from licensees of our Queen et al. patents prior to patent expiry as well as periodic milestone payments. We have no performance obligations with respect to such fees. Maintenance fees were recognized as they became due and when payment was reasonably assured. Total annual maintenance and milestone payments in each of the last several years have been less than 1% of total revenue.

Although the last of our Queen et al. patents expired in December 2014, we have received royalties beyond expiration based on the terms of our licenses and our legal settlement. Under the terms of the legal settlement between Genentech and PDL, the first quarter of 2016 was the last period for which Genentech paid royalties to PDL for Avastin, Herceptin, Xolair, Kadcyla and Perjeta. Royalty payments for Avastin, Herceptin, Xolair, Kadcyla and Perjeta accounted for 86% of the $121.5 million Queen et al. royalty revenue recognized in the first quarter of 2016 and our royalties from our Queen et al. patents declined to $14.2 million in the second quarter of 2016. Other products from the Queen et al. patent licenses, such as Tysabri, entitle us to royalties following the expiration of our patents with respect to sales of licensed product manufactured prior to patent expiry in jurisdictions providing patent protection licenses. The amount of royalties we are due for product manufactured prior to patent expiry but sold after patent expiry is uncertain; however, the Company's revenues from payments made from these Queen et al. patent licenses and settlements materially decreased in the second quarter of 2016. The continued success of the Company is dependent on the timing and our ability to acquire new income generating assets in order to provide recurring revenues going forward and to support the Company's business model, and to pay amounts due on our debt as they become due.

Royalty Rights - At Fair Value

Currently, 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.

The changes in the estimated fair value from investments in royalty rights along with cash receipts each reporting period are presented together on our Condensed Consolidated Statements of Income as a component of revenue under the caption, “Royalty rights - change in fair value.”


11



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 June 30,
 
Six Months Ended June 30,
Licensee
 
Product Name
 
2016
 
2015
 
2016
 
2015
Genentech
 
Avastin
 
0
%
 
28
%
 
31
%
 
27
%
 
 
Herceptin
 
0
%
 
29
%
 
31
%
 
27
%
 
 
Xolair
 
0
%
 
8
%
 
10
%
 
8
%
 
 
 
 
 
 
 
 
 
 
 
Biogen
 
Tysabri ®
 
68
%
 
10
%
 
23
%
 
10
%
 
 
 
 
 
 
 
 
 
 
 
Depomed
 
Glumetza, Janumet and Jentadueto
 
20
%
 
7
%
 
N/M

 
6
%
 
 
 
 
 
 
 
 
 
 
 
AcelRx
 
Zalviso
 
10
%
 
0
%
 
3
%
 
0
%
 
 
 
 
 
 
 
 
 
 
 
kaléo
 
Interest revenues
 
22
%
 
4
%
 
8
%
 
3
%
____________________
N/M = Not meaningful

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

We hedged certain Euro-denominated currency exposures related to royalties associated with our licensees’ product sales with Euro forward contracts. In general, those contracts are intended to offset the underlying Euro market risk in our royalty revenues. The last of those contracts expired in the fourth quarter of 2015 and was settled in the first quarter of 2016. We designated foreign currency exchange contracts used to hedge royalty revenues based on underlying Euro-denominated licensee product sales as cash flow hedges.

The fair value of the Euro forward contracts was estimated using pricing models with readily observable inputs from actively quoted markets and was disclosed on a gross basis. The aggregate unrealized gains or losses, net of tax, on the effective component of the hedge was recorded in stockholders’ equity as "Accumulated other comprehensive income." Realized 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 "Interest and other income, net" in the period the ineffectiveness occurs.

Income Taxes

The provision for income taxes is determined using the asset and liability approach. Tax laws require items to be included in tax filings at different times than the items are reflected in the financial statements. A current liability is recognized for the estimated taxes payable for the current year. Deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. Deferred taxes are adjusted for enacted changes in tax rates and tax laws. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.


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Comprehensive Income (Loss)

Comprehensive income (loss) comprises net income adjusted for other comprehensive income (loss), using the specific identification method, which includes the changes in unrealized gains and losses on cash flow hedges and changes in unrealized gains and losses on our investments in available-for-sale securities, all net of tax, which are excluded from our net income.

Adopted Accounting Pronouncements

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs , which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This ASU requires retrospective adoption and is effective for the Company beginning in the first quarter of 2016. The Company adopted this update in the first quarter of 2016 resulting in an immaterial impact on its unaudited condensed consolidated results of operations, financial position and cash flows. At December 31, 2015, the Company had $4.0 million in unamortized debt expense that was classified as a long-term asset and reclassified as a contra liability included in long-term debt. As of June 30, 2016, long-term debt included a contra liability of $3.1 million for unamortized debt expense previously recognized as a long-term asset.

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes , which amends existing guidance on income taxes to require the classification of all deferred tax assets and liabilities as non-current on the balance sheet. ASU No. 2015-17 was adopted on a prospective basis by the Company in the first quarter of 2016, thus resulting in the reclassification of $1.0 million of current deferred tax liabilities to non-current on the accompanying condensed consolidated balance sheet. The prior reporting period was not retrospectively adjusted. The adoption of this guidance had no impact on the Company’s results of operations, financial positions or cash flows.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers . The updated standard will replace most existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued an update to defer the effective date of this update by one year. The updated standard becomes effective for the Company in the first quarter of fiscal year 2018, but allows the Company to adopt the standard one year earlier if it so chooses. The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard will have on its unaudited Condensed Consolidated Financial Statements and related disclosures, and is therefore unable to determine the impact on the Company's unaudited Condensed Consolidated Financial Statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases , which seeks to increase transparency and comparability among organizations by, among other things, recognizing lease assets and lease liabilities on the balance sheet for leases classified as operating leases under previous GAAP and disclosing key information about leasing arrangements.  ASU No. 2016-02 becomes effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted.  The Company is currently evaluating the provisions of ASU No. 2016-02 and assessing the impact, if any, it may have on the Company’s unaudited Condensed Consolidated Financial Statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting , intended to improve the accounting for share-based payment transactions as part of its simplification initiative. The new guidance mainly requires entities to record all excess tax benefits and tax deficiencies as an income tax benefit or expense in the statement of income. The recognition of excess tax benefits and deficiencies and changes to diluted earnings per share are to be applied prospectively while a cumulative-effective adjustment in retained earnings would be made for tax benefits that had not previously been recognized and potential changes to forfeiture recognition.  Cash flow presentation changes can be applied prospectively or retrospectively. The ASU is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. Upon adoption, the ASU may result in approximately $7.5 million cumulative-effect adjustment in retained earnings associated with tax benefits that were not previously recognized. The Company is continuing to evaluate the impact of the updated standard on its consolidated results of operations, financial position and cash flows.

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

13




2. Net Income per Share
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
Net Income per Basic and Diluted Share:
 
2016
 
2015
 
2016
 
2015
  (in thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
Income used to compute net income per basic and diluted share
 
$
4,148

 
$
78,264

 
$
60,035

 
$
162,762

 
 
 
 
 
 
 
 
 
Denominator
 
 

 
 

 
 
 
 
Total weighted average shares used to compute net income per basic share
 
163,791

 
163,544

 
163,729

 
163,188

Restricted stock outstanding
 
238

 
134

 
191

 
117

Effect of dilutive stock options
 

 
19

 

 
19

Assumed conversion of Series 2012 Notes
 

 

 

 
266

Assumed conversion of warrants
 

 
503

 

 
1,551

Assumed conversion of May 2015 Notes
 

 
1,184

 

 
2,235

Shares used to compute net income per diluted share
 
164,029

 
165,384

 
163,920

 
167,376

 
 
 
 
 
 
 
 
 
Net income per share - basic
 
$
0.03

 
$
0.48

 
$
0.37

 
$
1.00

Net income per share - diluted
 
$
0.03

 
$
0.47

 
$
0.37

 
$
0.97


We compute net income per diluted share using the sum of the weighted-average number of common and common equivalent shares outstanding. Common equivalent shares used in the computation of net income per diluted share include shares that may be issued under our stock options and restricted stock awards, the Series 2012 Notes and the 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 the February 2015 Notes was exchanged for the Series 2012 Notes, and in the third quarter of 2013, $1.0 million aggregate principal of the February 2015 Notes was exchanged for the Series 2012 Notes and the February 2015 Notes were retired. In the first quarter of 2014, $131.7 million aggregate principal of the Series 2012 Notes was retired in a privately negotiated exchange and purchase agreement, and in the fourth quarter of 2014, the Company entered into a privately negotiated exchange agreement under which it retired approximately $26.0 million in principal of the outstanding Series 2012 Notes. In the first quarter of 2015, the Company completed the retirement of the remaining $22.3 million of aggregate principal of its Series 2012 Notes.

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

In the second quarter of 2015, the Company completed the retirement of the remaining $155.1 million of aggregate principal of its May 2015 Notes. Concurrently with the retirement of the May 2015 Notes, we exercised our purchased call options and received 5.2 million of PDL's common shares, which was the amount equal to the number of shares required to be delivered by us to the note holders for the excess conversion value (Note 9).

February 2018 Notes Purchase Call Option and Warrant Potential Dilution

We excluded from our calculation of net income per diluted share 23.8 million shares for the three and six months ended June 30, 2016 , respectively, and 29.0 million shares for the three and six months ended June 30, 2015 , respectively, 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, therefore 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 26.9 million shares were excluded from our calculation of net income per diluted share for the three and six months ended June 30, 2016 , respectively, and 32.7 million shares were excluded from our calculation of net income per

14



diluted share for the three and six months ended June 30, 2015 , because they have no effect on net income per diluted 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 months ended June 30, 2016 and 2015 , we excluded approximately 1,154,000 and 39,000 shares underlying restricted stock awards, respectively, and for the six months ended June 30, 2016 and 2015 , we excluded approximately 1,095,000 and 38,000 shares underlying 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.

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.
 
 
June 30, 2016
 
December 31, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
59,630

 
$

 
$

 
$
59,630

 
$
94,801

 
$

 
$

 
$
94,801

Certificates of deposit
 

 
75,000

 

 
75,000

 

 

 

 

Corporate securities
 

 

 

 

 

 
1,469

 

 
1,469

Foreign currency hedge contracts
 

 

 

 

 

 
2,802

 

 
2,802

Warrants
 

 
339

 
695

 
1,034

 

 
984

 

 
984

Royalty rights - at fair value
 

 

 
339,338

 
339,338

 

 

 
399,204

 
399,204

Total
 
$
59,630

 
$
75,339

 
$
340,033

 
$
475,002

 
$
94,801

 
$
5,255

 
$
399,204

 
$
499,260

 
As of June 30, 2016, PDL held $75.0 million in a long-term certificate of deposit, which is designated as cash collateral for the letter of credit issued with respect to the first anniversary payment under the Noden Purchase Agreement described below. Except of the transfer of the long-term certificate of deposit into level 2, there have been no other transfers between levels during each of the three or six-month periods ended June 30, 2016 , and December 31, 2015 . The Company recognizes transfers between levels on the date of the event or change in circumstances that caused the transfer.

Certificates of Deposit

The fair value of the certificates of deposit is determined using quoted market prices for similar instruments and non-binding market prices that are corroborated by observable market data.

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.

15




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 (which was subsequently acquired by Salix, which itself was recently acquired by Valeant Pharmaceuticals) 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 N.V. 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 receives 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 June 30, 2016 , and December 31, 2015 , 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 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 financial asset acquired represents a single unit of accounting. The fair value of the financial asset acquired was determined by using a discounted cash flow analysis related to the expected future cash flows to be generated by each licensed product. This financial asset is classified as a Level 3 asset within the fair value hierarchy, as 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 flows are based upon expected royalties from sales of licensed products over a ten-year period. The discount rates utilized range from approximately 15% to 25% . Significant judgment is required in selecting appropriate discount rates. At June 30, 2016 , an evaluation was performed to assess those rates and general market conditions potentially affecting the fair market value. Should these discount rates increase or decrease by 2.5%, the fair value of the asset could decrease by $8.4 million or increase by $9.4 million, respectively. A third-party expert was engaged to help management develop its original estimate of the expected future cash flows. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from those estimates. We periodically assess the expected future cash flows and to the extent such payments are greater or less than our initial estimates, or the timing of such payments is materially different than our original estimates, we will adjust the estimated fair value of the asset. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $3.4 million or decrease by $3.4 million, respectively.

When PDL acquired the Depomed royalty rights, Glumetza was marketed by Santarus. In January 2014, Salix acquired Santarus and assumed responsibility for commercializing Glumetza, which was generally perceived to be a positive development because of Salix's larger sales force and track record in the successful commercialization of therapies. In late 2014, Salix made a number of disclosures relating to an excess of supply at the distribution level of Glumetza and other drugs that it commercialized, the practices leading to this excess of supply which were under review by Salix's audit committee in relation to the related accounting practices. Because of these disclosures and PDL's lack of direct access to information as to the levels of inventory of Glumetza in the distribution channels, PDL commenced a review of all public statements by Salix, publicly available historical third-party prescription data, analyst reports and other relevant data sources. PDL also engaged a third-party expert to specifically assess estimated inventory levels of Glumetza in the distribution channel and to ascertain the

16



potential effects those inventory levels may have on expected future cash flows. Salix was acquired by Valeant Pharmaceuticals in early April 2015. In mid-2015, Valeant Pharmaceuticals implemented two price increases on Glumetza. At year-end 2015, a third-party expert was engaged by PDL to assess the impact of the Glumetza price adjustments and near-term market entrance of manufacturer of generic equivalents to Glumetza to the expected future cash flows. Based on the analysis performed, management revised the underlying assumptions used in the discounted cash flow analysis at year-end 2015. In February 2016, a manufacturer of generic equivalents to Glumetza entered the market. At March 31, 2016, management evaluated, with assistance of a third-party expert, the erosion of market share data, the gross-to-net revenue adjustment assumptions and Glumetza demand data. These data and assumptions are based on available but limited information. Our expected future cash flows at year-end 2015 anticipated a reduction in future cash flows of Glumetza as a result of the generic competition in 2016. However, based on the demand and supply data of Glumetza it appeared that the loss of market share progressed more rapidly than forecasted at year-end 2015. At the end of the second quarter in 2016, management re-evaluated, with the assistance of a third-party expert, the cash flow projections concluding that a further deterioration in the net pricing warranted revision of the assumptions used in the discounted cash flow model at June 30, 2016.

As of June 30, 2016 , our discounted cash flow analysis reflects our expectations as to the amount and timing of future cash flows up to the valuation date. We continue to monitor whether the generic competition further affects sales of Glumetza and thus royalties on such sales paid to PDL. Due to the uncertainty around Valeant's marketing and pricing strategy, as well as the recent generic competition and limited historical demand data after generic market entrance, we may need to further reduce future cash flows in the event of more rapid reduction in market share of Glumetza or a further erosion in net pricing. PDL exercised its audit right under the Depomed Royalty Agreement with respect to the Glumetza royalties in January 2016 and expects to conclude the audit in the second half of 2016.

In May 31, 2016, PDL obtained a notification indicating that the FDA approved Jentadueto XR for use in patients with type 2 diabetes. In June 2016, PDL received a $6.0 million FDA approval milestone. The product approval was earlier than initially expected, based on the FDA approval and expected product launch, PDL has adjusted the timing of future cash flows and discount rate used in the discounted cash flow model at June 30, 2016.

As of June 30, 2016 , the fair value of the asset acquired as reported in our Condensed Consolidated Balance Sheet was $136.6 million and the maximum loss exposure was $136.6 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 pre-market approval from the FDA, in exchange for a $15.5 million cash payment, less fees.

The royalty rights acquired includes royalties accruing from and after April 1, 2014. Under the terms of the VB Royalty Agreement, the Company receives all royalty payments due to VB pursuant to certain technology transfer agreements between VB and Paradigm Spine until the Company has received payments equal to 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 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 June 30, 2016 , 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 ten-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 $1.3 million or increase by $1.5 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $0.4 million or decrease by $0.4 million, respectively. A third-party expert was 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. At each reporting period, an evaluation is performed to assess those estimates, discount rates utilized and general market conditions affecting fair market value.

As of June 30, 2016 , the fair value of the asset acquired as reported in our Condensed Consolidated Balance Sheet was $14.6 million and the maximum loss exposure was $14.6 million .


17



U-M Royalty Agreement

On November 6, 2014, PDL acquired a portion of all royalty payments of the U-M’s worldwide royalty interest in Cerdelga (eliglustat) for $65.6 million . Under the terms of the Michigan Royalty Agreement, PDL will receive 75% of all royalty payments due under U-M’s license agreement with Genzyme until expiration of the licensed patents, excluding any patent term extension. Cerdelga, an oral therapy for adult patients with Gaucher disease type 1, was developed by Genzyme, a Sanofi company. Cerdelga was approved in the United States on August 19, 2014, in the European Union on January 22, 2015, and in Japan in March 2015. In addition, marketing applications for Cerdelga are under review by other regulatory authorities. While marketing applications have been approved in the European Union and Japan, national pricing and reimbursement decisions are delayed in some countries. At June 30, 2016, a third party expert was engaged by PDL to assess the impact of the delayed pricing and reimbursement decisions to Cerdelga's expected future cash flows. Based on the analysis performed, management revised the underlying assumptions used in the discounted cash flow analysis at June 30, 2016.

The fair value of the royalty right at June 30, 2016 , 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 six-year period. The discount rate utilized was approximately 12.8% . Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $5.0 million or increase by $5.6 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $1.6 million or decrease by $1.6 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 affecting fair market value is performed in each reporting period.

As of June 30, 2016 , the fair value of the asset acquired as reported in our Condensed Consolidated Balance Sheet was $64.0 million and the maximum loss exposure was $64.0 million .

ARIAD Royalty Agreement

On July 28, 2015, PDL entered into the ARIAD Royalty Agreement, whereby the Company acquired the rights to receive royalties payable from ARIAD's net revenues generated by the sale, distribution or other use of Iclusig ® (ponatinib), a cancer medicine for the treatment of adult patients with chronic myeloid leukemia, in exchange for up to $200.0 million in cash payments. The purchase price of $100.0 million is payable in two tranches of $50.0 million each, with the first tranche funded on the closing date and the second tranche to be funded on the first anniversary of the closing date. The ARIAD Royalty Agreement provided ARIAD with an option to draw up to an additional $100.0 million in up to two draws at any time between the six and 12 months after the closing date. ARIAD may repurchase the royalty rights at any time for a specified amount. Upon the occurrence of certain events, PDL has the right to require ARIAD to repurchase the royalty rights for a specified amount. Under the ARIAD Royalty Agreement, the Company has the right to a make-whole payment from ARIAD if the Company does not receive payments equal to or greater than the amounts funded on or prior to the fifth anniversary of each of the respective fundings. In such case, ARIAD will pay to the Company the difference between the amounts paid to such date by ARIAD (excluding any delinquent fee payments) and the amounts funded by the Company. PDL has elected the fair value option to account for the hybrid instrument in its entirety. Any embedded derivative shall not be separated from the host contract.

Under the terms of the ARIAD Royalty Agreement, the Company receives royalty payments at a royalty rate ranging from 2.5% to 7.5% of Iclusig revenue until the first to occur of (i) repurchase of the royalty rights by ARIAD or (ii) December 31, 2033. The annual royalty payments shall not exceed $20.0 million in any fiscal year for the years ended December 31, 2015 through December 31, 2018. If Iclusig revenue does not meet certain agreed-upon projections on an annual basis, PDL is entitled to certain royalty payments from net revenue of another ARIAD product, brigatinib, up to the amount of the shortfall from the projections for the applicable year. 

On May 9, 2016, ARIAD entered into a share purchase agreement with Incyte, pursuant to which ARIAD agreed to sell to Incyte all of the outstanding shares of ARIAD Pharmaceuticals (Luxembourg) S.a.r.l., which is the parent company of ARIAD’s European subsidiaries responsible for the commercialization of Iclusig in the European Union and certain other countries.

On May 9, 2016, the Company and ARIAD agreed to amend the ARIAD Royalty Agreement to, among other things, include in the Iclusig Net Revenues calculation payable to the Company by ARIAD under the ARIAD Royalty Agreement, net sales of Iclusig made by Incyte once it takes over ARIAD’s commercialization operations with respect to Iclusig in the European Union

18



and certain other countries. In addition, the Company and ARIAD agreed to restructure future funding under the ARIAD Royalty Agreement such that ARIAD’s option to draw up to an additional $100.0 million between January and July of 2016 was reduced to a maximum amount of up to an additional $40.0 million , which will be funded at ARIAD’s option in July of 2017 upon 90 days’ written notice to the Company. The amendment to the ARIAD Royalty Agreement did not affect the Company’s obligation to fund the second tranche of $50.0 million on the first anniversary of the ARIAD Royalty Agreement, which was funded on July 28, 2016.

The asset acquired pursuant to the ARIAD Royalty Agreement represents a single unit of accounting. The fair value of the royalty right at June 30, 2016 , 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 six-year period. The discount rate utilized was approximately 10.0% . Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $7.9 million or increase by $9.0 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $1.3 million or decrease by $1.3 million, respectively. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. The fair value of the asset is subject to variation should those cash flows vary significantly from our estimates. An evaluation of those estimates, discount rates utilized and general market conditions affecting fair market value is performed in each reporting period.

As of June 30, 2016 , the fair value of the asset acquired as reported in our Condensed Consolidated Balance Sheet was $50.3 million and the maximum loss exposure was $50.3 million .

AcelRx Royalty Agreement

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

As of June 30, 2016 , and December 31, 2015 , the Company determined that its royalty rights under the agreement with ARPI LLC represented a variable interest in a variable interest entity. However, the Company does not have the power to direct the activities of ARPI LLC that most significantly impact ARPI LLC's economic performance and is not the primary beneficiary of ARPI LLC; therefore, ARPI LLC is not subject to consolidation by the Company.

The fair value of the royalty right at June 30, 2016 , 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 fifteen-year period. The discount rate utilized was approximately 13.4% . Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $10.2 million or increase by $12.7 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $1.8 million or decrease by $1.8 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. At each reporting period, an evaluation of those estimates, discount rates utilized and general market conditions affecting fair market value is performed in each reporting period.

As of June 30, 2016 , the fair value of the asset acquired as reported in our Condensed Consolidated Balance Sheet was $71.8 million and the maximum loss exposure was $71.8 million .

Dr. Stephen Hoffman is the President of 10x Capital, Inc., a third-party consultant to the Company, and is also a member of the board of directors of AcelRx. Dr. Hoffman recused himself from the AcelRx board of directors with respect to the entirety of its discussions and considerations of the transaction. Dr. Hoffman is being compensated for his contribution to consummate this

19



transaction by PDL as part of his consulting agreement. PDL concluded Dr. Hoffman is not considered a related party in accordance with FASB ASC 850, Related Party Disclosures and SEC Regulation S-X, Related Party Transactions Which Affect the Financial Statements .

Avinger Credit and Royalty Agreement

On April 18, 2013, PDL entered into the Avinger Credit and Royalty Agreement, under which we made available to Avinger up to $40.0 million (of which only $20.0 million was funded) to be used by Avinger in connection with the commercialization of its lumivascular catheter devices and the development of Avinger's lumivascular atherectomy device. On September 22, 2015, Avinger elected to prepay the note receivable in whole for a payment of $21.4 million in cash.

Under the terms of the Avinger Credit and Royalty Agreement, the Company was entitled to receive royalties at a rate of 1.8% on Avinger's net revenues until the note receivable was repaid by Avinger. Upon the repayment of the note receivable, which occurred on September 22, 2015, the royalty rate was reduced to 0.9% subject to certain minimum payments from the prepayment date until April 2018. The Company has accounted for the royalty rights in accordance with the fair value option. The fair value of the royalty right at June 30, 2016 , 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 two-year period. The discount rate utilized was approximately 15.0% . Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 5%, the fair value of this asset could decrease by $93,000 or increase by $103,000, respectively. Should the expected royalties increase or decrease by 5%, the fair value of the asset could increase by $105,000 or decrease by $105,000, respectively. Management considered the contractual minimum payments when developing its estimate of the expected future cash flows. 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 affecting fair market value is performed in each reporting period.

As of June 30, 2016 , the fair value of the royalty asset as reported in our Condensed Consolidated Balance Sheet was $2.1 million and the maximum loss exposure was $2.1 million .

The following tables summarize the changes in Level 3 assets and the gains and losses included in earnings for the six months ended June 30, 2016 :

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(in thousands)
 
Royalty Rights
 
Preferred Stock
Warrants
Fair value as of December 31, 2015
 
$
399,204

 
$

 
 
 
 
 
 
 
 
 
Fair value of financial instruments purchased
 

 
797

 
Total net change in fair value for the period
 
 
 
 
 
 
Change in fair value
 
(27,957
)
 
(102
)
 
 
Proceeds
 
(31,909
)
 

 
 
 
Total net change in fair value for the period
 
(59,866
)
 
(102
)
 
 
 
 
 
 
 
 
Fair value as of June 30, 2016
 
$
339,338

 
$
695


20




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

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
(in thousands)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for assets held at the end of the reporting period
 
$
(855
)
 
$
12,216

 
$
(27,957
)
 
$
23,578


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

 
 
June 30, 2016
 
December 31, 2015
 
 
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

 
$

 
$
52,468

 
$
50,191

 
$

 
$
55,970

Hyperion note receivable
 
1,200

 

 
1,200

 
1,200

 

 
1,200

LENSAR note receivable
 
43,909

 

 
46,229

 
42,271

 

 
42,618

Direct Flow Medical note receivable
 
57,022

 

 
60,537

 
51,852

 

 
51,992

Paradigm Spine note receivable
 
54,332

 

 
54,450

 
53,973

 

 
54,250

kaléo note receivable
 
146,731

 

 
145,494

 
146,778

 

 
146,789

CareView note receivable
 
18,797

 

 
19,500

 
18,640

 

 
19,495

Total
 
$
372,182

 
$

 
$
379,878

 
$
364,905

 
$

 
$
372,314

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

February 2018 Notes
 
$
232,847

 
$
234,125

 
$

 
$
228,862

 
$
197,946

 
$

March 2015 Term Loan
 

 

 

 
24,966

 

 
25,000

Total
 
$
232,847

 
$
234,125

 
$

 
$
253,828

 
$
197,946

 
$
25,000



As of June 30, 2016 and December 31, 2015 , the estimated fair values of our Paradigm Spine note receivable, kaléo note receivable, Hyperion note receivable, Avinger note receivable, LENSAR note receivable, CareView 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.

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 Wellstat Diagnostics Note Receivable and Credit Agreement, as amended and restated, is secured by substantially all assets and equity interests in Wellstat Diagnostics. In addition, the note is subject to a guaranty from the Wellstat Diagnostics Guarantors. The estimated fair value of the collateral assets was determined by using an asset approach and discounted cash flow model related to the underlying collateral and was adjusted to consider estimated costs to sell the assets.

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On June 30, 2016 , the carrying values of several of our notes receivable differed from their estimated fair value. This is the result of discount rates used when performing a discounted cash flow for fair value valuation purposes. We determined these notes receivable to be Level 3 assets, as our valuations utilized significant unobservable inputs, estimates of future revenues, expectations about settlement and required yield. To provide support for the fair value measurements, we considered forward-looking performance, and current measures associated with high yield and published 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.

Warrants

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

4. Cash, Cash Equivalents and Investments
 
As of June 30, 2016 , and December 31, 2015 , 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 income" 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.

The following tables summarize the Company’s cash and available-for-sale securities’ amortized cost, gross unrealized gains, gross unrealized losses, and fair value by significant investment category reported as cash and cash equivalents, short-term restricted cash, or short-term investments as of June 30, 2016, and December 31, 2015:

 
 
 
 
 
 
 
 
Reported as:
 
 
 Amortized Cost
 
 Unrealized Gains
 
 Estimated Fair Value
 
 Cash and Cash Equivalents
 
Short-Term Restricted Cash
 
Short-Term Investments
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
162,162

 
$

 
$
162,162

 
$
56,224

 
$
105,938

 
$

Money market funds
 
59,630

 

 
59,630

 
59,630

 

 

Total
 
$
221,792

 
$

 
$
221,792

 
$
115,854

 
$
105,938

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Cash
 
$
124,082

 
$

 
$
124,082

 
$
124,082

 
$

 
$

Money market funds
 
94,801

 

 
94,801

 
94,801

 

 

Corporate securities
 
799

 
670

 
1,469

 

 

 
1,469

Total
 
$
219,682

 
$
670

 
$
220,352

 
$
218,883

 
$

 
$
1,469


For the three and six months ended June 30, 2016 , we recognized approximately $746,000 and $882,000 , on sales of available-for-sale securities, respectively. No gains or losses on sales of available-for-sale securities were recognized for the three and six months ended June 30, 2015 .

The unrealized gain on investments included in "Other comprehensive income (loss), net of tax" was approximately zero and $435,000 as of June 30, 2016 , and December 31, 2015, respectively.

As of June 30, 2016, PDL held $105.9 million in short-term restricted cash, as designated for payment of the acquisition consideration to be paid on July 1, 2016 for the Noden transaction, and held $75.0 million in a long-term certificate of deposit,

22



which is designated as cash collateral for the letter of credit issued with respect to the first anniversary payment under the Noden Purchase Agreement described below.

5. Foreign Currency Hedging

We designate the foreign currency exchange contracts used to hedge our royalty revenues based on underlying Euro-denominated sales as cash flow hedges. Euro forward contracts are presented on a net basis on our Condensed Consolidated Balance Sheets as we have entered into a netting arrangement with the counterparty. As of December 31, 2015 , all outstanding Euro forward contracts were classified as cash flow hedges. There were no Euro forward contracts outstanding as of June 30, 2016 .

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
 
December 31, 2015
 
 
 
 
 
 
(In thousands)
Currency
 
Settlement Price
($ per Euro)
 
Type
 
Notional Amount
 
Fair Value
Euro
 
1.260
 
Sell Euro
 
$
16,500

 
$
2,802

 
 The location and fair values of our Euro forward contracts in our Condensed Consolidated Balance Sheets were as follows:

Cash Flow Hedge
 
Location
 
December 31,
2015
(In thousands)
 
 
 
 
Euro forward contracts
 
Prepaid and other current assets
 
$
2,802


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

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2016
 
2015
 
2016
 
2015
(In thousands)
 
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax (1)
 
$

 
$
(1,305
)
 
$

 
$
4,363

Gain (loss) reclassified from accumulated OCI into "Queen et al. royalty revenue," net of tax (2)
 
$

 
$
1,739

 
$
1,821

 
$
2,408

 _______________________________
(1) Net change in the fair value of cash flow hedges, net of tax.
(2) Effective portion classified as royalty revenue.

6. Notes and Other Long-Term Receivables

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

Wellstat Diagnostics Note Receivable and Credit Agreement

In March 2012, the Company executed a $7.5 million two -year senior secured note receivable with the holders of the equity interests in Wellstat Diagnostics. In addition to bearing interest at 10% per annum, the note receivable 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 receivable. This $10.0 million note receivable 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.


23



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.

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 was to be repaid. The internal rate of return calculation, although increased, was reset when the credit agreement was amended and restated.

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 included 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 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 the Wellstat Diagnostics Borrower Notice. The Wellstat Diagnostics 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, included an amount that, together with interest and royalty payments

24



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 the Wellstat Diagnostics Guarantor Notice. The Wellstat Diagnostics 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’ stockholders.

On September 24, 2014, the Company filed the Wellstat Diagnostics Petition, which was granted on the same day. The order granting the Wellstat Diagnostics 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.

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 is conditioned upon the agreement by Wellstat Diagnostics to make certain operational changes within Wellstat Diagnostics, which the Company believes will allow the receiver to more efficiently optimize the value of the collateral.

During the second quarter of 2015, the receiver initiated a process for a public sale of the assets of Wellstat Diagnostics and retained the investment banking firm of Duff & Phelps to organize and manage the sale process. The receiver filed a "Motion For Approval of Sale Procedures" with the Circuit Court for Montgomery County, Maryland, which is the court having jurisdiction over the receivership and a hearing was held on July 22, 2015 at which time arguments were heard from interested parties regarding the sale procedures. No significant substantive disagreements between the parties regarding the sale procedures remained after the hearing and a decision approving the receiver’s sale procedures was made in the third quarter of 2015. PDL submitted a credit bid for the Wellstat Diagnostic assets at a value corresponding to some portion of the outstanding amount due under the amended and restated credit agreement which is subject to court approval. A hearing was scheduled in the Maryland Circuit Court for April 13, 2016 to hear the Receiver’s motion to approve the credit bid sale to PDL. However, on April 12, 2016, Wellstat Diagnostics changed its name to Defined Diagnostics, LLC and filed for bankruptcy under Chapter 11 in the United Stated Bankruptcy Court in the Southern District of New York. The filing of the bankruptcy case stays the proceedings in the Maryland Circuit Court pursuant to the automatic stay provisions of the Bankruptcy Code. On June 15, 2016, in response to a Motion to Dismiss filed by the Company alleging, inter alia, that the New York Bankruptcy Court is not a proper venue for Defined Diagnostics to file for bankruptcy under Chapter 11, the New York Bankruptcy Court dismissed and transferred the action to the United States Bankruptcy Court in Delaware. On August 2, 2016 the Delaware Bankruptcy Court announced its decision to grant the Company’s motion to dismiss the chapter 11 petition with prejudice as a bad faith filing, which should result in the receivership sale in the Maryland Circuit Court proceeding promptly.

On September 4, 2015, PDL filed in the Supreme Court of New York a motion for summary judgment in lieu of complaint which requested that the court enter judgment against Wellstat Diagnostics Guarantors for the total amount due on the Wellstat Diagnostics debt, plus all costs and expenses including lawyers’ fees incurred by the Company in enforcement of the related guarantees. On September 23, 2015, PDL filed in the same court an ex parte application for a temporary restraining order and order of attachment of the Wellstat Diagnostics Guarantors' assets. At a hearing on September 24, 2015, regarding the Company’s request for a temporary restraining order, the court ordered that the Company’s request for attachment and for summary judgment would be heard at a hearing on November 5, 2015. Although the court denied the Company’s request for a temporary restraining order at the hearing on September 24, 2015, it ordered that assets of the Wellstat Diagnostics Guarantors should be held in status quo ante and only used in the normal course of business pending the outcome of the matters under consideration at the hearing.

On July 29, 2016, the Supreme Court of New York issued its Memorandum of Decision granting the Company’s motion for summary judgment and denying the Wellstat Diagnostics Guarantors’ cross-motion for summary judgment. The Supreme Court of New York held that the Wellstat Diagnostics Guarantors are liable for all “Obligations” owed by Wellstat Diagnostics to the Company. It did not set a specific dollar amount due, but ordered that a judicial hearing officer or special referee be designated to determine the amount of the Obligations owing, and awarded the Company its attorneys’ fees and costs in an amount to be determined. The Supreme Court of New York has also set a hearing on August 23, 2016 to consider the implication of the status quo ante instruction on certain actions of the Wellstat Diagnostics Guarantors and whether to issue a writ of attachment.

On July 29, 2016, the Wellstat Diagnostics Guarantors filed a notice of appeal from the Memorandum of Decision. This appeal does not stay the Supreme Court of New York from entering a money judgment for the balance owing based on the decision of the judicial hearing officer or special referee to be designated to determine the amount of the Obligations owing pursuant to the Memorandum of Decision.

25




On October 22, 2015, the Wellstat Diagnostics Guarantors filed a complaint against the Company in the Supreme Court of New York seeking a declaratory judgment that certain contractual arrangements entered into between the parties subsequent to Wellstat Diagnostics’ default, and which relate to a split of proceeds in the event that the Wellstat Diagnostics Guarantors voluntarily monetize any assets that are the Company’s collateral, is of no force or effect.

Through the period ended June 30, 2016 , PDL has advanced to Wellstat Diagnostics $16.2 million to fund the ongoing operations of the business and other associated costs. This funding has been expensed as incurred. As of June 30, 2016, PDL is owed $117.5 million , which includes unpaid principal, and interest and repayment of amounts funded for ongoing operations of Wellstat Diagnostics.

Effective April 1, 2014, and as a result of the event of default, we determined the loan to be impaired and we ceased to accrue interest revenue. At that time and as of June 30, 2016 it has been determined that an allowance on the carrying value of the note was not necessary as the Company believes the value of the collateral securing Wellstat Diagnostics’ obligations exceeds the carrying value of the asset and is sufficient to enable the Company to recover the current carrying value of $50.2 million . The Company continues to closely monitor the timing and expected recovery of amounts due, including litigation and other matters related to Wellstat Diagnostics Guarantors' assets. There can be no assurance that an allowance on the carrying value of the notes receivable investment will not be necessary in a future period depending on future developments.

Hyperion Agreement

On January 27, 2012, 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 two equal payments of $1.2 million on each of March 5, 2013 and 2014. The first payment of $1.2 million was paid on March 5, 2013, but Hyperion has not made the second payment that was due on March 5, 2014. The Company completed an impairment analysis as of June 30, 2016 . Effective with this date and as a result of the event of default, we ceased to accrue interest revenue. As of June 30, 2016 , the estimated fair value of the collateral was determined to be in excess of the carrying value. There can be no assurance that this will be true in the event of the Company's foreclosure on the collateral, nor can there be any assurance of realizing value from such collateral.

AxoGen Note Receivable and AxoGen Royalty Agreement

In October 2012, PDL entered into the AxoGen Royalty Agreement with AxoGen providing for the payment of specified royalties to PDL 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 had an eight -year term and provided PDL with royalties of 9.95% based on AxoGen's net revenues, subject to agreed-upon guaranteed quarterly minimum payments of approximately $1.3 million to $2.5 million , which began 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 was 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. The royalty rights were secured by the cash and accounts receivable of AxoGen.

On August 14, 2013, PDL purchased 1,166,666 shares of registered common stock of AxoGen (AXGN) at $3.00 per share, totaling $3.5 million . On December 22, 2014, PDL sold these shares at $3.03 per share, totaling approximately $3.5 million .

On November 13, 2014, the Company agreed to terminate the AxoGen Royalty Agreement in consideration for a payment of $30.3 million in cash, which was the sum of the outstanding principal, interest and embedded derivative. At the same time, the Company acquired 643,382 shares of registered common stock of AxoGen for approximately $1.7 million at a public offering price of $2.72 per share. The shares were classified as available for sale securities and recorded as short-term investments on the Condensed Consolidated Balance Sheets. In the third and fourth quarters of 2015, PDL sold 200,000 and 149,650 shares, respectively, at a price range between $5.46 and $5.69 per share, resulting in a gain totaling approximately $1.9 million . In the first and second quarters of 2016, PDL sold 50,000 and 243,732 shares, respectively, at a price range between $5.44 and $6.10 per share, resulting in a gain totaling approximately $882,000 .

As of June 30, 2016 , PDL held zero shares of AxoGen common stock.


26



Avinger Credit and Royalty Agreement

On April 18, 2013, PDL entered into the Avinger Credit and Royalty Agreement, 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 available to Avinger, we funded an initial $20.0 million , net of fees, at the close of the transaction. Outstanding borrowings under the initial loan bore interest at a stated rate of 12% per annum.

On September 22, 2015, Avinger elected to prepay the note receivable in whole for a payment of $21.4 million in cash, which was the sum of the outstanding principal, interest and a prepayment fee.

Under the terms of the Avinger Credit and Royalty Agreement, the Company receives a low, single-digit royalty on Avinger's net revenues until April 2018. Commencing in October 2015, after Avinger repaid the note receivable prior to its maturity date, the royalty on Avinger's net revenues reduced by 50% , subject to certain minimum payments from the prepayment date until April 2018. PDL has accounted for the royalty rights in accordance with the fair value option.

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 remaining $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 bore interest at the rate of 15.5% per annum, payable quarterly in arrears.

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

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

On November 15, 2015, New LENSAR, a wholly owned subsidiary of Alphaeon, and LENSAR entered into the Asset Purchase Agreement whereby New LENSAR agreed to acquire substantially all the assets and assumed certain liabilities of LENSAR subject to the satisfaction of certain closing conditions. The acquisition was consummated on December 15, 2015.

In connection with the closing of the acquisition, New LENSAR entered into an amended and restated credit agreement with PDL, assuming $42.0 million in loans as part of the borrowings under PDL’s prior credit agreement with LENSAR. In addition, Alphaeon issued 1.7 million shares of its Class A common stock to PDL.

Under the terms of the amended and restated credit agreement, PDL has a first lien security interest in substantially all of the equity interests and assets of New LENSAR. The loans bear interest of 15.5% per annum, payable quarterly in arrears. New LENSAR may elect to pay in kind interest the first three interest payments in the form of additional principal amount added to the loans. The principal repayment will commence on the ninth interest payment date. The principal amount outstanding at commencement of repayment is to be repaid in equal installments until final maturity of the loans which is December 15, 2020.

PDL concluded that the amendment and restatement of the original LENSAR credit agreement shall be accounted for as a troubled debt restructuring due to the concession granted by PDL and LENSAR’s financial difficulties. PDL has recognized a loss on extinguishment of notes receivable of $4.0 million and expensed $3.0 million of closing fees as general & administrative costs as incurred at closing on December 15, 2015.


27



We have estimated a fair value of $3.84 per share for the 1.7 million shares of Alphaeon Class A common stock received in connection with the transactions and recognized this investment as a cost-method investment of $6.6 million included in other long-term asset. The Alphaeon Class A common stock is subject to other-than-temporary impairment assessments in future periods. There is no other-than-temporary impairment charge incurred as of June 30, 2016.

The Company completed an impairment analysis as of June 30, 2016. Effective as of this date and as a result of the non-compliance with certain covenants, we determined the loan to be impaired and we ceased to accrue interest revenue. As of June 30, 2016, the estimated fair value of the collateral underlying the LENSAR loan was determined to be in excess of the carrying value. In the event the Company was to foreclose on the collateral, there can be no assurance as to the accuracy of the estimated fair value of the collateral, nor can there be any assurance of realizing value from such collateral.

Direct Flow Medical Credit Agreement

On November 5, 2013, PDL entered into a credit agreement with Direct Flow Medical, under which PDL agreed to provide up to $50.0 million to Direct Flow Medical. Of the $50.0 million available to Direct Flow Medical, an initial $35.0 million (tranche one), net of fees, was funded by the Company at the close of the transaction. Pursuant to the original terms of the credit agreement the Company agreed to provide Direct Flow Medical with an additional $15.0 million tranche, net of fees, upon the attainment of a specified revenue milestone to be accomplished no later than December 31, 2014 (the tranche two milestone). Until the occurrence of the tranche two milestone, outstanding borrowings under tranche one bore 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 an equity offering prior to December 31, 2014. In exchange, the parties amended the credit agreement to provide for additional fees associated with certain liquidity events, such as a change of control or the consummation of an initial public offering, and granted PDL certain board of director observation rights. On November 19, 2014, upon Direct Flow Medical satisfying the amended tranche two milestone, the Company funded the $15.0 million second tranche to Direct Flow Medical, net of fees. Upon occurrence of the borrowing of this second tranche, the interest rate applicable to all loans under the credit agreement was decreased to 13.5% per annum, payable quarterly in arrears.

Under the terms of the credit agreement, principal repayment will commence on the 12th 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 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.

On December 21, 2015, Direct Flow Medical and PDL entered into a waiver to the credit agreement in anticipation of Direct Flow Medical being unable to comply with the liquidity covenant and make interest payments due under the credit agreement.

On January 14, 2016, both parties agreed to provide Direct Flow Medical with an extension to waive the liquidity covenant and delay the timing of the interest payments through the period ending September 30, 2016.

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

On February 26, 2016, PDL and Direct Flow Medical entered into the fourth Amendment to the Credit Agreement that, among other things, (i) converted the $5.0 million short-term secured promissory note into a loan under the credit agreement with substantially the same interest and payment terms as the existing loans, (ii) added a conversion feature whereby the $5.0 million loan would convert into equity of Direct Flow Medical upon the occurrence of certain events and (iii) provided for a second $5.0 million convertible loan tranche commitment, to be funded at the option of PDL. The commitment for the second tranche was not funded and has since expired. In addition, (i) PDL agreed to waive the liquidity covenant and delay the timing of the unpaid interest payments until September 30, 2016 and (ii) Direct Flow Medical agreed to issue to PDL a specified amount of warrants to purchase shares of convertible preferred stock on the first day of each month for the duration of the waiver period at an exercise price of $0.01 per share. At June 30, 2016, we determined an estimated fair value of the warrants of $0.7 million .

On July 15, 2016, PDL and Direct Flow Medical entered into the Fifth Amendment and Limited Waiver to the Credit Agreement. PDL funded an additional $1.5 million to Direct Flow Medical in the form of a note with substantially the same interest and payment terms as the existing loans and a conversion feature whereby the $1.5 million loan would convert into

28



equity of Direct Flow Medical upon the occurrence of certain events. In addition, Direct Flow Medical agreed to issue to PDL warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.

The Company completed an impairment analysis as of June 30, 2016. Effective as of this date and as a result of the waived defaults, we determined the loan to be impaired and we ceased to accrue interest revenue. As of June 30, 2016, the estimated fair value of the collateral was determined to be in excess of the carrying value. In the event the Company was to foreclose on the collateral, there can be no assurance as to the accuracy of the estimated fair value of the collateral, nor can there be any assurance of realizing value from such collateral.

Paradigm Spine Credit Agreement

On February 14, 2014, the Company entered into the Paradigm Spine Credit Agreement, 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. The second and third tranches of up to an additional $25.0 million in the aggregate, net of fees, are no longer available under the terms of the Paradigm Spine Credit Agreement.

On October 27, 2015, PDL and Paradigm Spine entered into an amendment to the Paradigm Spine Credit Agreement to provide additional term loan commitments of up to $7.0 million payable in two tranches of $4.0 million and $3.0 million , of which the first tranche was drawn on the closing date of the amendment, net of fees. Paradigm Spine chose not to draw down the second tranche of $3.0 million and such tranche is no longer available.

Borrowings under the credit agreement bear interest at the rate of 13.0% per annum, payable quarterly in arrears.

Under the terms of the Paradigm Spine Credit Agreement, principal repayment will commence on the 12th 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 mature on February 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 Paradigm Spine 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 the kaléo Revenue Interests and 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 kaléo Revenue Interests exceed the quarterly interest payment, as limited by a quarterly payment cap. The final maturity of the secured notes is June 2029. kaléo may redeem the secured notes at any time, subject to a redemption premium.

As of June 30, 2016 , 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.

On October 28, 2015, Sanofi US initiated a voluntary nationwide recall of all Auvi-Q ® units effectively immediately. Sanofi is the exclusive licensee of kaléo for the manufacturing and commercialization of Auvi-Q. While Sanofi has not identified the reason for the recall, press reports indicate that a small number of units have failed to activate or delivered inadequate doses of epinephrine. Subsequent to the recall, kaléo made a full and timely payment of $9.5 million , which included all principal and interest due in the fourth quarter of 2015.

On February 18, 2016, PDL was advised that Sanofi and kaléo would terminate their license and development agreement at a future date. On March 31, 2016, PDL was informed by kaléo that the license and development agreement was terminated and that all U.S. and Canadian commercial and manufacturing rights to Auvi-Q ® and Allerject ® had been returned to kaléo. All manufacturing equipment had also been returned to kaléo, and kaléo is evaluating the timing and options for bringing Auvi-Q

29



and Allerject back to the market. As part of our financing transaction, kaléo was required to establish an interest reserve account of $20.0 million from the $150.0 million provided by PDL. The purpose of this interest reserve account is to cover any possible shortfalls in interest payments owed to PDL. While the interest reserve account was depleted in the second quarter of 2016, kaléo continues to make interest payments due to PDL under the note purchase agreement and we expect that kaléo will fund future interest payments with existing cash until Auvi-Q is returned to the market.

PDL will monitor the timing and options for bringing Auvi-Q back to the market and how it may impact the ability of kaléo to meet its obligations under the note purchase agreement, but as of June 30, 2016 , it has been determined that there is no impairment.

CareView Credit Agreement

On June 26, 2015, PDL entered into a credit agreement with CareView, under which the Company made available to CareView up to $40.0 million in two tranches of $20.0 million each. Under the terms of the credit agreement, the first tranche of $20.0 million was to be funded by the Company upon CareView’s attainment of a specified milestone relating to the placement of CareView Systems ® , to be accomplished no later than October 31, 2015. The Company expects to fund CareView an additional $20.0 million upon CareView’s attainment of specified milestones relating to the placement of CareView Systems and Consolidated EBITDA (as defined in the credit agreement), to be accomplished no later than June 30, 2017. Outstanding borrowings under the credit agreement will bear interest at the rate of 13.5% per annum and are payable quarterly in arrears.

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

On October 7, 2015, PDL and CareView entered into an amendment of the credit agreement to modify certain definitions related to the first and second tranche milestones. On this date, PDL also funded the first tranche of $20.0 million , net of fees, upon attainment of the modified first tranche milestone relating to the placement of CareView Systems. The additional $20.0 million in the form of a second tranche continues to be available upon CareView’s attainment of specified milestones relating to the placement of CareView Systems and Consolidated EBITDA, to be accomplished no later than June 30, 2017 under the terms of the amended credit agreement.

In connection with the amendment of the credit agreement, PDL and CareView also agreed to amend the warrant to purchase common stock agreement by reducing the warrant's exercise price from $0.45 to $0.40 per share. At June 30, 2016 , we determined an estimated fair value of the warrant of $0.3 million .

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

7. Accrued Liabilities

Accrued liabilities consist of the following:

 
 
June 30,
2016
 
December 31,
2015
(In thousands)
 
 
 
 
Compensation
 
$
3,861

 
$
1,979

Interest
 
4,107

 
4,107

Deferred revenue
 
1,118

 
87

Dividend payable
 
168

 
184

Legal
 
1,423

 
730

Other
 
1,061

 
922

Total
 
$
11,738

 
$
8,009



30



8. Commitments and Contingencies

PDL BioPharma, Inc. v Merck Sharp & Dohme, Corp.

On October 28, 2015, the Company filed a Complaint against Merck Sharp & Dohme, Corp (“Merck”) for patent infringement in the United States District Court for the District of Nevada. In the Complaint, the Company alleges that manufacture and sales of certain of Merck’s Keytruda product infringes one or more claims of the Company’s '761 Patent. The Company has requested judgment that Merck has infringed the '761 Patent, an award of damages due to the infringement, a finding that such infringement was willful and deliberate and trebling of damages therefore, and a declaration that the case is exceptional and warrants an award of attorney’s fees and costs. Although the '761 Patent expired on December 2, 2014, the Company believes that Merck infringed the patent through, e.g., manufacture and/or sale of Keytruda prior to the expiration of the '761 Patent. On December 21, 2015, Merck filed a Motion to Dismiss for Lack of Personal Jurisdiction. In response to Merck’s motion, on January 22, 2016, rather than dispute Merck’s contentions regarding jurisdiction, the Company elected to dismiss the action in Nevada and refile the Complaint in its entirety in the District of New Jersey. On May 25, 2016, Merck filed a Motion to Bifurcate Discovery and Trial into Liability and Damages Phases. The Company filed an opposition to Merck’s motion. The court has not yet ruled on the motion.

Wellstat Litigation

On September 4, 2015, PDL filed in the Supreme Court of New York a motion for summary judgment in lieu of complaint
which requested that the court enter judgment against Wellstat Diagnostics Guarantors for the total amount due on the Wellstat Diagnostics debt, plus all costs and expenses including lawyers’ fees incurred by the Company in enforcement of the related guarantees. On September 23, 2015, PDL filed in the same court an ex parte application for a temporary restraining order and order of attachment of the Wellstat Diagnostics Guarantors' assets. At a hearing on September 24, 2015, regarding the Company’s request for a temporary restraining order, the court ordered that the Company’s request for attachment and for summary judgment would be heard at a hearing on November 5, 2015. Although the court denied the Company’s request for a temporary restraining order at the hearing on September 24, 2015, it ordered that assets of the Wellstat Diagnostics Guarantors should be held in status quo ante and only used in the normal course of business pending the outcome of the matters under consideration at the hearing. On July 29, 2016, the court issued its Memorandum of Decision granting the Company’s motion for summary judgment and denying the Wellstat Diagnostics Guarantors’ cross-motion for summary judgment. The Supreme Court of New York held that the Wellstat Diagnostics Guarantors are liable for all “Obligations” owed by Wellstat Diagnostics to the Company. It did not set a specific dollar amount due, but ordered that a judicial hearing officer or special referee be designated to determine the amount of the Obligations owing, and awarded the Company its attorneys’ fees and costs in an amount to be determined. The Supreme Court of New York has also set a hearing on August 23, 2016 to consider the implication of the status quo ante instruction on certain actions of the Wellstat Diagnostics Guarantors and whether to issue a writ of attachment. On July 29, 2016, the Wellstat Diagnostics Guarantors filed a notice of appeal from the Memorandum of Decision. This appeal does not stay the Supreme Court of New York from entering a money judgment for the balance owing based on the decision of the judicial hearing officer or special referee to be designated to determine the amount of the Obligations owing pursuant to the Memorandum of Decision.

On October 22, 2015, the Wellstat Diagnostics Guarantors filed a complaint against the Company in the Supreme Court of New York seeking a declaratory judgment that certain contractual arrangements entered into between the parties subsequent to Wellstat Diagnostics’ default, and which relate to a split of proceeds in the event that the Wellstat Diagnostics Guarantors voluntarily monetize any assets that are the Company’s collateral, is of no force or effect.

Other Legal Proceedings

From time to time, we are involved in lawsuits, arbitrations, claims, investigations and proceedings, consisting of intellectual property, commercial, employment and other matters, which arise in the ordinary course of business. We make provisions for liabilities when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Such provisions are reviewed at least quarterly and adjusted to reflect the impact of settlement negotiations, judicial and administrative rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. If any unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of our operations of that period and on our cash flows and liquidity.

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

31



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 June 30, 2016 , the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $62.0 million . In April 2010, Abbott Laboratories acquired Facet and later renamed the entity AbbVie. If AbbVie 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 June 30, 2016 , and December 31, 2015 , related to this guarantee. In future periods, we may adjust this liability for any changes in the ultimate outcome of this matter that are both probable and estimable.

9. Convertible Notes and Term Loans
  
 
 
 
 
Principal Balance Outstanding
 
Carrying Value
 
 
 
 
 
June 30,
 
June 30,
 
December 31,
 
Description
 
Maturity Date
 
2016
 
2016
 
2015
 
(In thousands)
 
 
 
 
 
 
 
 
 
Convertible Notes
 
 
 
 
 
 
 
 
 
February 2018 Notes
 
February 1, 2018
 
$
246,447

 
$
232,847

 
$
228,862

 
March 2015 Term Loan
 
February 15, 2016
 
$

 

 
24,966

 
Total
 
 
 
 

 
$
232,847

 
$
253,828

 


Series 2012 Notes

In January 2012, we issued and exchanged $169.0 million aggregate principal of Series 2012 Notes for an identical principal amount of the February 2015 Notes, plus a cash payment of $5.00 for each $1,000 principal amount tendered, totaling approximately $845,000 . The cash 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 were 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 issued and exchanged an additional $10.0 million aggregate principal amount of the Series 2012 Notes for an identical principal amount of the 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 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 Series 2012 Notes. Immediately following the exchange, no principal amount of the February 2015 Notes remained outstanding and $180.0 million principal amount of the Series 2012 Notes is outstanding.

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 Series 2012 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 de-recognition 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 that was amortized over the remaining life of the Series 2012 Notes.

On October 20, 2014, the Company entered into a privately negotiated exchange agreement under which it retired approximately $26.0 million in principal of the outstanding Series 2012 Notes. The exchange agreement provided for the

32



issuance, by the Company, of shares of common stock and a cash payment for the Series 2012 Notes being exchanged. The Company issued approximately 1.8 million shares of its common stock and paid a cash payment of approximately $26.2 million . Immediately following the exchange, $22.3 million principal amount of the Series 2012 Notes was outstanding with approximately $0.1 million of remaining original issuance discount to be amortized over the remaining life of the Series 2012 Notes.

The Series 2012 Notes were due February 17, 2015, and bore interest at a rate of 2.875% per annum, payable semi-annually in arrears on February 15 and August 15 of each year. On February 17, 2015, the Company completed the retirement of the remaining $22.3 million of aggregate principal of its Series 2012 notes at their stated maturity for $22.3 million , plus approximately 1.34 million shares of its common stock.

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

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Contractual coupon interest
 
$

 
$