PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-Q, Received: 11/03/2016 17:27:14)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
  (Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 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-LOGOA05A01A01A01A05.JPG
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 October 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
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
FINANCIAL STATEMENTS (unaudited)
 
 
 
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2016 and 2015
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2016 and 2015
 
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2016, and December 31, 2015
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 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 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
 
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
 
 
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



PART I. FINANCIAL INFORMATION
 
ITEM  1.         FINANCIAL STATEMENTS
 
PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Revenues
 
 
 
 
 
 
 
 
Royalties from Queen et al. patents
 
$
14,958

 
$
119,222

 
$
150,645

 
$
363,916

Royalty rights - change in fair value
 
16,085

 
(4,280
)
 
(11,872
)
 
19,298

Interest revenue
 
8,594

 
9,096

 
24,901

 
28,596

Product revenue, net
 
14,128

 

 
14,128

 

License and other
 
(127
)
 
580

 
7

 
580

Total revenues
 
53,638

 
124,618

 
177,809

 
412,390

 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 

 
 

Amortization of intangible assets
 
6,014

 

 
6,014

 

General and administrative
 
10,396

 
8,450

 
27,193

 
23,545

Sales and marketing
 
11

 

 
11

 

Research and development
 
1,933

 

 
1,933

 

Change in fair value of anniversary payment and contingent consideration
 
2,083

 

 
2,083

 

Acquisition-related costs
 
546

 

 
3,505

 

Total operating expenses
 
20,983

 
8,450

 
40,739

 
23,545

Operating income
 
32,655

 
116,168

 
137,070

 
388,845

 
 
 
 
 
 
 
 
 
Non-operating expense, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
162

 
87

 
404

 
294

Interest expense
 
(4,513
)
 
(5,901
)
 
(13,524
)
 
(21,710
)
Total non-operating expense, net
 
(4,351
)
 
(5,814
)
 
(13,120
)
 
(21,416
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
28,304

 
110,354

 
123,950

 
367,429

Income tax expense
 
14,400

 
40,895

 
50,011

 
135,208

Net income
 
13,904

 
69,459

 
73,939

 
232,221

Net loss attributable to noncontrolling interests
 
3

 

 
3

 

Net income attributable to PDL's shareholders
 
$
13,907

 
$
69,459

 
$
73,942

 
$
232,221

 
 
 
 
 
 
 
 
 
Net income per share
 
 

 
 

 
 

 
 

Basic
 
$
0.08

 
$
0.42

 
$
0.45

 
$
1.42

Diluted
 
$
0.08

 
$
0.42

 
$
0.45

 
$
1.42

Weighted average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
163,856

 
163,560

 
163,771

 
163,314

Diluted
 
164,285

 
163,742

 
164,075

 
163,899

 
 
 
 
 
 
 
 
 
Cash dividends declared per common share
 
$

 
$

 
$
0.10

 
$
0.60

 
See accompanying notes.

3



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

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Net income
 
$
13,904

 
$
69,459

 
$
73,939

 
$
232,221

 
 
 
 
 
 
 
 
 
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
 

 
634

 
122

 
445

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

 
(406
)
 
(557
)
 
(406
)
Total change in unrealized gains on investments in available-for-sale securities, net of tax (a)
 

 
228

 
(435
)
 
39

Change in unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedges, net of tax
 

 
(57
)
 

 
4,306

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

 
(1,495
)
 
(1,821
)
 
(3,903
)
Total change in unrealized losses on cash flow hedges, net of tax (b)
 

 
(1,552
)
 
(1,821
)
 
403

Total other comprehensive income (loss), net of tax
 

 
(1,324
)
 
(2,256
)
 
442

Comprehensive income
 
13,904

 
68,135

 
71,683

 
232,663

Comprehensive loss attributable to noncontrolling interests
 
3

 

 
3

 

Comprehensive income attributable to PDL's shareholders
 
$
13,907

 
$
68,135

 
$
71,686

 
$
232,663

 ______________________________________________
(a) Net of tax of zero and $123 for the three months ended September 30, 2016 and 2015 , respectively, and ($234) and $21 for the nine months ended September 30, 2016 and 2015, respectively.
(b) Net of tax of zero and ($836) for the three months ended September 30, 2016 and 2015 , respectively, and ($981) and $217 for the nine months ended September 30, 2016 and 2015, respectively.

See accompanying notes.

4



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
 
 
September 30,
 
December 31,
 
2016
 
2015
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
106,590

 
$
218,883

Short-term investments
7,985

 
1,469

Accounts receivable
26,035

 

Receivables from licensees and other
5,757

 

Deferred tax assets

 
981

Notes receivable
131,123

 
58,398

Investments-other
75,000

 

Inventory
1,593

 

Prepaid and other current assets
973

 
2,979

Total current assets
355,056

 
282,710

Property and equipment, net
16

 
31

Royalty rights - at fair value
399,592

 
399,204

Notes and other receivables, long-term
189,874

 
306,507

Long-term deferred tax assets
24,234

 
16,172

Intangible assets, net
234,556

 

Goodwill
3,735

 

Other assets
9,003

 
7,581

Total assets
$
1,216,066

 
$
1,012,205

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
7,134

 
$
394

Accrued liabilities
9,479

 
7,922

Deferred revenue
11,608

 
87

Accrued income taxes
5,793

 
3,372

Term loan payable

 
24,966

Anniversary payment
87,500

 

Total current liabilities
121,514

 
36,741

Convertible notes payable
234,895

 
228,862

Contingent consideration
48,950

 

Other long-term liabilities
56,851

 
50,650

Total liabilities
462,210

 
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 September 30, 2016, and December 31, 2015, respectively
1,655

 
1,643

Additional paid-in capital
(119,468
)
 
(117,983
)
Accumulated other comprehensive income
3

 
2,256

Retained earnings
867,442

 
810,036

Total PDL's stockholders' equity
749,632

 
695,952

Noncontrolling interests
4,224

 

Total stockholders' equity
753,856

 
695,952

Total liabilities and stockholders' equity
$
1,216,066

 
$
1,012,205

See accompanying notes.

5



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2016
 
2015
Cash flows from operating activities
 
 
 
Net income
$
73,939

 
$
232,221

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

 
 

Amortization of convertible notes and term loan offering costs
6,067

 
9,744

Amortization of intangible assets
6,014

 

Change in fair value of royalty rights - at fair value
11,872

 
(19,298
)
Change in fair value of derivative asset
875

 

Change in fair value of anniversary payment and contingent consideration
2,083

 

Other amortization, depreciation and accretion of embedded derivative
16

 
29

Gain on sale of available-for-sale securities
(881
)
 
(580
)
Stock-based compensation expense
2,649

 
1,348

Deferred income taxes
(6,013
)
 
9,143

Changes in assets and liabilities, net of affects of business acquired:
 

 
 

Accounts receivable
(26,035
)
 

Receivables from licensees and other
(5,757
)
 
(294
)
Prepaid and other current assets
(470
)
 
(4,434
)
Accrued interest on notes receivable
(2,745
)
 
(3,076
)
Inventory
(1,593
)
 

Other assets
30

 
35

Accounts payable
6,740

 
103

Accrued liabilities
1,575

 
(861
)
Deferred revenue
9,194

 
51

Accrued income taxes
2,421

 
(3,293
)
Other long-term liabilities
6,084

 
10,548

Net cash provided by operating activities
86,065

 
231,386

Cash flows from investing activities
 

 
 

Acquisition of a business, net of cash
(109,938
)
 

Purchase of investments
(7,985
)
 

Purchase of investments-other
(75,000
)
 

Proceeds from sales of available-for-sale securities
1,680

 
1,124

Purchase of royalty rights - at fair value
(59,500
)
 
(115,000
)
Proceeds from royalty rights - at fair value
47,240

 
8,970

Purchase of notes receivable
(8,000
)
 
(8,976
)
Repayment of notes receivable
54,653

 
20,600

Purchase of property and equipment

 
(9
)
Net cash used in investing activities
(156,850
)
 
(93,291
)
Cash flows from financing activities
 

 
 

Proceeds from term loan

 
100,000

Repurchase of convertible notes

 
(177,387
)
Payment of debt issuance costs
(325
)
 
(607
)
Repayment of term loan
(25,000
)
 
(50,000
)
Cash received from noncontrolling interest holder
250

 

Cash dividends paid
(16,433
)
 
(73,623
)
Net cash used in financing activities
(41,508
)
 
(201,617
)
Net decrease in cash and cash equivalents
(112,293
)
 
(63,522
)
Cash and cash equivalents at beginning of the period
218,883

 
291,377

Cash and cash equivalents at end of period
$
106,590

 
$
227,855

 
 
 
 
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
50,000

 
$
125,000

Cash paid for interest
$
9,930

 
$
16,045

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

 
$
9,794

Warrants received for notes receivable
$
2,342

 
$
(1,258
)
Accrued Anniversary Payment associated with the acquisition of a business
$
87,007

 
$

Accrued contingent consideration associated with the acquisition of a business
$
47,360

 
$

See accompanying notes.

6



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

1. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited Condensed Consolidated Financial Statements of PDL Biopharma, Inc. and its subsidiaries (collectively, the "Company" or "PDL") have been prepared in accordance with Generally Accepted Accounting Principles (United States) ("GAAP") for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments), that management of the Company 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 the Company's audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2015 , included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2015, filed with the Securities and Exchange Commission ("SEC") on February 23, 2016. 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. The accompanying unaudited Condensed Consolidated Financial Statements are prepared in accordance with GAAP and the rules and regulations of the SEC.

A subsidiary is an entity in which the Company, directly or indirectly, controls more than one half of the voting power; has the power to appoint or remove the majority of the members of the board of directors; to cast a majority of votes at the meeting of the board of directors or to govern the financial and operating policies of the investee under a statute or agreement among the shareholders or equity holders.

The Company applies the guidance codified in Accounting Standard Codification ("ASC") 810, Consolidations , which requires certain variable interest entities to be consolidated by the primary beneficiary of the entity in which it has a controlling financial interest. The Company identifies an entity as a variable interest entity if either: (1) the entity does not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the entity's equity investors lack the essential characteristics of a controlling financial interest. The Company performs ongoing qualitative assessments of its variable interest entities to determine whether the Company has a controlling financial interest in any variable interest entity and therefore is the primary beneficiary, and if it has the power to direct activities that impact the activities of the entity.

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.

Product Revenue

General
The Company recognizes revenue from the sale of its products when delivery has occurred, title has transferred, the selling price is fixed or determinable, collectability is reasonably assured and the Company has no further performance obligations. Revenues from Tekturna ® , Tekturna HCT ® , Rasilez ® and Rasilez HCT ® sales are recorded net of estimated chargebacks, rebates, discounts, and other deductions and returns in the same period the related sales are recorded.


7



For the period to September 30, 2016, all of the Company's products were distributed by Novartis under the terms of the Noden Purchase Agreement with Novartis as transfer of the marketing right authorizations was pending. The Company recorded revenue under the Novartis transition arrangement on a net basis and established a reserve for allowances.

Provisions
Discounts granted are based on the terms of arrangements with direct, indirect and other market participants, as well as market conditions, including prices charged by competitors. Rebates, which include third-party managed care, Medicare Part D rebates, Medicaid rebates and other government rebates, are estimated based on contractual terms, historical experience, patient outcomes, trend analysis and projected market conditions in the various markets served. The Company evaluates market conditions for products or groups of products primarily through the analysis of wholesaler and other third-party sell-through and market research data, as well as internally generated information.

Returns are generally estimated and recorded based on historical sales and returns information. Products that exhibit unusual sales or return patterns due to dating, competition or other marketing matters are specifically investigated and analyzed as part of the accounting for sales returns accruals.

Chargebacks represents an amount payable in the future to a wholesaler for the difference between the invoice price paid by our wholesale customer for a particular product and the negotiated contract price that the wholesaler’s customer pays for that product. The chargeback provision and related reserve varies with changes in product mix, changes in customer pricing and changes to estimated wholesaler inventories.

Royalty Rights - At Fair Value

Currently, the Company accounts for its 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 the Company’s 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 in each reporting period are presented together on the Company’s Condensed Consolidated Statements of Income as a component of revenue under the caption, “Royalty rights - change in fair value.”

Realized gains and losses on Royalty Rights are recognized as they are earned and when collection is reasonably assured. Royalty Rights revenue is recognized over the respective contractual arrangement period. Critical estimates may include product demand and market growth assumptions, inventory target levels, product approval and pricing assumptions. Factors that could cause a change in estimates of future cash flows include a change in estimated market size, a change in pricing strategy or reimbursement coverage, a delay in obtaining regulatory approval, a change in dosage of the product, and a change in the number of treatments. For each arrangement, the Company is entitled to royalty payments based on revenue generated by the net sales of the product.

Notes Receivable and Other Long-Term Receivables

The Company accounts for its notes receivable at both amortized cost, net of unamortized origination fees, if any, and as dependent on collateral repayment of the loan 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.

The Company evaluates 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, the Company determines it is probable that it 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 the Company expects 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.


8



The Company records interest on an accrual basis and recognizes it as earned in accordance with the contractual terms of the credit agreement, to the extent that such amounts are expected to be collected. When a note receivable or loan becomes past due, or if management otherwise does not expect that principal, interest, and other obligations due will be collected in full, the Company will generally place the note receivable or loan on non-accrual status and cease recognizing interest income on that note receivable or loan until all principal and interest due has been paid or until such time that the Company believes the borrower has demonstrated the ability to repay its current and future contractual obligations. Any uncollected interest related to prior periods is reversed from income in the period that collection of the interest receivable is determined to be doubtful. However, the Company may make exceptions to this policy if the investment has sufficient collateral value and is in the process of collection.

At September 30, 2016, the Company had four notes receivable investments on non-accrual status with a cumulative investment cost and fair value of approximately $155.4 million and $160.3 million , compared to three note receivable investments on non-accrual at December 31, 2015 with a cumulative investment cost and fair value of approximately $103.2 million and $109.2 million . During the period ended September 30, 2016 and 2015, the Company recognized no loss on extinguishment of notes receivable. For the periods ended September 30, 2016 and 2015, the Company did not recognize any interest for note receivable investments on non-accrual status.

Queen et al. Royalty Revenues

Under the Company's license agreements related to patents covering the humanization of antibodies, which it refers to as the Queen et al. patents, the Company receives royalty payments based upon its licensees’ net sales of covered products. Generally, under these agreements, the Company receives royalty reports from its 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. The Company recognizes royalty revenues when it can reliably estimate such amounts and collectability is reasonably assured. Under this accounting policy, the royalty revenues the Company reports are not based upon estimates, and such royalty revenues are typically reported in the same period in which the Company receives payment from its licensees.

Although the last of the Queen et al. patents expired in December 2014, the Company has received royalties beyond expiration based on the terms of its licenses and its legal settlement. Under the terms of the legal settlement between Genentech, Inc. ("Genentech") and the Company, the first quarter of 2016 was the last period for which Genentech paid royalties to the Company for Avastin, Herceptin, Xolair, Kadcyla and Perjeta. Other products from the Queen et al. patent licenses, such as Tysabri, entitle the Company to royalties following the expiration of its patents with respect to sales of licensed product manufactured prior to patent expiry in jurisdictions providing patent protection licenses. The amount of royalties the Company is due for products manufactured prior to 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.

9




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

 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Licensee
 
Product Name
 
2016
 
2015
 
2016
 
2015
Genentech
 
Avastin
 
%
 
32
%
 
22
%
 
28
%
 
 
Herceptin
 
%
 
32
%
 
22
%
 
28
%
 
 
Xolair
 
%
 
10
%
 
7
%
 
8
%
 
 
 
 
 
 
 
 
 
 
 
Biogen
 
Tysabri ®
 
28
%
 
11
%
 
24
%
 
10
%
 
 
 
 
 
 
 
 
 
 
 
Depomed
 
Glumetza, Janumet, Jentadueto XT and
Invokamet XR
 
18
%
 
N/M

 
N/M

 
2
%
 
 
 
 
 
 
 
 
 
 
 
Novartis/
Noden
 
Tekturna, Tekturna HCT, Rasilez and Rasilez HCT
 
26
%
 
%
 
8
%
 
%
____________________
N/M = Not meaningful

The concentration of credit risk relating to Tekturna, Tekturna HCT, Rasilez and Rasilez HCT accounts receivable is not significant as of September 30, 2016.

Business Combination

The Company applies ASC 805, Business combinations , pursuant to which the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any noncontrolling interests. The excess of the (i) the total of cost of acquisition, fair value of the noncontrolling interests and acquisition date fair value of any previously held equity interest in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the Condensed Consolidated Statements of Income and Comprehensive income.

The determination and allocation of fair values to the identifiable assets acquired and liabilities assumed is based on various assumptions and valuation methodologies requiring considerable management judgment. The most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. Management determines discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of products and forecasted life cycle and forecasted cash flows over that period. Although management believes that the assumptions applied in the determination are reasonable based on information available at the date of acquisition, actual results may differ from the forecasted amounts and the difference could be material.

Investments
 
The Company's investments include held to maturity investments, available-for-sale investments, equity method investments and cost method investments in certain publicly traded companies and privately-held companies.

On July 1, 2016, Noden Pharma DAC, entered into an asset purchase agreement ("Noden Purchase Agreement") where by it purchased from Novartis Pharma AG ("Novartis") the exclusive worldwide rights to manufacture, market, and sell the branded prescription medicine product sold under the name Tekturna ® and Tekturna HCT ® in the United States and Rasilez ® and Rasilez HCT ® in the rest of the world (collectively the "Noden Products") and certain related assets and assumed certain related

10



liabilities (the "Noden Transaction"). Upon the consummation of the Noden Transaction, a noncontrolling interest holder acquired a 6% equity interest in Noden Pharma DAC and Noden Pharma USA Inc. (collectively "Noden"). The equity interest of the noncontrolling interest holder is subject to vesting and repurchase rights over a four year period. At September 30, 2016, 80% of the noncontrolling interest was subject to repurchase. The Company determined that Noden shall be consolidated under the voting interest model as of September 30, 2016. For a complete discussion of the Noden Transaction, see Note 15.

Inventory

Inventory, which consists of finished goods, is stated at the lower of cost or market value. The Company determines cost using the first-in, first-out method. Inventory levels are analyzed periodically and written down to their net realizable value if they have become obsolete, have a cost basis in excess of its expected net realizable value or are in excess of expected requirements. There were no write downs related to obsolete inventory recorded for each of the three and nine months ended September 30, 2016 and 2015.

Convertible Notes

The Company issued its 2.875% Convertible Senior Notes due February 17, 2015 ("Series 2012 Notes"), 3.75% Convertible Senior Notes due May 1, 2015 ("May 2015 Notes") and 4.0% Convertible Senior Notes due February 1, 2018 ("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 the Company’s common stock. In accordance with accounting guidance for convertible debt instruments that may be settled in cash or other assets upon conversion, the Company 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. For a complete discussion of the Company’s convertible notes, see Note 9.

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

The Company hedged certain Euro-denominated currency exposures related to royalties associated with its licensees’ product sales with Euro forward contracts. In general, those contracts are intended to offset the underlying Euro market risk in the Company’s royalty revenues. The last of those contracts expired in the fourth quarter of 2015 and was settled in the first quarter of 2016. The Company 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 these hedge contracts is reported in "Interest and other income, net" in the period the ineffectiveness occurs.

Foreign Currency Translation

The Company uses the U.S. dollar predominately as the functional currency of its foreign subsidiaries. For foreign subsidiaries where the U.S. dollar is the functional currency, gains and losses from remeasurement of foreign currency balances into U.S. dollars are included in the Condensed Consolidated Statements of Income. The aggregate net gains (losses) resulting from foreign currency transactions and remeasurement of foreign currency balances into U.S. dollars that were included in the Condensed Consolidated Statements of Income was insignificant for the three and nine month periods ended September 30, 2016 and 2015.

Segment Reporting

Under ASC 280, Segment Reporting , operating segments are defined as components of an enterprise about which separate financial information is available that is regularly evaluated by the entity’s chief operating decision maker, in deciding how to allocate resources and in assessing performance. The Company has evaluated its operating segments in accordance with ASC 280, and has identified  two  reportable segments: income generating assets and product sales at September 30, 2016.


11



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.

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 investments in available-for-sale securities, all net of tax, which are excluded from the Company's net income.

Adopted Accounting Pronouncements

In April 2015, the Financial Accounting Standard Board ("FASB") issued Accounting Standards Update ("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 September 30, 2016, long-term debt included a contra liability of $2.6 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.


12



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.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments . The new standard provides for specific guidance how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years, and interim periods with those years, beginning after December 15, 2017. Early adoption is permitted. The Company is currently evaluating ASU 2016-15 and assessing the impact, if any, it may have to the Company's consolidated statement of cash flows.

2. Net Income per Share
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
Net Income per Basic and Diluted Share:
 
2016
 
2015
 
2016
 
2015
  (in thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
Income attributable to PDL's shareholders used to compute net income per basic and diluted share
 
$
13,907

 
$
69,459

 
$
73,942

 
$
232,221

 
 
 
 
 
 
 
 
 
Denominator
 
 

 
 

 
 
 
 
Total weighted average shares used to compute net income attributable to PDL's shareholders, per basic share
 
163,856

 
163,560

 
163,771

 
163,314

Restricted stock outstanding
 
429

 
167

 
304

 
131

Effect of dilutive stock options
 

 
15

 

 
18

Assumed conversion of Series 2012 Notes
 

 

 

 
33

Assumed conversion of warrants
 

 

 

 
403

Shares used to compute net income attributable to PDL's shareholders, per diluted share
 
164,285

 
163,742

 
164,075

 
163,899

 
 
 
 
 
 
 
 
 
Net income attributable to PDL's shareholders per share - basic
 
$
0.08

 
$
0.42

 
$
0.45

 
$
1.42

Net income attributable to PDL's shareholders per share - diluted
 
$
0.08

 
$
0.42

 
$
0.45

 
$
1.42


The Company computes 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 pursuant to outstanding stock options and restricted stock awards, the Series 2012 Notes and the May 2015 Notes, in each case, 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 2.875% Convertible Senior Notes due February 15, 2015 ("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

13



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 retired the remaining $22.3 million of aggregate principal of its Series 2012 Notes.

In May 2011, the Company issued the May 2015 Notes, and in January and February 2012, the Company 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 shares of the Company's common stock. The weighted-average share adjustments related to the Series 2012 Notes and May 2015 Notes, as shown in the table above, include the shares issuable in respect of such excess.

In the second quarter of 2015, the Company retired the remaining $155.1 million of aggregate principal of its May 2015 Notes. Concurrently with the retirement of the May 2015 Notes, the Company exercised its purchased call options and received 5.2 million shares of the Company's common stock from the hedge counterparties, which was the number of shares required to be delivered by the Company to the note holders for the excess conversion value.

February 2018 Notes Purchased Call Option and Warrant Potential Dilution

The Company excluded 23.8 million shares from the calculation of net income per diluted share for each of the three and nine months ended September 30, 2016 , and 29.0 million shares for each of the three and nine months ended September 30, 2015 , for warrants issued in February 2014, because the exercise price of the warrants exceeded the volume-weighted average share price ("VWAP") of the Company's common stock and conversion of the underlying February 2018 Notes is not assumed, therefore no stock would be issuable upon conversion; however, these securities could be dilutive in future periods. The purchased call options, issued in February 2014, will always be anti-dilutive; therefore 26.9 million shares were excluded from the calculation of net income per diluted share for each of the three and nine months ended September 30, 2016 , and 32.7 million shares were excluded from the calculation of net income per diluted share for each of the three and nine months ended September 30, 2015 . For information related to the conversion rates on the Company's convertible debt, see Note 9.

Anti-Dilutive Effect of Stock Options and Restricted Stock Awards

For the three months ended September 30, 2016 and 2015 , the Company excluded approximately 1,247,000 and 475,000 shares underlying restricted stock awards, respectively, and for the nine months ended September 30, 2016 and 2015 , the Company excluded approximately 1,146,000 and 437,000 shares underlying restricted stock awards, respectively, calculated on a weighted average basis, from its net income per diluted share calculations because their effect was anti-dilutive.

  3. Fair Value Measurements

The fair value of the Company's financial instruments are estimates of the amounts that would be received if the Company 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.


14



The following tables present the fair value of the Company's financial instruments measured at fair value on a recurring basis by level within the valuation hierarchy.
 
 
September 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
 
$
190

 
$

 
$

 
$
190

 
$
94,801

 
$

 
$

 
$
94,801

Certificates of deposit
 

 
75,000

 

 
75,000

 

 

 

 

Commercial paper
 

 
17,981

 

 
17,981

 

 

 

 

Corporate securities
 

 

 

 

 

 
1,469

 

 
1,469

Foreign currency hedge contracts
 

 

 

 

 

 
2,802

 

 
2,802

Warrants
 

 
211

 
1,070

 
1,281

 

 
984

 

 
984

Royalty rights - at fair value
 

 

 
399,592

 
399,592

 

 

 
399,204

 
399,204

Total
 
$
190

 
$
93,192

 
$
400,662

 
$
494,044

 
$
94,801

 
$
5,255

 
$
399,204

 
$
499,260

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 

Anniversary payment
 
$

 
$

 
$
87,500

 
$
87,500

 
$

 
$

 
$

 
$

Contingent consideration
 

 

 
48,950

 
48,950

 

 

 

 

Total
 
$

 
$

 
$
136,450

 
$
136,450

 
$

 
$

 
$

 
$

 
As of September 30, 2016, the Company 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. There have been no transfers between levels during each of the three or nine-month periods ended September 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.

The following table represents significant unobservable inputs used in determining the estimated fair value of impaired notes receivable investments:
Asset
 
Valuation
Technique
 
Unobservable
Input
 
September 30,
2016
 
December 31,
2015
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics
 
 
 
 
 
 
 
 
Intellectual Property
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
13%
 
13%
 
 
 
 
Royalty amount
 
$55-74 million
 
$54-74 million
Real Estate Property
 
Market Approach
 
 
 
 
 
 
 
 
 
 
Annual appreciation rate
 
4%
 
4%
 
 
 
 
Estimated realtor fee
 
6%
 
6%
 
 
 
 
Estimated disposal date
 
12/31/2017
 
12/31/2017
Direct Flow Medical
 
 
 
 
 
 
 
 
All Assets
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
27%
 
27%
 
 
 
 
Implied revenue multiple
 
6.9
 
6.9
LENSAR
 
 
 
 
 
 
 
 
All Assets
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
15.5%
 
15.75%
 
 
 
 
Implied revenue multiple
 
3.0
 
-


15



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.

Royalty Rights - At Fair Value

Depomed Royalty Agreement

On October 18, 2013, the Company entered into the Royalty Purchase and Sale Agreement (the "Depomed Royalty Agreement") with Depomed, Inc. and Depo DR Sub, LLC (together, "Depomed"), 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 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, Inc. ("Santarus") (which was subsequently acquired by Salix Pharmaceuticals, Inc. ("Salix), which itself was acquired by Valeant Pharmaceuticals International, Inc. ("Valeant")) with respect to sales of Glumetza (metformin HCL extended-release tablets) in the United States; (b) from Merck & Co., Inc. 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 recently approved fixed-dose combination of Invokana ® (canagliflozin) and extended-release metformin tablets, marketed as Invokamet XR ® ; (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, including its recently approved product, Jentadueto XR ® ; and (e) from LG Life Sciences and Valeant 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 September 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 the Company's valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future commercialization for products not yet approved by the U.S. Food and Drug Administration ("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 September 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 $6.2 million or increase by $7.0 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. The Company periodically assesses the expected future cash flows and to the extent such payments are greater or less than its initial estimates, or the timing of such payments is materially different than the original estimates, the Company

16



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 $3.3 million or decrease by $3.3 million, respectively.

When the Company 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 and 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 the Company's lack of direct access to information as to the levels of inventory of Glumetza in the distribution channels, the Company commenced a review of all public statements by Salix, publicly available historical third-party prescription data, analyst reports and other relevant data sources. The Company also engaged a third-party expert to specifically assess estimated inventory levels of Glumetza in the distribution channel and to ascertain the potential effects those inventory levels may have on expected future cash flows. Salix was acquired by Valeant in early April 2015. In mid-2015, Valeant implemented two price increases on Glumetza. At year-end 2015, a third-party expert was engaged by the Company 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. The Company's 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 its market share decreased more rapidly than forecasted at year-end 2015. At the end of the third 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 September 30, 2016.

As of September 30, 2016 , the Company's discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date. The Company continues to monitor whether the generic competition further affects sales of Glumetza and thus royalties on such sales paid to the Company. 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, the Company 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. In January 2016, the Company exercised its audit right under the Depomed Royalty Agreement with respect to the Glumetza royalties. The information initially provided by Valeant to the independent auditors engaged to perform the royalty audit was substantially incomplete, and the Company has since identified the information necessary to complete the audit to Valeant and is awaiting the provision of the necessary and missing information.

On May 31, 2016, the Company obtained a notification indicating that the FDA approved Jentadueto XR for use in patients with Type 2 diabetes. In June 2016, the Company 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, the Company adjusted the timing of future cash flows and discount rate used in the discounted cash flow model at June 30, 2016.

On September 21, 2016, the Company obtained a notification indicating that the FDA approved Invokamet XR for use in patients with Type 2 diabetes. The product approval triggered a $5.0 million approval milestone. Based on the FDA approval and expected product launch, the Company adjusted the timing of future cash flows and discount rate used in the discounted cash flow model at September 30, 2016.

As of September 30, 2016 , the fair value of the asset acquired as reported in the Company's Condensed Consolidated Balance Sheet was $134.3 million and the maximum loss exposure was $134.3 million .

VB Royalty Agreement

On June 26, 2014, the Company entered into a Royalty Purchase and Sale Agreement (the "VB Royalty Agreement") with Viscogliosi Brothers, LLC ("VB"), 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 2.3 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

17



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 September 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 the Company's 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 the Company's 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 September 30, 2016 , the fair value of the asset acquired as reported in the Company's Condensed Consolidated Balance Sheet was $14.8 million and the maximum loss exposure was $14.8 million .

U-M Royalty Agreement

On November 6, 2014, the Company acquired a portion of all royalty payments of the Regents of the University of Michigan's ("U-M") worldwide royalty interest in Cerdelga (eliglustat) for $65.6 million pursuant to the Royalty Purchase and Sale Agreement with U-M (the "U-M Royalty Agreement"). Under the terms of the U-M Royalty Agreement, the Company will receive 75% of all royalty payments due under U-M’s license agreement with Genzyme Corporation, a Sanofi company ("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. 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 the Company 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 September 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 the Company's 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 $4.8 million or increase by $5.4 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 the Company's 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 September 30, 2016 , the fair value of the asset acquired as reported in the Company's Condensed Consolidated Balance Sheet was $64.6 million and the maximum loss exposure was $64.6 million .

ARIAD Royalty Agreement

On July 28, 2015, the Company entered into the revenue interest assignment agreement (the "ARIAD Royalty Agreement") with ARIAD Pharmaceuticals, Inc. ("ARIAD"), 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 was payable in two tranches of $50.0 million each, with the first tranche having been funded on July 28, 2015 and the second tranche having been funded on July 28, 2016. Prior to an amendment as discussed below, 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, the Company has the right to require ARIAD to repurchase the

18



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. The Company 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, the Company 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 Corporation ("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 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 September 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 the Company's 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 $7.6 million or increase by $8.6 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $2.5 million or decrease by $2.5 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 the Company's 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 September 30, 2016 , the fair value of the asset acquired as reported in the Company's Condensed Consolidated Balance Sheet was $100.1 million and the maximum loss exposure was $100.1 million .

AcelRx Royalty Agreement

On September 18, 2015, the Company entered into a royalty interest assignment agreement (the "AcelRx Royalty Agreement") with ARPI LLC, a wholly owned subsidiary of AcelRx Pharmaceuticals, Inc. ("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. Grünenthal launched Zalviso in the second quarter of 2016 and the Company started to receive royalties in the third quarter of 2016.


19



As of September 30, 2016 , and December 31, 2015 , the Company determined that its royalty rights under the AcelRx Royalty Agreement 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 September 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 the Company's 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 $12.6 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $1.9 million or decrease by $1.9 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 the Company's 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 September 30, 2016 , the fair value of the asset acquired as reported in the Company's Condensed Consolidated Balance Sheet was $74.0 million and the maximum loss exposure was $74.0 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 was compensated for his contribution to consummate this transaction by the Company as part of his consulting agreement with the Company. The Company 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, the Company entered into the Credit Agreement (the "Avinger Credit and Royalty Agreement") with Avinger, Inc. ("Avinger"), under which the Company 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 (including interest and a prepayment fee) 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 by Avinger, 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 September 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 the Company's 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 $73,000 or increase by $81,000, respectively. Should the expected royalties increase or decrease by 5%, the fair value of the asset could increase by $94,000 or decrease by $94,000, 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 the Company's 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 September 30, 2016 , the fair value of the royalty asset as reported in the Company's Condensed Consolidated Balance Sheet was $1.9 million and the maximum loss exposure was $1.9 million .

Kybella Royalty Agreement

On July 8, 2016, the Company entered into a royalty purchase and sales agreement with an individual, whereby the Company acquired that individual's rights to receive certain royalties on sales of KYBELLA ® by Allergan, in exchange for a $9.5 million

20



cash payment and up to $1.0 million in future milestone payments based upon product sales targets. The Company started to receive royalty payments during the third quarter of 2016.

The fair value of the royalty right at September 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 the Company's 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 a licensed product over a nine-year period. The discount rate utilized was approximately 14.4% . 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 $1.1 million or increase by $1.3 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $244,000 or decrease by $244,000, 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 the Company's 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 September 30, 2016, the fair value of the asset acquired as reported in the Company's Condensed Consolidated Balance Sheets was $9.8 million and the maximum loss exposure was $9.8 million .

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

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

 
 
 
 
 
 
 
 
Fair value of financial instruments purchased
 
 
 
59,500

 
Total net change in fair for the period
 
 
 
 
 
 
Change in fair value of royalty rights - at fair value
 
$
(11,872
)
 
 
 
 
Proceeds from royalty rights - at fair value
 
$
(47,240
)
 
 
 
 
Total net change in fair value for the period
 
 
 
(59,112
)
 
 
 
 
 
 
 
Fair value as of September 30, 2016
 


 
$
399,592


Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Royalty Rights Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair Value as of
 
New Royalty
 
Royalty Rights -
 
Fair Value as of
(in thousands)
 
December 31, 2015
 
Assets
 
Change in Fair Value
 
September 30, 2016
Depomed
 
$
191,865

 
$

 
$
(57,559
)
 
$
134,306

VB
 
17,133

 

 
(2,328
)
 
14,805

U-M
 
70,186

 

 
(5,549
)
 
64,637

ARIAD
 
50,041

 
50,000

 
103

 
100,144

AcelRx
 
67,437

 

 
6,612

 
74,049

Avinger
 
2,542

 

 
(667
)
 
1,875

KYBELLA
 

 
9,500

 
276

 
9,776

 
 
$
399,204

 
$
59,500

 
$
(59,112
)
 
$
399,592


21




Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Other Assets
 
 
 
(in thousands)
 
Preferred Stock
Warrants
Fair value as of December 31, 2015
 
$

 
 
 
 
 
 
Fair value of financial instruments purchased
 
1,172

 
Total net change in fair for the period
 
(102
)
 
 
 
 
 
Fair value as of September 30, 2016
 
$
1,070


Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Liabilities
 
 
 
 
 
(in thousands)
 
Anniversary Payment
 
Contingent Consideration
Fair value as of December 31, 2015
 
$

 
$

 
 
 
 
 
 
 
 
Fair value of financial instruments purchased
 
(87,007
)
 
(47,360
)
 
Total net change in fair for the period
 
(493
)
 
(1,590
)
 
 
 
 
 
 
 
Fair value as of September 30, 2016
 
$
87,500

 
$
48,950


The fair value of the contingent consideration was determined using an income approach derived from the Noden Products revenue estimates and a probability assessment with respect to the likelihood of achieving (a) the level of net sales or (b) generic product launch that would trigger the milestone payments. The key assumptions in determining the fair value are the discount rate and the probability assigned to the potential milestones being achieved. The fair value of the contingent consideration is remeasured each reporting period, with changes in fair value recorded in the condensed consolidated statements of income. The change in fair value of the contingent consideration during the period ending September 30, 2016 is due primarily to the passage of time, as there have been no significant changes to date in the key assumptions used in the fair value calculation at the date of acquisition.

Gains and losses from changes in Level 3 assets included in earnings for each period are presented in "Royalty rights - change in fair value" and gains and losses from changes in Level 3 liabilities included in earnings for each period are presented in "Change in fair value of anniversary payment and contingent consideration" as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for royalty right assets held at the end of the reporting period
 
$
16,085

 
$
(4,280
)
 
$
(11,872
)
 
$
19,298

 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for liabilities held at the end of the reporting period
 
$
(2,083
)
 
$

 
$
(2,083
)
 
$



22



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

 
 
September 30, 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

 
$

 
$
52,688

 
$
50,191

 
$

 
$
55,970

Hyperion note receivable
 
1,200

 

 
1,200

 
1,200

 

 
1,200

LENSAR note receivable
 
43,909

 

 
43,909

 
42,271

 

 
42,618

Direct Flow Medical note receivable
 
60,111

 

 
62,484

 
51,852

 

 
51,992

Paradigm Spine note receivable
 

 

 

 
53,973

 

 
54,250

kaléo note receivable
 
146,707

 

 
143,884

 
146,778

 

 
146,789

CareView note receivable
 
18,879

 

 
20,168

 
18,640

 

 
19,495

Total
 
$
320,997

 
$

 
$
324,333

 
$
364,905

 
$

 
$
372,314

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

February 2018 Notes
 
$
234,895

 
$
239,978

 
$

 
$
228,862

 
$
197,946

 
$

March 2015 Term Loan
 

 

 

 
24,966

 

 
25,000

Total
 
$
234,895

 
$
239,978

 
$

 
$
253,828

 
$
197,946

 
$
25,000


As of September 30, 2016 and December 31, 2015 , the estimated fair values of the Paradigm Spine, LLC note receivable, kaléo, Inc. note receivable, Hyperion Catalysis International, Inc. note receivable, LENSAR, LLC note receivable, CareView Communications Inc. note receivable and Direct Flow Medical, Inc. 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 the Company engages a third-party valuation expert to assist in evaluating its investments and the related inputs needed to estimate the fair value of certain investments. The Company determined its notes receivable assets are Level 3 assets as the Company's 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, the Company 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.

On September 30, 2016 , the carrying values of several of the Company's 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. The Company determined these notes receivable to be Level 3 assets, as its valuations utilized significant unobservable inputs, estimates of future revenues, expectations about settlement and required yield. To provide support for the fair value measurements, the Company 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 the Company's convertible notes were determined using quoted market pricing or dealer quotes.


23



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 September 30, 2016 , and December 31, 2015 , the Company had invested its excess cash balances primarily in money market funds, and a corporate equity security. The Company's 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, the Company has not experienced credit losses on investments in these instruments, and it does not require collateral for its 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, or short-term investments as of September 30, 2016, and December 31, 2015:

 
 
 
 
 
 
 
 
Reported as:
 
 
 Amortized Cost
 
 Unrealized Gains
 
 Estimated Fair Value
 
 Cash and Cash Equivalents
 
Short-Term Investments
(In thousands)
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 
 
 
 
 
 
 
 
 
 
Cash
 
$
96,404

 
$

 
$
96,404

 
$
96,404

 
$

Money market funds
 
190

 

 
190

 
190

 

Commercial paper
 
17,981

 

 
17,981

 
9,996

 
7,985

Total
 
$
114,575

 
$

 
$
114,575

 
$
106,590

 
$
7,985

 
 
 
 
 
 
 
 
 
 
 
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 nine months ended September 30, 2016 , the Company recognized approximately zero and $882,000 , on sales of available-for-sale securities, respectively. For each of the three and nine months ended September 30, 2015 , the Company recognized approximately $580,000 on sales of available-for-sale securities.

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

5. Foreign Currency Hedging

The Company designates the foreign currency exchange contracts used to hedge its royalty revenues based on underlying Euro-denominated sales as cash flow hedges. Euro forward contracts are presented on a net basis on the Company's Condensed Consolidated Balance Sheets as it has 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 September 30, 2016 .


24



The notional amounts, Euro exchange rates and fair values of the Company's 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 the Company's Euro forward contracts in the Company's 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 the Company's derivative instruments in its Condensed Consolidated Statements of Income and its Condensed Consolidated Statements of Comprehensive Income were as follows:

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

 
$
(57
)
 
$

 
$
4,306

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

 
$
1,495

 
$
1,821

 
$
3,903

 _______________________________
(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, LLC a/k/a Defined Diagnostics, LLC ("Wellstat Diagnostics"). In addition to bearing interest at 10% per annum, the note receivable gave the Company certain rights to negotiate for certain future financing transactions. In August 2012, the Company 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 agreement entered into with the Company on the same date, as described below.

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, the Company 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. The Company sent Wellstat Diagnostics a notice of default on January 22, 2013, and accelerated the amounts owed under the credit agreement. In

25



connection with the notice of default, the Company exercised one of its available remedies and transferred approximately $8.1 million of available cash from a bank account of Wellstat Diagnostics to the Company and applied the funds to amounts due under the credit agreement. On February 28, 2013, the parties entered into a forbearance agreement whereby the Company 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. The Company agreed to provide up to $7.9 million