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PDL BioPharma, Inc. (NASDAQ:PDLI)

Piper Jaffray 2013 Healthcare Conference Call

December 3, 2013 3:00 PM ET

Executives

John McLaughlin – President and CEO

Pete Garcia – VP and CFO

Analysts

Charles C. Duncan - Piper Jaffray

Charles C. Duncan - Piper Jaffray

I think we’ll get started with this session. I very much appreciate everyone’s interest and wanted to welcome you to the 25th Annual Piper Jaffray Healthcare Conference. The afternoon of Day 1 starts to get a little bit rugged because there is none of Red Bull in the world for me to keep all this straight. But it is a pleasure to introduce the next presenting company and that is PDL BioPharma. I would argue that PDL has probably one of the more interesting business models of all the companies I’ve ever run across. And it’s certainly evolving. And so it’s a pleasure to introduce Mr. John McLaughlin who is the company’s CEO; Mr. Pete Garcia who is the company’s CFO. They’re going to tell us a little bit about PDL and we’ll ask questions. If you have any please just raise your hand, I’ll try to catch you or just yell at me.

So, John, first of all tell me your perspective on PDL, you’ve been there for a while, you’ve seen it undergo some real changes. Why’d you join and where you think it’s going?

John McLaughlin

So, I joined because I asked the question. So, one day I joined the Board and we were talking about splitting the company up and part of it was to spin off the R&D operation and part was spin-off of the royalty operations. And everybody was thinking about the R&D operations, and finally I stuck my hand up and said, what are we going to do with the guys that are actually making money, the royalty operation, and they said well that’s a good question, we haven’t figured that out, why don’t you go take care of that. So, always be careful of what you’re asking.

Charles C. Duncan - Piper Jaffray

Be careful of what you ask.

John McLaughlin

So, what we decided to do was a different model to – we were discussing with a group of investors early today and they would saying you’re unique, and I did - there is probably some truth to that. Early on we decided we were going to return our money to shareholders, we started paying dividends in 2009. We attracted a dividend income sensitive shareholder base, the story evolved as shareholders came to us and said love the dividend, you folks have been paying a nice dividend of, our current dividend is $0.60 per year per share, we announced it a year in advance.

But the concern that was raised consistently among our shareholders was can you continue to pay dividends after your patents expire in 2014, at the end of 2014. And to be clear, we’ll continue to get revenues from the current patents materials made before the [inaudible] expiration but sold afterwards. But after discussions with a series of shareholders we began investing in new income generating assets to support our dividend.

Charles C. Duncan - Piper Jaffray

Well that’s what we’re going to talk a lot about in terms of going forward the income generating assets but why don’t we talk a little bit about first of all the IP behind the current role of paying a dividend. The perspective I think for most investors is that it’s going to run out at the end of 2014 maybe couple of months later but what’s your view on that?

John McLaughlin

So, it’s interesting. The IP covers the manufacture of the humanization of antibodies. For those of you who’ve been involved in biotech businesses you know that synthesizing an antibody takes a lot longer than for example a small molecule; you can synthesize a typical small molecule in a week, two weeks, if it’s really complicated, maybe three weeks. Between bulk stage manufacture and filling [inaudible] sequences perfectly, you’re talking about seven months or thereabouts. And to point of your question, it’s for that reason that most of the manufacturers keep a substantial inventory 24 months or more on hand to the extent that the product is made before our patents expire in December 2014 and sold after and again bear in mind it takes about seven plus months to make the stuff most of them keep quite a bit more than that on hand but let’s just assume they only kept 12 months on hand, that would still allow us to collect royalties through late 2015 into early 2016.

Charles C. Duncan - Piper Jaffray

Yeah. So, you’ve been hanging around with Roche for a long time and probably studying their practices. What’s their usual practice, are they really good at making proteins fast, faster than anyone else or are they average and would you anticipate call it a year’s worth of inventory to be made?

John McLaughlin

The cells only grow so fast, you can’t grow them any faster, and you can only purify them so fast. There is a recipe that works, it’s a good recipe. Some of the most conservative people you will find in any biotech company are the folks in manufacturing, they don’t depart from a recipe that works.

Charles C. Duncan - Piper Jaffray

Yes.

John McLaughlin

So, I don’t think we’re going to see much difference, I think they’ll probably continue to keep size of inventories and I think we are comfortable in guiding people to at least 12 months worth of inventory.

Charles C. Duncan - Piper Jaffray

Okay. So, you’re saying that it’s possible and you could realize royalties through 2015 or so, my words.

John McLaughlin

No, that’s correct, and actually I mean potentially through 2016 because we get paid about a quarter in arrears. So, going by virtue how a royalty payment works that actually gets through the first quarter of 2016.

Charles C. Duncan - Piper Jaffray

Sure. Okay. Good. Well, surely that is part of the reason the stock has moved recently; stock’s had a very good run as of late and what a difference a year makes, really a nice move. And there is a paucity of other income generating assets out there certainly in biotech land I think that number is two or three that pay. But what do you think is behind the large stock move recently?

John McLaughlin

So, I think part of it – it’s a couple of thoughts, so some are very straight forward. We’d announced our third quarter earnings and basically royalty income was up 13% and total income was up 14%. And I think people are continuing to appreciate that there is more growth in the current portfolio. Probably a bigger driver though was we announced that in the last few weeks prior to the earnings call, and these were deals we’ve been working on, in some cases for many months. We had deployed $360 million some odd in capital in new income generating assets and over the two years of 2012 and 2013 just under $500 million. And I think people had seen a deal here, a deal there but it was probably the first time where they saw in the aggregate pool and the quality assets, their strong management teams and that’s a good size number.

Charles C. Duncan - Piper Jaffray

Yeah, there is a fair number of deals that you’ve been doing, or you’ve done doing deals, you’re capacity constrained or could we anticipate additional ones?

John McLaughlin

It’d be nice if we did goof off; we’re not goofed off anymore. So, we had two good years, we’ve got to go out and replicate those kinds of years.

Charles C. Duncan - Piper Jaffray

So, what kind of internal rates of returns are you targeting?

John McLaughlin

So, we typically don’t disclose what the internal rate of return is but if you look at the deals we’ve done they’re adjusted in terms of the risk reward ratio. So, you’ll see for example if you look at Durata the coupon rate on the money we loaned them is reasonably high once they get approval, and we have high confidence they will get approval in fact they just picked up priority review the other day on their filing which was accepted for processing by the FDA.

Charles C. Duncan - Piper Jaffray

Yeah.

John McLaughlin

Then the coupon rate comes down so it starts at like 15.5 and I think it comes down to probably 13.5. So, they’re risk adjusted, we tried at least others that the coupon rates were a little higher either because it’s not because we don’t like the product but perhaps they’re earlier in their commercialization of the product and we want to have a little more of a return for our shareholders based on taking that kind of risk.

Charles C. Duncan - Piper Jaffray

So, in this last year the market has been pretty good, spend better than it has been for a long time in terms of equity, availability of equity investment. Has that slowed down the deal flow for you and are you starting to see a pick up towards the end of the year, maybe equity catalyst not so available.

John McLaughlin

It’s a very good question, it’s a very good question. So, we saw good deal flow this year and in fact we turned down a lot of deals, we’re in the process of trying to hire one to two more people because we are starting to see a little bit more of an uptick as people get nervous about will the equity markets particularly for the drug companies be as available as they were in 2013, I mean 2013 was a great year. Unfortunately great years are sometimes followed by not so great years at least at some point.

Charles C. Duncan - Piper Jaffray

Yeah, I think it will be a stock picker’s year next year. So, what kind of deals are you looking for and would you be willing to take on some additional debt to make them happen?

John McLaughlin

So, the answer is yes, in fact we actually did take on a little additional debt. Pete, do you want to talk about that for a second.

Pete Garcia

Yeah. So, related to the deal flow that we had we get our royalty payments in the mid quarter of every quarter.

Charles C. Duncan - Piper Jaffray

Yeah.

Pete Garcia

We did an interim kind of a short term loan, a 12 month loan with RBC and Wells Fargo Bank which was for $75 million at really good rates that was 2.25% for the year.

Charles C. Duncan - Piper Jaffray

Yeah, that is good.

Pete Garcia

Yeah. So, those are the type of hopefully and we’re not at the point where we can do more longer term debt but at some point we would be looking at that.

Charles C. Duncan - Piper Jaffray

So, it seems like many of your deals have been kind of device-y or a diagnostic like – is that because you feel they are less risky or is there a greater demand for cash there?

John McLaughlin

It actually goes to the observation you just made with respect to the biotech companies, they’ve had great access to the capital markets.

Charles C. Duncan - Piper Jaffray

Yeah.

John McLaughlin

That has not been as true for some of the medtech stories.

Charles C. Duncan - Piper Jaffray

Yeah.

John McLaughlin

You just don’t, I mean you look at some of the ones where we did some financings for a Direct Flow Medical, it’s a revenue story, they were the major hit at TCT conference the major conference for catheter delivery systems.

Charles C. Duncan - Piper Jaffray

Sure.

John McLaughlin

They’ve got some great data, nice revenue curve and yet the catheter markets is just aren’t as quite as available today, were it a Avinger or a private company, again John Simpson the guy has co-founded and sold six catheter companies for $2 billion.

Charles C. Duncan - Piper Jaffray

You can’t get funded.

John McLaughlin

Yeah. So, really successful entrepreneur. So, to your point we are seeing more of those kinds of deals but I do think your other point is valid as well I do think that with perhaps the catheter markets maybe not requiring as a - not quite as available to the drug story, we may see some bouncing in the number of deals.

Charles C. Duncan - Piper Jaffray

So, besides being a source of cash, do you have any competitive advantage, is there anything you can offer these folks, it would seem to me just thinking about I’ve covered the stock for many years, it seems to me that the challenges that you’ve had with some of your royalty payers in terms of keeping them honest about what they should pay you maybe you can bring that to bear and in terms of some of these deals.

John McLaughlin

It is good – it’s a very good point. And so particularly where you have to - more and more you do have to actively manage the portfolio, I mean that’s the lesson everybody is learning.

Charles C. Duncan - Piper Jaffray

Yeah.

John McLaughlin

Be it us or some of the other royalty buyers it does require active management. And in a couple of instances we’re talking about putting consortiums together we have other royalty buyers for much bigger deals that we couldn’t fund or wouldn’t want to fund by ourselves. And to your point they’re basically saying, look one of the things we want you guys to do is actually manage the portfolio of [inaudible] these guys.

Charles C. Duncan - Piper Jaffray

Sure, you’re the operators.

John McLaughlin

Exactly. And I think that’s the range we were comfortable with and we want to pull a couple of those off.

Charles C. Duncan - Piper Jaffray

Yeah. Let me ask you just the kind of big elephant in the room. Are you going to keep doing this?

John McLaughlin

Yes, I hope so. The Board is going to make a decision whether or not we’re going to keep doing this to be clear.

Charles C. Duncan - Piper Jaffray

Yeah.

John McLaughlin

At the end of either this month more likely next month but we’ve done a fair number of deals; we’re happy with the quality of the deals and it’s something that we’re going to sit down and talk with the Board about these and see if they agree but we promised two years ago we gave shareholders some indications as to whether or not we thought it was a successful experiment and we started, time is about up and we’re going to give them answer.

Charles C. Duncan - Piper Jaffray

It maybe – and maybe an obvious thing but what is the key criteria by which the Board or you folks would recommend to the Board, you continue doing this, is it a return of capital to shareholders, what is the key thing?

John McLaughlin

Yes, yes and yes.

Charles C. Duncan - Piper Jaffray

Okay.

John McLaughlin

It is all about can we pay dividends to return money to shareholders, we have a dividend sensitive, income sensitive shareholder base and can we give them a good dividend and support that dividend, that’s – that is a first and last thing and all in between.

Charles C. Duncan - Piper Jaffray

Right. I mean because once you start on there you got to continue it.

John McLaughlin

And we started paying out – to your point we started paying a regular dividend a couple of years ago when we went to a regular dividend because shareholders said to us look special dividend means you guys could change your minds, regular dividend means you’re kind of stuck with this number, you’re going to support it and it really shouldn’t go down, can you withstand that?

Charles C. Duncan - Piper Jaffray

Right.

John McLaughlin

We respect it and that’s the goal.

Charles C. Duncan - Piper Jaffray

Are there any questions at this point for John? I have others but, yes sir.

Question-and-Answer Session

Unidentified Analyst

We’re starting to see a lot more players in the royalty space or [inaudible] investors, big funds [inaudible] but it seems you [inaudible] I’m curious if the accessible IRR is dropping as it used to be like 15% and I don’t know what the new number is this week. And the low interest rate environment so that’s why hence you deserve the multiple expansion you’ve had, I’m just curious [inaudible].

John McLaughlin

No, it’s a fair point, so clearly there have been a couple of funds that are put together, it does ratify somewhat by size, we tend to play more in the $50 million or $250 million range. So, with the little less competitive, there are much bigger players than us to play sort of in the $400 million to $500 million range and there is a lot of players in the sub $10 million range and 10 through kind of 30 range, thereabouts.

Unidentified Analyst

Yeah.

John McLaughlin

So, most of the transactions we’ve done we’ve been able to do on a non-competitive basis.

Charles C. Duncan - Piper Jaffray

Does that answer your question?

Unidentified Analyst

But in terms of rate of return that you’re seeking, I’m not just - naturally with rates being as low as they are you can afford to accept a little less?

John McLaughlin

No, so to your point there are certain processes that people run where we can see the clearing rate’s going to be 8%, 9%, 10% of the transaction. We might get the [inaudible]; we typically don’t bid on those. I’m not –I mean they’re great transactions, they’re good, could we make probably money for our shareholders? Yeah, but well we’ve got a queue where we’re kind of in the mid-teens or north of 15%, 16%, 17%. There is only a finite amount of money so let’s see am I going to put an 8%, or am I going to put in a 16% or 15%. At some point that day may come to past, no so far.

Charles C. Duncan - Piper Jaffray

Any other questions at this point from the audience? Yes sir. John, I was going to ask you a question which I know you’re not going to answer so I’m going to answer it, [inaudible]?

John McLaughlin

Do you want to answer the question?

Charles C. Duncan - Piper Jaffray

You can even ask the question to me. How is it going with the Roche litigation?

John McLaughlin

So, what Charles is referring to is we have some litigation with Genentech and Roche and it stems from a fax they sent us in August of 2010 which basically said look we Genentech and Roche are – we Genentech are ready to deal with the best at Roche, Novartis because they’re not sure they owe you money on European sales, royalties on European sales. Now to be clear they have paid the money on the European sales since we got that fax however many years ago at this point. We are in litigation with them, we’ve done an audit on them to make sure they’ve been paying and it’s a breach of contract case so it’s a case that says we had a settlement agreement with you Genentech, you said you wouldn’t challenge our patents or help anybody challenge our patents,, we think that constitutes a challenge and that’s what’s in the court. What Charles is referring to is we recently announced because it was publicly visible that some of the activities had slowed down or been delayed by the agreement of the parties that we were in the settlement conversations and unfortunately we can’t saying anything other than we are in settlement conversations, if they’re productive you’re going to hear from us, if they’re not productive, you’re going to hear from us and we really can’t speculate as to whether it’s going to – they will be fruitful or not.

Unidentified Analyst

Which markets [Inaudible]?

John McLaughlin

So, the challenge the letter refers to the European markets, EU.

Unidentified Analyst

[Inaudible]?

John McLaughlin

So, it’s probably in excess of 50%, 53% someplace in there. So, it’s a good size number.

Charles C. Duncan - Piper Jaffray

But they’ve - to be clear, they’ve continued paying.

John McLaughlin

So, the fax came in August and we have gotten royalty checks from them now for three plus years since.

Charles C. Duncan - Piper Jaffray

So, is there is a certain timeline for a settlement discussions to be done discussion.

Unidentified Analyst

How much more time [inaudible] that’s in question?

Charles C. Duncan - Piper Jaffray

That’s what we’re talking about, so December 14 but then they would pay through the end of the inventory, so let’s call it 12 months later, 18 months later [inaudible]. So, we’re talking one to three years. But is it driven - are the timelines driven by coming to an agreement or is it driven by some [gain chart] [ph] thing that some guy in Switzerland has to live up to.

John McLaughlin

Yeah, I apologize, I really can’t comment anymore. Sorry.

Charles C. Duncan - Piper Jaffray

So, [inaudible] like in couple of days or couple of weeks?

John McLaughlin

I wish, I wish I could say more, I can’t, I’m sorry.

Charles C. Duncan - Piper Jaffray

Okay. I understand. I know you wouldn’t answer that. You’ve always been gracious taking my questions, silly questions and that is – it could be worthwhile two year to complete that, although they’ve been paying the royalties.

John McLaughlin

Yeah. And from our view the most important thing right now is to get the money in hand for our shareholders to be able to pay dividends. Obviously there are some potential damages there, were it not to be successful litigation, we’ll see. Our first obligation is to get the money in hand for our shareholders, pay them and then figure out if there is damages to be had.

Charles C. Duncan - Piper Jaffray

I got you.

Unidentified Analyst

Just say you pay out to the shareholders and then you lose the litigation [inaudible] return the royalties [inaudible]?

John McLaughlin

No.

Charles C. Duncan - Piper Jaffray

So, once the money is in your bank it’s – you can’t –there is no way that they can make you.

Unidentified Analyst

The delay [Inaudible] very good.

Charles C. Duncan - Piper Jaffray

Well, but has there been an active delay on your part?

John McLaughlin

Yes, and that’s what prompted actually the disclosure was, people were reading the court document very carefully, they could discern that and we figured rather than having somebody read a court record and hold something so to say what do you know and give him some sort of a garbled answer, we just decided the better part of the dollar was just to sort of tell everybody like here is what’s going on in case you are just tripping over and tell everybody at the same time recognizing that we couldn’t say much beyond we’re having conversations.

Charles C. Duncan - Piper Jaffray

Does this have anything to do with the Board discussion you’re talking about earlier regarding continuing their current business plan?

John McLaughlin

Coincidental.

Charles C. Duncan - Piper Jaffray

Coincidental.

John McLaughlin

Coincidental timing.

Charles C. Duncan - Piper Jaffray

So, one does not impact the other?

John McLaughlin

Coincidental timing.

Charles C. Duncan - Piper Jaffray

Okay. All right. Any other questions from the audience. Well it’s a very interesting business John, you guys have built in, clearly your source of capital very different, I’m not sure I understand how to value it but I do know that lot of biotech investors that are interested in my work or interested in hearing from you guys. So, I wish you luck in searching for some additional deals and being able to continue to pay that dividend. Thank you for sharing the story with us.

John McLaughlin

Thank you very much Charles for inviting us and thanks for your attention all.

Charles C. Duncan - Piper Jaffray

Thank you.

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