PDL BioPharma, Inc.
PDL BIOPHARMA, INC. (Form: 10-Q, Received: 11/13/2017 17:08:38)


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, 2017
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
 
PDLLOGOEAA01.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 ¨
Emerging growth company ¨
(Do not check if a smaller reporting company)
 
 
 
 
 
If an emerging growth company, indicated by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes   ¨     No   ý
As of November 7, 2017 , there were 154,338,793 shares of the registrant’s Common Stock outstanding.




  PDL BIOPHARMA, INC.
2017 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, 2017 and 2016
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016
 
 
 
 
Condensed Consolidated Balance Sheets at September 30, 2017 and December 31, 2016
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016
 
 
 
 
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,
 
 
2017
 
2016
 
2017
 
2016
Revenues
 
 
 
 
 
 
 
 
Royalties from Queen et al. patents
 
$
1,443

 
$
14,958

 
$
31,884

 
$
150,645

Royalty rights - change in fair value
 
35,353

 
16,085

 
132,224

 
(11,872
)
Interest revenue
 
6,051

 
8,594

 
16,968

 
24,901

Product revenue, net
 
20,067

 
14,128

 
51,477

 
14,128

License and other
 
(165
)
 
(127
)
 
19,471

 
7

Total revenues
 
62,749

 
53,638

 
252,024

 
177,809

 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 

 
 

Cost of product revenue (excluding intangible asset amortization)
 
5,565

 

 
12,632

 

Amortization of intangible assets
 
6,275

 
6,014

 
18,438

 
6,014

General and administrative
 
11,989

 
10,396

 
35,853

 
27,193

Sales and marketing
 
4,994

 
11

 
11,194

 
11

Research and development
 
605

 
1,933

 
6,652

 
1,933

Change in fair value of anniversary payment and contingent consideration
 
700

 
2,083

 
3,349

 
2,083

Acquisition-related costs
 

 
546

 

 
3,505

Total operating expenses
 
30,128

 
20,983

 
88,118

 
40,739

Operating income
 
32,621

 
32,655

 
163,906

 
137,070

 
 
 
 
 
 
 
 
 
Non-operating expense, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
238

 
162

 
726

 
404

Interest expense
 
(5,096
)
 
(4,513
)
 
(15,082
)
 
(13,524
)
Gain (loss) on bargain purchase
 
(2,276
)
 

 
3,995

 

Total non-operating expense, net
 
(7,134
)
 
(4,351
)
 
(10,361
)
 
(13,120
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
25,487

 
28,304

 
153,545

 
123,950

Income tax expense
 
4,755

 
14,400

 
65,180

 
50,011

Net income
 
20,732

 
13,904

 
88,365

 
73,939

Less: Net income/(loss) attributable to noncontrolling interests
 

 
(3
)
 
(47
)
 
(3
)
Net income attributable to PDL’s shareholders
 
$
20,732

 
$
13,907

 
$
88,412

 
$
73,942

 
 
 
 
 
 
 
 
 
Net income per share
 
 

 
 

 
 

 
 

Basic
 
$
0.14

 
$
0.08

 
$
0.56

 
$
0.45

Diluted
 
$
0.14

 
$
0.08

 
$
0.56

 
$
0.45

Weighted average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
151,146

 
163,856

 
156,802

 
163,771

Diluted
 
152,317

 
164,285

 
157,529

 
164,075

Cash dividends declared per common share
 
$

 
$

 
$

 
$
0.10

 
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,
 
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Net income
 
$
20,732

 
$
13,904

 
$
88,365

 
$
73,939

 
 
 
 
 
 
 
 
 
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
 
648

 

 
648

 
122

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

 

 

 
(557
)
Total change in unrealized gains on investments in available-for-sale securities, net of tax (a)
 
648

 

 
648

 
(435
)
Change in unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
Adjustment to royalties from Queen et al. patents for net (gains) losses realized and included in net income, net of tax
 

 

 

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

 

 

 
(1,821
)
Total other comprehensive income/(loss), net of tax
 
648

 

 
648

 
(2,256
)
Comprehensive income
 
21,380

 
13,904

 
89,013

 
71,683

Less: Comprehensive income/(loss) attributable to noncontrolling interests
 

 
(3
)
 
(47
)
 
(3
)
Comprehensive income attributable to PDL’s shareholders
 
$
21,380

 
$
13,907

 
$
89,060

 
$
71,686

 ______________________________________________
(a) Net of tax of $349 and zero for the three months ended September 30, 2017 and 2016 , respectively, and $349 and ($234) for the nine months ended September 30, 2017 and 2016 , respectively.
(b) Net of tax of zero and zero for the three months ended September 30, 2017 and 2016 , respectively, and zero and ($981) for the nine months ended September 30, 2017 and 2016 , respectively.

See accompanying notes.

4



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)  
 
September 30,
 
December 31,
 
2017
 
2016
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
510,085

 
$
147,154

Short-term investments
6,409

 
19,987

Accounts receivable, net
17,465

 
40,120

Notes receivable
57,545

 
111,182

Investments-other

 
75,000

Inventories
12,216

 
2,884

Prepaid and other current assets
9,510

 
1,704

Total current assets
613,230

 
398,031

Property and equipment, net
8,130

 
38

Escrow receivable
1,400

 

Royalty rights - at fair value
351,969

 
402,318

Notes and other receivables, long-term
13,091

 
159,768

Long-term deferred tax assets
6,186

 
19,257

Intangible assets, net
222,074

 
228,542

Other assets
7,758

 
7,433

Total assets
$
1,223,838

 
$
1,215,387

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
10,448

 
$
7,016

Accrued liabilities
51,607

 
30,575

Accrued income taxes
7,155

 
4,723

Anniversary payment

 
88,001

Convertible notes payable
124,922

 

Total current liabilities
194,132

 
130,315

Convertible notes payable
115,716

 
232,443

Contingent consideration
45,000

 
42,650

Other long-term liabilities
46,008

 
54,556

Total liabilities
400,856

 
459,964

 
 
 
 
Commitments and contingencies (Note 11)


 


 
 
 
 
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; 154,339 and 165,538 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
1,543

 
1,655

Additional paid-in capital
(102,591
)
 
(107,628
)
Accumulated other comprehensive income
648

 

Retained earnings
923,382

 
857,116

Total PDL’s stockholders’ equity
822,982

 
751,143

Noncontrolling interests

 
4,280

Total stockholders’ equity
822,982

 
755,423

Total liabilities and stockholders’ equity
$
1,223,838

 
$
1,215,387


See accompanying notes.

5



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities
 
 
 
Net income
$
88,365

 
$
73,939

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

 
 

Amortization of convertible notes and term loan offering costs
8,195

 
6,067

Amortization of intangible assets
18,438

 
6,014

Change in fair value of royalty rights - at fair value
(132,224
)
 
11,872

Change in fair value of derivative asset
29

 
875

Change in fair value of anniversary payment and contingent consideration
3,349

 
2,083

Other amortization, depreciation and accretion of embedded derivative
1,478

 
16

Gain on sale of available-for-sale securities
(108
)
 
(881
)
Escrow receivable
(1,400
)
 

Bargain purchase gain
(3,995
)
 

Inventory obsolesence
30

 

Bad debt allowance
22

 

Stock-based compensation expense
3,014

 
2,649

Deferred income taxes
28,970

 
(6,013
)
Changes in assets and liabilities, net of affects of business acquired:
 

 
 

Accounts receivable
19,454

 
(26,035
)
Receivables from licensees and other
5,111

 
(5,757
)
Prepaid and other current assets
(4,166
)
 
(470
)
Accrued interest on notes receivable
1,577

 
(2,745
)
Inventories
(2,285
)
 
(1,593
)
Other assets
347

 
30

Accounts payable
1,395

 
6,740

Accrued liabilities
18,980

 
10,769

Accrued income taxes
2,432

 
2,421

Other long-term liabilities
1,055

 
6,084

Net cash provided by operating activities
58,063

 
86,065

Cash flows from investing activities
 

 
 

Purchase consideration paid in advance

 
(109,938
)
Purchase of investments
(23,213
)
 
(7,985
)
Purchase of investments-other

 
(75,000
)
Maturities of investments-other
75,000

 

Proceeds from sales of available-for-sale securities
37,895

 
1,680

Proceeds from the sale of notes receivables
144,829

 

Purchase of royalty rights - at fair value

 
(59,500
)
Proceeds from royalty rights - at fair value
74,404

 
47,240

Sale of royalty rights - at fair value
108,169

 

Purchase of notes receivable

 
(8,000
)
Proceeds from sales of assets held for sale
8,142

 
54,653

Purchase of property and equipment
(1,160
)
 

Net cash provided by / (used in) investing activities
424,066

 
(156,850
)
Cash flows from financing activities
 

 
 

Payment of debt issuance costs

 
(325
)
Repayment of term loan

 
(25,000
)
Cash received from noncontrolling interest holder

 
250

Payment of anniversary payment
(87,007
)
 

Cash paid for purchase of noncontrolling interest
(2,170
)
 

Cash dividends paid
(21
)
 
(16,433
)
Repurchase and retirement of common stock
(30,000
)
 

Net cash used in financing activities
(119,198
)
 
(41,508
)
Net increase (decrease) in cash and cash equivalents
362,931

 
(112,293
)
Cash and cash equivalents at beginning of the period
147,154

 
218,883

Cash and cash equivalents at end of period
$
510,085

 
$
106,590

 
 
 
 

6



 
Nine Months Ended September 30,
 
2017
 
2016
Supplemental cash flow information
 

 
 

Cash paid for income taxes
$
35,120

 
$
50,000

Cash paid for interest
$
7,224

 
$
9,930

 
 
 
 
Supplemental schedule of non-cash investing and financing activities
 
 
 
Warrants received for notes receivable
$

 
$
2,342

Asset held for sale reclassified from notes receivable to other assets
$
10,000

 
$

Extinguishment of notes receivable
$
43,909

 
$

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.

7



PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(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, 2016 , included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the Securities and Exchange Commission (“SEC”) on March 1, 2017. The Condensed Consolidated Balance Sheet at December 31, 2016 , has been derived from the audited Consolidated Financial Statements at that date, but does not include all disclosures required by GAAP.

During the quarter ended September 30, 2017, the Company corrected errors in its deferred tax assets and equity accounts, which decreased deferred tax assets by $20.4 million, decreased retained earnings by $29.9 million and increased additional paid-in capital by $9.5 million. The Company concluded that these errors are not material to the previously issued financial statements.

Significant Accounting Policies

There have been no material changes to the significant accounting policies discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, that are of significance, or potential significance to the Company.

Adopted Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 ASU 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.  For tax benefits that were not previously recognized because the related tax deduction had not reduced taxes payable, the Company recorded a $7.7 million cumulative-effect adjustment in retained earnings as of the beginning of 2017, the year of adoption. The Company applied the presentation changes for excess tax benefits from financing activities to operating activities in the statement of cash flows using a prospective transition method. The guidance allows for an election to recognize forfeitures as they occur rather than on an estimated basis. The Company will continue to account for forfeitures on an estimated basis. During the nine months ended September 30, 2017 , there were $0.2 million excess tax benefits recognized in the Consolidated Statement of Income and classified as an operating activity in the Condensed Consolidated Statement of Cash Flows.

In January 2017, the FASB issued ASU No. 2017-01,  Clarifying the Definition of a Business , included in ASC 805,  Business Combinations , which revises the definition of a business. The revised definition clarifies that outputs must be the result of inputs and substantive processes that provide goods or services to customers, other revenue, or investment income. The guidance will be effective for the Company's annual and interim reporting periods beginning January 1, 2018, and early adoption is permitted. The Company adopted the new definition of a business during the first quarter of 2017, and it did not have a material impact on its business practices, financial condition, results of operations, or disclosures.

Recently Issued Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued ASU No. 2014-09,  Revenue from Contracts with Customers . The new standard can be applied either retrospectively to each prior reporting period presented (i.e., full retrospective adoption) or with the cumulative effect of

8



initially applying the update recognized at the date of the initial application (i.e., modified retrospective adoption) along with additional disclosures. Revenue from financial instruments which are valued under Subtopic 825 will not be subject to the application of ASU 2014-09. As a result, the Company believes that Royalty Rights - At Fair Value are financial instruments within the scope of Subtopic 825 and will be specifically exempted from applying the new revenue standard.

This new standard will replace most of the existing revenue recognition guidance in GAAP when it becomes effective. The new standard, as amended, becomes effective for the Company in the first quarter of fiscal year 2018. The Company currently anticipates adopting this standard using the full retrospective method to restate each prior period presented.

The new revenue standard is principle based and interpretation of those principles may vary from company to company based on their unique circumstances. It is possible that interpretation, industry practice, and guidance may evolve as companies and the accounting profession work to implement this new standard. The Company is still in the process of evaluating the effect of the new standard on the Company’s historical financial statements and disclosures. While the Company has not completed its evaluation, the Company currently believes that the impact to revenue and expense recognized will not be material to any of the years presented. As the Company completes its evaluation of this new standard, new information may arise that could change the Company’s current understanding of the impact to revenue and expense recognized.

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 Condensed Consolidated Financial Statements.

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 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 Condensed Consolidated Statement of Cash Flows.

In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory , which requires companies to account for the income tax effects of intercompany sales and transfers of assets other than inventory in the period in which the transfer occurs. The new standard is effective for public business entities for annual periods beginning after December 15, 2017 (i.e. 2018 for a calendar-year entity). Early adoption is permitted for all entities as of the beginning of an annual period. The guidance is to be applied using a modified retrospective approach with a cumulative catch-up adjustment to opening retained earnings in the period of adoption. The Company is currently analyzing the impact of ASU No. 2016-16 on the Company’s Condensed Consolidated Financial Statements.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash , which requires entities to show the changes in total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. As a result, entities will no longer present transfers between cash and cash equivalents and restricted cash in the statement of cash flows. When cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item on the balance sheet, the new guidance requires a reconciliation of the totals in the statement of cash flows to the related captions on the balance sheet. The reconciliation can either be presented either on the face of the statement of cash flows or in the notes to the financial statements.  The new standard is effective for public business entities for fiscal years beginning after December 15, 2017 and interim periods therein and is to be applied retrospectively. Early adoption is permitted. The Company is currently analyzing the impact of ASU No. 2016-18 on the Company’s Condensed Consolidated Financial Statements.


9



2. Net Income per Share
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
Net Income per Basic and Diluted Share:
 
2017
 
2016
 
2017
 
2016
  (in thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
Income attributable to PDL’s shareholders used to compute net income per basic and diluted share
 
$
20,732

 
$
13,907

 
$
88,412

 
$
73,942

 
 
 
 
 
 
 
 
 
Denominator
 
 

 
 

 
 
 
 
Total weighted average shares used to compute net income attributable to PDL’s shareholders, per basic share
 
151,146

 
163,856

 
156,802

 
163,771

Restricted stock outstanding
 
1,171

 
429

 
727

 
304

Shares used to compute net income attributable to PDL’s shareholders, per diluted share
 
152,317

 
164,285

 
157,529

 
164,075

 
 
 
 
 
 
 
 
 
Net income attributable to PDL’s shareholders per share - basic
 
$
0.14

 
$
0.08

 
$
0.56

 
$
0.45

Net income attributable to PDL’s shareholders per share - diluted
 
$
0.14

 
$
0.08

 
$
0.56

 
$
0.45


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 4.0% Convertible Senior Notes due February 1, 2018 (the “February 2018 Notes”) and the 2.75% Convertible Senior Notes due December 1, 2021 (the “December 2021 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.

February 2018 Notes Purchased Call Option and Warrant Potential Dilution

The Company excluded from its calculation of net income per diluted share 12.2 million and 23.8 million shares for the three and nine months ended September 30, 2017 and 2016, respectively, 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 13.8 million and 26.9 million shares were excluded from the calculation of net income per diluted share for the three and nine months ended September 30, 2017 and 2016, respectively, and were excluded from the calculation of net income per diluted share. For information related to the conversion rates on the Company’s convertible debt, see Note 12.

December 2021 Notes Capped Call Potential Dilution

In November 2016, the Company issued $150.0 million in aggregate principal of the December 2021 Notes, which provide in certain situations for the conversion of the outstanding principal amount of the December 2021 Notes into shares of the Company’s common stock at a predefined conversion rate. For additional information on the conversion rates on the Company’s convertible debt, see Note 12. In conjunction with the issuance of the December 2021 Notes, the Company entered into a capped call transaction with a hedge counterparty. The capped call transaction is expected generally to reduce the potential dilution, and/or offset, to an extent, the cash payments the Company may choose to make in excess of the principal amount, upon conversion of the December 2021 Notes. The Company has excluded the capped call transaction from the diluted EPS computation as such securities would have an antidilutive effect and those securities should be considered separately rather than in the aggregate in determining whether their effect on diluted EPS would be dilutive or antidilutive. For additional information regarding the capped call transaction related to the Company’s December 2021 Notes, see Note 12.

Anti-Dilutive Effect of Restricted Stock Awards and Stock Options

For the three months ended September 30, 2017 and 2016 , the Company excluded approximately 1.8 million and 1.2 million shares underlying restricted stock awards, respectively, and for the nine months ended September 30, 2017 and 2016 , the

10



Company excluded approximately 1.9 million and 1.1 million 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.

For the three months ended September 30, 2017 and 2016, the Company excluded approximately 126,000 and zero shares underlying outstanding stock options, respectively, and for the nine months ended September 30, 2017 and 2016, the Company excluded approximately 59,000 and zero shares underlying outstanding stock options, respectively, calculated on a weighted average basis, its our 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.

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, 2017
 
December 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
14,705

 
$

 
$

 
$
14,705

 
$
4

 
$

 
$

 
$
4

Certificates of deposit
 

 

 

 

 

 
75,000

 

 
75,000

Commercial paper
 

 
2,060

 

 
2,060

 

 
19,987

 

 
19,987

Corporate securities
 
4,349

 

 

 
4,349

 

 

 

 

Warrants
 

 
49

 

 
49

 

 
78

 

 
78

Royalty rights - at fair value
 

 

 
351,969

 
351,969

 

 

 
402,318

 
402,318

Total
 
$
19,054

 
$
2,109

 
$
351,969

 
$
373,132

 
$
4

 
$
95,065

 
$
402,318

 
$
497,387

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 

Anniversary payment
 
$

 
$

 
$

 
$

 
$

 
$

 
$
88,001

 
$
88,001

Contingent consideration
 

 

 
45,000

 
45,000

 

 

 
42,650

 
42,650

Total
 
$

 
$

 
$
45,000

 
$
45,000

 
$

 
$

 
$
130,651

 
$
130,651

 
As of December 31, 2016 , the Company held $75.0 million in a short-term certificate of deposit, which was designated as cash collateral for the letter of credit issued with respect to the first anniversary payment under the Noden Purchase Agreement (as defined in Note 18 below). On July 3, 2017, the first anniversary payment of $89.0 million was paid pursuant to the Noden Purchase Agreement and on July 31, 2017, the certificate of deposit matured. There have been no transfers between levels during the three or nine-month periods ended September 30, 2017 and December 31, 2016 . The Company recognizes transfers between levels on the date of the event or change in circumstances that caused the transfer.

Certificates of Deposit

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


11



Commercial Paper

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

Corporate Securities

Corporate securities consist primarily of U.S. corporate security holdings. The fair value of corporate securities is estimated using market quoted prices.

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.

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, 2017 , and December 31, 2016 , 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 nine-year period. The discount rates utilized range from approximately 15% to 25% . Significant judgment is required in selecting appropriate discount rates. At September 30,

12



2017 , 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 $12.5 million or increase by $14.0 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 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 or decrease by $5.6 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 generic equivalents 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 and August of 2016, a total of three generic equivalents to Glumetza were approved to enter the market. In February 2016, Lupin Pharmaceuticals, Inc. launched a generic equivalent approved product. To date, the other two generic equivalent approved products have not launched.

In May 2017, the Company received notification that a subsidiary of Valeant had launched an authorized generic equivalent product in February 2017, and the Company received royalties on such authorized generic equivalent product under the same terms as the branded Glumetza, retroactive to February 2017.

At June 30, 2017, management re-evaluated, with assistance of a third-party expert, the market share data, the gross-to-net revenue adjustment assumptions and Glumetza demand data, including the delay in launch of additional generic equivalent products and the entry of an authorized generic product by Valeant. These data and assumptions are based on available but limited information. At September 30, 2017 , management updated the expected future cash flows based on the current period demand and supply data of Glumetza and the authorized generic equivalent product launched by Valeant.

As of September 30, 2017 , 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, including future cash flows for the authorized generic equivalent product. The Company continues to monitor whether the generic competition further affects sales of Glumetza and thus royalties on such sales paid to the Company, and the impact of the launched authorized generic equivalent. 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 evaluate future cash flows in the event of more rapid reduction or increase in market share of Glumetza and its authorized generic equivalent product and/or a further erosion in net pricing. In February 2016, at the Company’s request and pursuant to the Depomed Royalty Agreement, Depomed exercised its audit right with respect to Glumetza royalties. The independent auditors engaged to perform the royalty audit completed it in July 2017, and based upon the results of the audit, Depomed, on behalf of the Company, filed a lawsuit on September 7, 2017, against Valeant and one of its subsidiaries, claiming damages for unpaid royalties, fees and interest.  Valeant, Depomed and the Company entered into a settlement agreement on October 27, 2017 whereby the parties agreed to dismiss the litigation, with prejudice, and Valeant agreed to pay to Depomed $13.0 million. The settlement payment was transferred to the Company under the terms of the Depomed Royalty Agreement in November of 2017 and has been reflected in the Depomed royalty rights asset discounted cashflow valuation as of September 30, 2017.

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 pursuant to the terms of the Depomed Royalty Agreement. The product approval was earlier than initially expected. Based on the FDA approval and anticipated timing of the 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. Management re-evaluated, with assistance of a third-party expert, the cash flow

13



assumptions for Jentadueto XR and revised the discounted cash flow model. As of September 30, 2017 , 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.

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 payment to the Company pursuant to the terms of the Depomed Royalty Agreement. Based on the FDA approval and timing of the product launch, the Company adjusted the timing of future cash flows and discount rate used in the discounted cash flow model at September 30, 2017 .

On December 13, 2016, the Company obtained a notification indicating that the FDA approved Synjardy XR for use in patients with Type 2 diabetes. The product approval triggered a $6.0 million approval milestone payment to the Company pursuant to the terms of the Depomed Royalty Agreement. 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, 2017 . In April 2017, Boehringer Ingelheim launched Synjardy XR.

As of September 30, 2017 , the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $222.7 million and the maximum loss exposure was $222.7 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 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, 2017 , 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 nine-year period. The discount rate utilized was approximately 17.5% . Significant judgment is required in selecting the appropriate discount rate. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $1.2 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 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, 2017 , the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $15.4 million and the maximum loss exposure was $15.4 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 receives 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

14



future cash flows. Based on the analysis performed, management revised the underlying assumptions used in the discounted cash flow analysis at period end.

The fair value of the royalty right at September 30, 2017 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 five-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 $2.0 million or increase by $2.2 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $0.9 million or decrease by $0.9 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. 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, 2017 , the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $35.4 million and the maximum loss exposure was $35.4 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 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. Upon the occurrence of certain events, including a change of control of ARIAD, the Company had the right to require ARIAD to repurchase the royalty rights for a specified amount. The Company 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. The asset acquired pursuant to the ARIAD Royalty Agreement represents a single unit of accounting.

In January 2017, Takeda Pharmaceutical Company Limited (“Takeda”) announced that it had entered into a definitive agreement to acquire ARIAD. The acquisition was consummated on February 16, 2017 and the Company exercised its put option on the same day, which resulted in an obligation by Takeda to pay the Company a 1.2x multiple of the $100.0 million funded by the Company under the ARIAD Royalty Agreement, less royalty payments already received by the Company.

On March 30, 2017, Takeda fulfilled its obligations under the put option and paid the Company the repurchase price of $108.2 million for the royalty rights under the ARIAD Royalty Agreement.

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.

As of September 30, 2017 , and December 31, 2016 , 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, 2017 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

15



discounted cash flow was based upon expected royalties from sales of licensed product over a fourteen-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 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, 2017 , the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $74.1 million and the maximum loss exposure was $74.1 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 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, 2017 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 one-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 $16,000 or increase by $17,000, respectively. Should the expected royalties increase or decrease by 5%, the fair value of the asset could increase or decrease by $43,000, 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, 2017 , the fair value of the royalty asset as reported in the Company’s Condensed Consolidated Balance Sheet was $0.9 million and the maximum loss exposure was $0.9 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 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, 2017 , 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 an eight-year period. The discount rate utilized was approximately 14.4% . Significant judgment is required in selecting the appropriate discount rate.

16



Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $0.3 million or increase by $0.3 million, respectively. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase by $0.1 million or decrease by $0.1 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. Management re-evaluated the cash flow projections during the current period, concluding that lower demand data resulted in a reduction of expected future cash flows, which warranted a revision of the assumptions used in the discounted cash flow model at September 30, 2017 .

As of September 30, 2017 , the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $3.5 million and the maximum loss exposure was $3.5 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, 2017 :
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, 2016
 
 
 
$
402,318

 
 
 
 
 
 
 
 
Financial instruments settled
 
 
 
(108,169
)
 
Total net change in fair for the period
 
 
 
 
 
 
Change in fair value of royalty rights - at fair value
 
$
132,224

 
 
 
 
Proceeds from royalty rights - at fair value
 
$
(74,404
)
 
 
 
 
Total net change in fair value for the period
 
 
 
57,820

 
 
 
 
 
 
 
Fair value as of September 30, 2017
 


 
$
351,969


Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Royalty Rights Assets
 
 
 
 
 
 
 
 
 
 
 
Fair Value as of
 
Change of
 
Royalty Rights -
 
Fair Value as of
(in thousands)
 
December 31, 2016
 
Ownership
 
Change in Fair Value
 
September 30, 2017
Depomed
 
$
164,070

 
$

 
$
58,625

 
$
222,695

VB
 
14,997

 

 
440

 
15,437

U-M
 
35,386

 

 
63

 
35,449

ARIAD
 
108,631

 
(108,169
)
 
(462
)
 

AcelRx
 
67,483

 

 
6,582

 
74,065

Avinger
 
1,638

 

 
(777
)
 
861

KYBELLA
 
10,113

 

 
(6,651
)
 
3,462

 
 
$
402,318

 
$
(108,169
)
 
$
57,820

 
$
351,969


17



Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Liabilities
 
 
 
 
 
(in thousands)
 
Anniversary Payment
 
Contingent Consideration
Fair value as of December 31, 2016
 
$
(88,001
)
 
$
(42,650
)
 
 
 
 
 
 
 
 
Total net change in fair for the period
 
(999
)
 
(2,350
)
 
Settlement of financial instrument
 
89,000

 

 
 
 
 
 
 
 
Fair value as of September 30, 2017
 
$

 
$
(45,000
)

The fair value of the contingent consideration was determined using an income approach derived from the Noden Products (as defined in Note 18 below) 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, 2017 is due primarily to the passage of time, as there have been no significant changes in the key assumptions used in the fair value calculation during the current period.

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)
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for royalty right assets held at the end of the reporting period
 
$
35,353

 
$
16,085

 
$
132,224

 
$
(11,872
)
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for liabilities held at the end of the reporting period
 
$
(700
)
 
$
(2,083
)
 
$
(3,349
)
 
$
(2,083
)


18



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, 2017
 
December 31, 2016
 
 
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

 
$

 
$
52,288

 
$
50,191

 
$

 
$
52,260

Hyperion note receivable
 
1,200

 

 
1,200

 
1,200

 

 
1,200

LENSAR note receivable (2)
 

 

 

 
43,909

 

 
43,900

Direct Flow Medical note receivable (1)
 

 

 

 
10,000

 

 
10,000

kaléo note receivable (3)
 

 

 

 
146,685

 

 
142,539

CareView note receivable
 
19,245

 

 
19,900

 
18,965

 

 
19,200

Total
 
$
70,636

 
$

 
$
73,388

 
$
270,950

 
$

 
$
269,099

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

February 2018 Notes
 
$
124,922

 
$
126,131

 
$

 
$
121,595

 
$
123,918

 
$

December 2021 Notes
 
115,716

 
163,313

 

 
110,848

 
122,063

 

Total
 
$
240,638

 
$
289,444

 
$

 
$
232,443

 
$
245,981

 
$

________________
(1) As a result of the foreclosure proceedings, the Company obtained ownership of most of the Direct Flow Medical assets through the Company’s wholly-owned subsidiary, DFM, LLC. Those assets are held for sale and carried at the lower of carrying amount or fair value, less estimated selling cost, as of September 30, 2017 . For a further discussions on this topic, see Note 7.
(2) As a result of the Company receiving 100% of LENSAR, Inc.’s equity securities in exchange for the cancellation of the Company’s claims as a secured creditor in the Chapter 11 case, LENSAR, Inc. became a wholly-owned subsidiary of the Company on May 11, 2017. For further discussions on this topic, see Note 18.
(3) On September 21, 2017, the Company entered into a note purchase agreement whereby it sold to a third party the kaléo, Inc. note receivable for an aggregate cash purchase price of $141.7 million , subject to an 18-month escrow hold back of $1.4 million against certain potential contingencies.

As of September 30, 2017 and December 31, 2016, the estimated fair values of the Hyperion Catalysis International, Inc. note receivable, and CareView Communications, 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. As of December 31, 2016, the estimated fair values of the kaléo, Inc. note receivable, LENSAR, Inc. note receivable, and Direct Flow Medical note receivable were also determined using the same method.

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 CareView note receivable is secured by substantially all assets and equity interests in CareView Communications, Inc. The Wellstat Diagnostics note is supported by 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, 2017 , 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

19



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.

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, 2017
 
December 31,
2016
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics
 
 
 
 
 
 
 
 
Wellstat Guarantors Intellectual Property
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
12%
 
13%
 
 
 
 
Royalty amount
 
$60 million
 
$54-74 million
Real Estate Property
 
Market Approach
 
 
 
 
 
 
 
 
 
 
Annual appreciation rate
 
4%
 
4%
 
 
 
 
Estimated realtor fee
 
6%
 
6%
 
 
 
 
Estimated disposal date
 
12/31/2018
 
12/31/2017
Direct Flow Medical
 
 
 
 
 
 
 
 
All Assets
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
N/A
 
27%
 
 
 
 
Implied revenue multiple
 
N/A
 
6.9
LENSAR
 
 
 
 
 
 
 
 
All Assets
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
N/A
 
25%
 
 
 
 
Implied revenue multiple
 
N/A
 
2.5

At September 30, 2017 , the Company had two notes receivable investments on non-accrual status with a cumulative investment cost and fair value of approximately $51.4 million and $53.5 million , respectively, compared to four note receivable investments on non-accrual status at December 31, 2016 with a cumulative investment cost and fair value of approximately $105.3 million and $107.4 million , respectively. For the three months ended September 30, 2017 and 2016, the Company did not recognize any interest for note receivable investments on non-accrual status. During the nine months ended September 30, 2017 and 2016, the Company recognized losses on extinguishment of notes receivable of $12.2 million and zero , respectively.

4. Cash, Cash Equivalents and Short-term Investments
 
As of September 30, 2017 , and December 31, 2016 , the Company had invested its excess cash balances primarily in cash, money market funds and commercial paper. 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.


20



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, 2017 , and December 31, 2016:
 
 
 
 
 
 
 
 
Reported as:
 
 
 Amortized Cost
 
 Unrealized Gains
 
 Estimated Fair Value
 
 Cash and Cash Equivalents
 
Short-Term Investments
(In thousands)
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
 
 
 
Cash
 
$
495,380

 
$

 
$
495,380

 
$
495,380

 
$

Money market funds
 
14,705

 

 
14,705

 
14,705

 

Commercial paper
 
2,060

 

 
2,060

 

 
2,060

Corporate securities
 
3,352

 
997

 
4,349

 

 
4,349

Total
 
$
515,497

 
$
997

 
$
516,494

 
$
510,085

 
$
6,409

 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
Cash
 
$
147,150

 
$

 
$
147,150

 
$
147,150

 
$

Money market funds
 
4

 

 
4

 
4

 

Commercial paper
 
19,987

 

 
19,987

 

 
19,987

Total
 
$
167,141

 
$

 
$
167,141

 
$
147,154

 
$
19,987


The unrealized gains on investments included in "Other comprehensive income (loss), net of tax" was approximately $648,000 and zero as of September 30, 2017 , and December 31, 2016, respectively.

5. Concentration of Credit Risk

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
 
2017
 
2016
 
2017
 
2016
Genentech
 
Avastin
 
%
 
%
 
%
 
22
%
 
 
Herceptin
 
%
 
%
 
%
 
22
%
 
 
 
 
 
 
 
 
 
 
 
Biogen
 
Tysabri ®
 
2
%
 
28
%
 
13
%
 
24
%
 
 
 
 
 
 
 
 
 
 
 
Depomed
 
Glumetza, Janumet XR, Jentadueto XR and Invokamet XR
 
50
%
 
18
%
 
50
%
 
N/A

 
 
 
 
 
 
 
 
 
 
 
N/A
 
Tekturna, Tekturna HCT, Rasilez and Rasilez HCT
 
24
%
 
26
%
 
17
%
 
8
%
__________________
N/A = Not applicable

6. 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. All Euro forward contracts were classified as cash flow hedges. There were no Euro forward contracts outstanding as of September 30, 2017 or December 31, 2016.


21



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,
 
 
2017
 
2016
 
2017
 
2016
(In thousands)
 
 
 
 
 
 
 
 
Gain (loss) reclassified from accumulated OCI into “Queen et al. royalty revenue,” net of tax (2)
 
$

 
$

 
$

 
$
1,821

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

7. Notes and Other Long-Term Receivables

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

Wellstat Diagnostics Note Receivable and Credit Agreement and Related Litigation

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. A portion of the proceeds of the $40.0 million credit agreement were used to repay certain notes receivable which Wellstat Diagnostics entered into in March 2012.

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 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. During such forbearance period, the Company provided approximately $1.3 million to Wellstat Diagnostics to fund ongoing operations of the business. During the year ended December 31, 2013, approximately $8.7 million was advanced pursuant to the forbearance agreement.

On August 15, 2013, the Company entered into an amended and restated credit agreement with Wellstat Diagnostics. The Company determined that the new agreement should be accounted for as a modification of the existing agreement.

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

In June 2014, the Company received information from Wellstat Diagnostics showing that it was generally unable to pay its debts as they became due, constituting an event of default under the amended and restated credit agreement.
On August 5, 2014, the Company delivered a notice of default (the “Wellstat Diagnostics Borrower Notice”) to Wellstat Diagnostics, which accelerated all obligations under the amended and restated credit agreement and demanded immediate payment in full in an amount equal to approximately $53.9 million (which amount, in accordance with the terms of the

22



amended and restated credit agreement, included an amount that, together with interest and royalty payments already made to the Company, would generate a specified internal rate of return to the Company), plus accruing fees, costs and interest, and demanded that Wellstat Diagnostics protect and preserve all collateral securing its obligations.

On August 7, 2014, the Company delivered a notice (the “Wellstat Diagnostics Guarantor Notice”) to each of the guarantors of Wellstat Diagnostics’ obligations to the Company (collectively, the “Wellstat Diagnostics Guarantors”) under the credit agreement, which included a demand that the guarantors remit payment to the Company in the amount of the outstanding obligations. The guarantors include certain affiliates and related companies of Wellstat Diagnostics, including Wellstat Therapeutics and Wellstat Diagnostics’ stockholders.

On September 24, 2014, the Company filed an ex-parte petition for appointment of receiver with the Circuit Court of Montgomery County, Maryland (the “Wellstat Diagnostics Petition”), which was granted on the same day. Wellstat Diagnostics remained in operation during the period of the receivership with incremental additional funding from the Company. On May 24, 2017, Wellstat Diagnostics transferred substantially all of its assets to the Company pursuant to a credit bid. The credit bid reduced the outstanding balance of the loan by an immaterial amount.

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

On July 29, 2016, the Supreme Court of New York granted the Company’s motion for summary judgment and held that the Wellstat Diagnostics Guarantor defendants are liable for all “Obligations” owed by Wellstat Diagnostics to the Company. After appeal by the Wellstat Diagnostics Guarantor defendants, on February 14, 2017, the Appellate Division of the Supreme Court of New York reversed on procedural grounds a portion of the Memorandum of Decision granting the Company summary judgment in lieu of complaint, but affirmed the portion of the Memorandum of Decision denying the Wellstat Diagnostics Guarantor defendants’ motion for summary judgment in which they sought a determination that the guarantees had been released. As a result, the litigation has been remanded to the Supreme Court of New York to proceed on the Company’s claims as a plenary action. On June 21, 2017, the Supreme Court of New York ordered the Company to file a Complaint, which was filed by the Company on July 20, 2017. The Wellstat Diagnostics Guarantors filed their answer on August 9, 2017, including counterclaims against the Company alleging breach of contract breach of fiduciary duty, and tortious interference with prospective economic advantage. This case is currently pending and in the pre-trial phase.

On October 14, 2016, the Company sent a notice of default and reference to foreclosure proceedings to certain of the Wellstat Diagnostics Guarantors which are not defendants in the New York action, but which are owners of real estate assets over which a deed of trust in favor of the Company securing the guarantee of the loan to Wellstat Diagnostics had been executed. On March 2, 2017, the Company sent a second notice to foreclose on the real estate assets, and noticed the sale for March 29, 2017. The sale was taken off the calendar by the trustee under the deed of trust and has not been re-scheduled yet. On March 6, 2017, the Company sent a letter to the Wellstat Diagnostics Guarantors seeking information in preparation for a UCC Article 9 sale of some or all of the intellectual property-related collateral of the Wellstat Diagnostics Guarantors. The Wellstat Diagnostics Guarantors did not respond to the Company’s letter, but on March 17, 2017, filed an order to show cause with the New York Supreme Court to enjoin the Company’s sale of the real estate or enforcing its security interests in the Wellstat Diagnostics Guarantors’ intellectual property during the pendency of any action involving the guarantees at issue. The court has not yet decided the Wellstat Diagnostics Guarantor motions, but reaffirmed the Wellstat Diagnostics Guarantors’ obligations to maintain the status quo with respect to their assets. In October 2017, the Company filed a motion with the New York Supreme Court requesting an attachment of a potential $55.8 million damages award, plus interest, entered against BTG International, Inc. in favor of Wellstat Therapeutics in Delaware Chancery Court on September 19, 2017. The New York Supreme Court has not yet considered the Company’s motion.

On October 22, 2015, certain of the Wellstat Diagnostics Guarantors filed a separate complaint against the Company in the Supreme Court of New York seeking a declaratory judgment that certain contractual arrangements entered into between the parties subsequent to Wellstat Diagnostics’ default, and which relate to a split of proceeds in the event that the Wellstat Diagnostics Guarantors voluntarily monetize any assets that are the Company’s collateral, is of no force or effect. This case is currently pending and the Supreme Court has instructed the Parties to coordinate this case with the pending case filed by the Company against the Wellstat Diagnostics Guarantors’ discussed above with respect to pre-trial activities.

23




Effective April 1, 2014, and as a result of the event of default, the Company determined the loan to be impaired and it ceased to accrue interest revenue. At that time and as of September 30, 2017 , it has been determined that an allowance on the carrying value of the note was not necessary, as the Company believes the value of the collateral securing Wellstat Diagnostics’ obligations exceeds the carrying value of the asset and is sufficient to enable the Company to recover the current carrying value of $50.2 million . The Company continues to closely monitor the timing and expected recovery of amounts due, including litigation and other matters related to Wellstat Diagnostics Guarantors’ assets. There can be no assurance that an allowance on the carrying value of the notes receivable investment will not be necessary in a future period depending on future developments.

Hyperion Agreement

On January 27, 2012, the Company and Hyperion Catalysis International, Inc. (“Hyperion”) (which is also a Wellstat Diagnostics Guarantor) entered into an agreement whereby Hyperion sold to the Company the royalty streams due from SDK related to a certain patent license agreement between Hyperion and SDK dated December 31, 2008. The agreement assigned the patent license agreement royalty stream accruing from January 1, 2012 through December 31, 2013, to the Company in exchange for the lump sum payment to Hyperion of $2.3 million . In exchange for the lump sum payment, the Company was to receive two equal payments of $1.2 million on each of March 5, 2013 and 2014. The first payment of $1.2 million was paid on March 5, 2013, but Hyperion has not made the second payment that was due on March 5, 2014. The Company completed an impairment analysis as of September 30, 2017 . Effective with this date and as a result of the event of default, the Company ceased to accrue interest revenue. As of September 30, 2017 , the estimated fair value of the collateral was determined to be in excess of the carrying value. There can be no assurance that this will be true in the event of the Company’s foreclosure on the collateral, nor can there be any assurance of realizing value from such collateral.

Avinger Credit and Royalty Agreement

Under the terms of the Avinger Credit and Royalty Agreement, the Company receives a low, single-digit royalty on Avinger’s net revenues until April 2018. Commencing in October 2015, after Avinger repaid $21.4 million pursuant to its note receivable prior to its maturity date, the royalty on Avinger’s net revenues reduce by 50% , 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. For a further discussion of the Avinger Credit and Royalty Agreement, see Note 3.

LENSAR Credit Agreement

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

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

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

On November 15, 2015, LENSAR, LLC (“LENSAR/Alphaeon”), a wholly owned subsidiary of Alphaeon Corporation (“Alphaeon”), and LENSAR entered into the Asset Purchase Agreement whereby LENSAR/Alphaeon agreed to acquire certain assets of LENSAR and assumed certain liabilities of LENSAR. The acquisition was consummated on December 15, 2015.

24




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

The Company has estimated a fair value of $3.84 per share for the 1.7 million shares of Alphaeon Class A common stock received in connection with the transactions and recognized this investment as a cost-method investment of $6.6 million included in other long-term assets. The Alphaeon Class A common stock is subject to other-than-temporary impairment assessments in future periods. There is no other-than-temporary impairment charge incurred as of September 30, 2017.

In December 2016, LENSAR, re-acquired the assets from LENSAR/Alphaeon and the Company entered into a second amended and restated credit agreement with LENSAR whereby LENSAR assumed all obligations under the amended and restated credit agreement with LENSAR/Alphaeon. Also in December, LENSAR filed for a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code (“Chapter 11 case”) with the support of the Company. In January 2017, the Company agreed to provide debtor-in-possession financing of up to $2.8 million in new advances to LENSAR so that it could continue to operate its business during the Chapter 11 case. LENSAR filed a Chapter 11 plan of reorganization with the Company’s support under which LENSAR would issue 100% of its equity securities to the Company in exchange for the cancellation of the Company’s claims as a secured creditor in the Chapter 11 case, other than with respect to the debtor-in-possession financing, and would thereby become an operating subsidiary of the Company. On April 26, 2017, the bankruptcy court approved the plan of reorganization.

Pursuant to the plan of reorganization, LENSAR emerged from bankruptcy on May 11, 2017 as a wholly-owned subsidiary of the Company, and the Company started to consolidate LENSAR’s financial statements under the voting interest model beginning May 11, 2017.

For additional information on LENSAR please refer to Note 9 under “Intangible Assets and Goodwill,” Note 18 under “Business Combinations” and Note 19 under “Segment Information.”

Direct Flow Medical Credit Agreement

On November 5, 2013, the Company entered into a credit agreement with Direct Flow Medical, Inc. (“Direct Flow Medical”) under which the Company agreed to provide up to $50.0 million to Direct Flow Medical. Of the $50.0 million available to Direct Flow Medical, an initial $35.0 million (tranche one), net of fees, was funded by the Company at the close of the transaction.

On November 10, 2014, the Company and Direct Flow Medical agreed to an amendment to the credit agreement to permit Direct Flow Medical to borrow the $15.0 million second tranche upon receipt by Direct Flow Medical of a specified minimum amount of proceeds from an equity offering prior to December 31, 2014. In exchange, the parties amended the credit agreement to provide for additional fees associated with certain liquidity events, such as a change of control or the consummation of an initial public offering, and granted the Company certain board of director observation rights. On November 19, 2014, upon Direct Flow Medical satisfying the amended tranche two milestone, the Company funded the $15.0 million second tranche to Direct Flow Medical, net of fees.

Outstanding borrowings under tranche one bore interest at the rate of 15.5% per annum, payable quarterly in arrears, until the occurrence of the second tranche. Upon occurrence of the borrowing of this second tranche, the interest rate applicable to all loans under the credit agreement was decreased to 13.5% per annum, payable quarterly in arrears.

Under the terms of the credit agreement, Direct Flow Medical’s obligation to repay loan principal commenced on the twelfth interest payment date, September 30, 2016. The principal amount outstanding at commencement of repayment was required to be repaid in equal installments until final maturity of the loans. The loans were to mature on November 5, 2018. The obligations under the credit agreement were secured by a pledge of substantially all the assets of Direct Flow Medical and any of its subsidiaries.

On December 21, 2015, Direct Flow Medical and the Company entered into a waiver to the credit agreement in anticipation of Direct Flow Medical being unable to comply with the liquidity covenant and make interest payments due under the credit agreement, which was subsequently extended on January 14, 2016, and further delayed the timing of the interest payments through the period ending September 30, 2016 while Direct Flow Medical sought additional financing to operate its business.


25



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

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

On July 15, 2016, the Company and Direct Flow Medical entered into the fifth amendment and limited waiver to the credit agreement. The Company funded an additional $1.5 million to Direct Flow Medical in the form of a note with substantially the same interest and payment terms as the existing loans and a conversion feature whereby the $1.5 million loan would convert into equity of Direct Flow Medical upon the occurrence of certain events. In addition, Direct Flow Medical agreed to issue to the Company warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.

On September 12, 2016, the Company and Direct Flow Medical entered into the sixth amendment and limited waiver to the credit agreement under which the Company funded an additional $1.5 million to Direct Flow Medical in the form of a note with substantially the same interest and payment terms as the existing loans. In addition, Direct Flow Medical agreed to issue to the Company a specified amount of warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.

On September 30, 2016, the Company and Direct Flow Medical entered into a waiver to the credit agreement where the parties agreed, among other things, to (i) delay payment on all overdue interest payments until October 31, 2016, (ii) waive the initial principal repayment until October 31, 2016 and (iii) continue to waive the liquidity requirements until October 31, 2016. Further, Direct Flow Medical agreed to issue to the Company a specified amount of warrants to purchase shares of convertible preferred stock at an exercise price of $0.01 per share.

On October 31, 2016, the Company agreed to extend the waivers described above until November 30, 2016 and on November 14, 2016, the Company advanced an additional $1.0 million loan while Direct Flow Medical continued to seek additional financing.

On November 16, 2016, Direct Flow Medical advised the Company that its potential financing source had modified its proposal from an equity investment to a loan with a substantially smaller amount and under less favorable terms. Direct Flow Medical shut down its operations in December 2016 and in January 2017 made an assignment for the benefit of creditors. The Company then initiated foreclosure proceedings, resulting in the Company obtaining ownership of most of the Direct Flow Medical assets through the Company’s wholly-owned subsidiary, DFM, LLC. The assets are held for sale and carried at the lower of carrying amount or fair value, less estimated selling costs, which is primarily based on supporting data from market participant sources, and valid offers from third parties.

At December 31, 2016, the Company completed an impairment analysis and concluded that the situation qualified as a troubled debt restructuring and recognized an impairment loss of $51.1 million .

In January 2017, the Company started to actively market the asset held for sale. On January 23, 2017, the Company and DFM, LLC entered into an Intellectual Property Assignment Agreement with Hong Kong Haisco Pharmaceutical Co., Limited (“Haisco”), a Chinese pharmaceutical company, whereby Haisco acquired former Direct Flow Medical clinical, regulatory and commercial information and intellectual property rights exclusively in China for $7.0 million . The Company, through DFM, LLC also sold Haisco certain manufacturing equipment for $450,000 and collected $692,000 on outstanding Direct Flow Medical accounts receivable during the nine months ended September 30, 2017. The Company is exploring alternatives to further monetize the remaining assets of Direct Flow Medical and has ascribed a carrying value of $1.8 million to the remaining assets held for sale at September 30, 2017 .

Paradigm Spine Credit Agreement

On February 14, 2014, the Company entered into the Credit Agreement (the “Paradigm Spine Credit Agreement”) with Paradigm Spine, LLC (“Paradigm Spine”), under which it made available to Paradigm Spine up to $75.0 million to be used by

26



Paradigm Spine to refinance its existing credit facility and expand its domestic commercial operations. Of the $75.0 million available to Paradigm Spine, an initial $50.0 million , net of fees, was funded by the Company at the close of the transaction. The second and third tranches of up to an additional $25.0 million in the aggregate, net of fees, are no longer available under the terms of the Paradigm Spine Credit Agreement.

On October 27, 2015, the Company and Paradigm Spine entered into an amendment to the Paradigm Spine Credit Agreement to provide additional term loan commitments of up to $7.0 million payable in two tranches, of which the first tranche of $4.0 million was drawn on the closing date of the amendment, net of fees. Paradigm Spine chose not to draw down the second tranche of $3.0 million and such tranche is no longer available. Borrowings under the credit agreement bore interest at the rate of 13.0% per annum, payable quarterly in arrears.

On August 26, 2016, the Company received $57.5 million in connection with the prepayment of the loans under the Paradigm Spine Credit Agreement, which included a repayment of the full principal amount outstanding of $54.7 million , plus accrued interest and a prepayment fee.

kaléo Note Purchase Agreement

On April 1, 2014, the Company entered into a note purchase agreement with Accel 300, LLC (“Accel 300”), a wholly-owned subsidiary of kaléo, Inc. (“kaléo”), pursuant to which the Company acquired $150.0 million of secured notes due 2029 (the “kaléo Note”). The kaléo Note was issued pursuant to an indenture between Accel 300 and U.S. Bank, National Association, as trustee, and was secured by 20% of net sales of its first approved product, Auvi-Q ® (epinephrine auto-injection, USP) (known as Allerject ® in Canada) and 10% of net sales of kaléo’s second proprietary auto-injector based product, EVZIO (naloxone hydrochloride injection) (the “kaléo Revenue Interests”), and a pledge of kaléo’s equity ownership in Accel 300.

On September 21, 2017, the Company entered into an agreement (the “kaléo Note Sale Agreement”) with MAM-Kangaroo Lender, LLC, a Delaware limited liability company (the “Purchaser”), pursuant to which the Company sold its entire interest in the kaléo Note.

Pursuant to the kaléo Note Sale Agreement, the Purchaser paid to the Company an amount equal to 100% of the then outstanding principal, a premium of 1% of such amount and accrued interest under the kaléo Note, for an aggregate cash purchase price of $141.7 million , subject to an 18-month escrow holdback of $1.4 million against certain potential contingencies. For further discussion on this topic, see Note 11.

The kaléo Note bore interest at 13% per annum, paid quarterly in arrears on principal outstanding. The principal balance of the kaléo Note was to be repaid to the extent that the kaléo Revenue Interests exceed the quarterly interest payment, as limited by a quarterly payment cap. The final maturity of the kaléo Note was June 2029; although, kaléo had the right to redeem the kaléo Note at any time, subject to a redemption premium.

CareView Credit Agreement

On June 26, 2015, the Company entered into a credit agreement with CareView, under which the Company made available to CareView up to $40.0 million in two tranches of $20.0 million each. Under the terms of the credit agreement, the first tranche of $20.0 million , net of fees, was funded by the Company upon CareView’s attainment of a specified milestone relating to the placement of CareView Systems ® , on October 7, 2015. On October 7, 2015, the Company and CareView entered into an amendment of the credit agreement to modify certain definitions related to the first and second tranche milestones. The second $20.0 million tranche would be funded upon CareView’s attainment of specified milestones relating to the placement of CareView Systems and consolidated earnings before interest, taxes, depreciation and amortization, to be accomplished no later than June 30, 2017. Such milestones were not achieved, and there is no additional funding obligation due from the Company. Outstanding borrowings under the credit agreement will bear interest at the rate of 13.5% per annum and are payable quarterly in arrears.

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

In connection with the October 2015 amendment of the credit agreement, the Company and CareView also agreed to amend the warrant to purchase common stock agreement by reducing the warrant’s exercise price from $0.45 to $0.40 per share. At September 30, 2017 , the Company determined an estimated fair value of the warrant to be less than $0.1 million .


27



For carrying value and fair value information related to the Company’s Notes and Other Long-term Receivables, see Note 3.

8. Inventories

Inventories consisted of the following (in thousands):
 
 
September 30,
 
December 31,
 
 
2017
 
2016
Raw materials
 
$
1,204

 
$

Work in process
 
3,950

 
1,625

Finished goods
 
7,062

 
1,259