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PDL BioPharma, Inc. (NASDAQ:PDLI)

Q2 2014 Earnings Conference Call

August 19, 2014 4:30 AM ET

Executives

Jennifer Williams – IR, Cook Williams Communications, Inc.

John P. McLaughlin – President and Chief Executive Officer

Peter S. Garcia – Vice President and Chief Financial Officer

Analysts

Kimberly Lee – Janney Capital Markets

Adnan Butt – RBC Capital Markets, LLC

Phil Nadeau – Cowen & Co.

Operator

Good afternoon and welcome to the PDL BioPharma’s Second Quarter 2014 Earnings Conference Call. Today’s call is being recorded.

For opening remarks and introductions, I would now like to turn the call over to Jennifer Williams.

Jennifer Williams

Good afternoon and thank you all for joining us today. I would like to first point out that there is a Slide presentation associated with today’s earnings call, and you’ll see that in the Investor Relations section of the PDL website, which you’ll find at pdl.com.

Before we begin, let me remind you that the information we will cover today contains forward-looking statements regarding our financial performance and other matters, and our actual results may differ materially from those expressed or implied in the forward-looking statements. Factors that may cause differences between current expectations and actual results are described in our filings with the Securities and Exchange Commission, copies of which may be obtained in the Investors’ section on our website at pdl.com.

The forward-looking statements made during this conference call should be considered accurate only as of the date of this call, and although we may elect to update forward-looking statements from time-to-time in the future, we specifically disclaim any duty or obligation to do so, even as new information becomes available or other events occur in the future.

I’ll now turn the call over to John McLaughlin, President and CEO of PDL BioPharma.

John P. McLaughlin

Thanks Jennifer and good afternoon everyone. With us today is Peter Garcia, our Vice President and Chief Financial Officer. As always in this call I’ll provide a summary of recent events before Pete provides an overview of our financial results from the quarter.

First of all, we apologize for having to delay this call by a week. As you know, we have been in discussions with the SEC on the accounting treatment of our Depomed royalty rights and this created the delay in filing our 10-Q for the quarter. Pete will talk later in the call about how this issue was resolved and how the Depomed royalty assets is accounted for.

Please turn with me now to Slide 3. As you know, it remains a top priority of ours to bring in additional income generating assets to increase value for our stockholders. During this year so far, we have committed over $240 million for these acquisitions bringing our total committed funds to over $800 million since we embarked on this strategy in 2012. We continue to see a measurable increase in our revenue on a quarterly basis due in part to the additional income generated by the assets we have acquired.

Along these lines in June, we acquired a royalty purchase and sale agreement with Viscogliosi Brothers whereby we have the right to receive royalties payable on sales of a PMA-approved spinal implant in exchange for $15.5 million. Additionally in May, we provided $15 million to Durata Therapeutics which was our second tranche of funding. This payment was the result of the good news that marketing approval of dalbavancin was granted by the FDA on May 23.

As you can see on Slide 4, as of now we have completed 11 transactions since launching our initiatives to create a portfolio of high-quality, income-generating assets. We’ve deployed $750 million in this program thus far and have a team that is continually evaluating assets which will provide the income necessary to support the ability to pay dividends to our shareholders.

While we are pleased with the portfolio of investments to-date, I would like to give more details on Wellstat Diagnostics and how we currently view this investment. To-date we have loaned Wellstat Diagnostics $45.7 million and we are owed approximately $54 million which include interest.

With regard to the Wellstat loan we delivered a notice of default to Wellstat Diagnostics, due to its ongoing failure to pay its debts as they become due and its failure to comply with certain covenants by contractually specified deadlines. The notice of default demands immediate repayment of the loan in the amount of approximately $54 million. We also set notices to the guarantors of the loan for immediate repayment of it.

The guarantors are affiliated or related companies, such as Wellstat Therapeutics or the two shareholders and founders of Wellstat Diagnostics and its related companies. To be clear, no payments were due to PDL, however, Wellstat Diagnostics’ financial position was sufficiently concerning to us as to necessitate this action on our part.

Our intent in these actions is to the place PDL in the best possible position to recover the full amounts due, they are designed to preserve and protect the collateral in the events that PDL elects to pursue a foreclosure sale and to put the guarantors on notice of our intent to collect them the loan from them to the extent possible. We will remain flexible in determining our ultimate course of action.

For example, we may forbear in exercising our remedy if Wellstat Diagnostics is able to secure additional funding either through third-party loan or through an equity placement. I would note that Wellstat Diagnostics has been successful in the past in finding third-parties funding to continue its operations, but we are unable to ascribe a likelihood of success to their current efforts.

Other examples of actions that PDL may take include we may proceed with the foreclosure sales of the assets of Wellstat Diagnostics in which PDL holds a perfected first party lien. The Wellstat Diagnostics collateral includes hard assets of the company such as models of their diagnostics systems, their assays, computers, lab equipments, intellectual properties such as their patents trade secrets, experimental data and engineering plans and licenses to intellectual property covering aspects of Wellstat Diagnostics assay technology.

A sale process will be conducted in accordance with applicable law as well as certain conditions, on the transfer of intellectual property licenses owned by Wellstat Diagnostics. If PDL finds a buyer at an acceptable price it may conduct a private foreclosure sale under Article 9 of UCC, if not PDL may conduct a public foreclosure sale and as such public sale PDL would have right to credit, bid part or all of its secured claims. If PDL’s credit bid results in PDL owning the asset, PDL could then evaluate its options with regard to monetizing of the assets of Wellstat Diagnostics at that time.

We may look to collect amounts due from the guarantors of the loans, which include certain affiliate and related companies of Wellstat Diagnostics as well as the two shareholders of Wellstat Diagnostics and related companies, such an action, may be subject to higher [priority] [ph] liens of third-party lenders to the Wellstat affiliate companies. It is also possible that efforts to collect from guarantors will require a legal action.

Further we can decide to collect any deficiency in amounts generated in a foreclosure sale of Wellstat Diagnostic assets, from one or more of the guarantors after the foreclosure sale is completed and the amount of any deficiency is determined.

At this point, I’ll turn the call over to Pete to review our financials for the second quarter. Pete.

Peter S. Garcia

Thank you John, good afternoon everyone. Please turn with me now to Slide number 6. Total revenues for the second quarter of 2014 increased approximately 10% to $162.8 million from $148.5 million in the second quarter of 2013. Revenues for the second quarter of 2014 include royalty payments from PDL's licensees to the Queen et al patents, net royalty payments from Depomed, the change in fair value of the Depomed asset, and interest revenue from notes receivable to debt financings to late stage healthcare companies.

The revenue growth in the second quarter of 2014 is offset by the timing differences of a flat royalty rate on the Genentech related products in 2014 versus a tiered rate in 2013. The second quarter 2014 royalty payment received from Genentech products was for worldwide net sales in the first quarter 2014. Prior to 2014, PDL's second quarter royalty revenue was historically the highest amount in any quarter because the applicable tiered royalty rate was 3%. However, as aggregate net sales increased with each subsequent quarter, the tiered royalty rate declined dropping to 1% in PDL's third, fourth and first quarters.

As a result, the blended royalty rate for all of 2013 for Genentech products was 1.9%. The settlement with Genentech resulted in a single fixed royalty rate of 2.125%, which results in a more uniform royalty revenue on a quarter-to-quarter basis in the current fiscal year. Thus, this decrease in Queen et al. related royalties between the second quarters of 2013 and 2014 is a function of the transition to the new fixed royalty rate, which new royalty rate is anticipated to result in greater royalties to PDL when measured on an annual basis.

We've previously disclosed that we have received a comment letter from the SEC staff regarding our accounting for the Depomed royalty agreement and we are engaged in discussions with them. The SEC staff asked us to explain why the transaction was accounted for as an acquisition of intangible assets as opposed to that of a financial asset. While significant judgment is required to determine the appropriate accounting for this transaction as either the acquisition of an intangible asset or a financial asset. We have concluded after consultation with our auditors and the Office of Chief Accountant of the SEC that it should be treated as a level three financial asset.

This is a change to the previously reported accounting as an intangible asset and important fact in the determination is that we only receive the rights to cash and not necessarily the intellectual property of the asset. We expect that future royalty transactions where we do not acquire intellectual property rights will be accounted for in the manner similar to that now being applied to Depomed, including our recent royalty transaction with the Viscogliosi Brothers.

Based upon this treatment as a financial asset, we recorded a correction to an error related to our acquisition of royalty rights from Depomed. Consistent with our accounting for Depomed as a financial asset, we will now measure it at fair value. The change in fair value along with net cash royalties received from Depomed is currently presented as a component of royalty rights, change in fair value in PDL's income statements. The estimated fair value is determined by using a discounted cash flow analysis related to the expected future cash flows to be received.

In addition, the previously recorded non-cash cost of royalty revenue amortization of the intangible asset was reversed and will no longer be reported. Of the $34.5 million recognized in royalty rights for the quarter ended June 30, 2014, $25.8 million were net cash royalty receipts from Depomed and $8.7 million was the net increase in fair value, including prior-period adjustments. The change in fair value includes a reduction in fair value of $4.9 million in Q2, offset by a gain a $13.6 million from the prior period adjustments but booked in Q2.

Going forward we would expect the net royalty received from Depomed to be offset by a similar reduction in fair value to Q2 unless we increased our cash flow analysis and or change inputs related to timing of future sales and discount rates applied to the cash flow. We would like to highlight our cash receipts from the Depomed transaction which were $25.8 million in Q2, $49.4 million year-to-date 2014 and $60.7 million in total since the announcement of the transaction in October of 2013.

To date this transaction has exceeded our expectations. Also of note and a change from the previous reporting and in recognition of our transitioning business model to acquire a new revenue generating assets we reclassified $12.6 million of interest income in the quarter ended June 30, 2014 related to interest from our notes receivable to interest revenue. This compares to $4.9 million in interest revenue for the second quarter of 2013. Additional details on the correction and reclassification can be found in our recently filed Form 10-Q and in our information sheet filed with our 8-K today.

To reconcile our actual results for the second quarter of $162.8 million to our revenue guidance of $140 million in June, the primary difference is $8.7 million non-cash net increase related to the change in fair value including prior period adjustments and the reclassification of $12.6 million interest income to interest revenue. We will continue to give revenue guidance in the beginning of the third month of each quarter and we will now include the estimated change in fair value from our royalty rights and interest revenue from our notes receivable in future guidance.

Turning to total revenues for the first six-months of 2014 revenues increased 23% to $299.6 million compared with $244.1 million for the first six-months of 2013. The increase for the first six-months of 2014 over 2013 is primarily driven by the addition of royalty payments from PDL’s purchase of Depomed diabetes-related royalties, increased royalties in the first two quarters of 2014, related to sales of Xolair, Kadcyla, Perjeta, and Actemra, along with a higher fixed royalty rate in 2014 over the blended fixed and tiered 2013 rate.

Also a $13.0 million increase in interest revenue related to acquisitions of new revenue generating assets, and a $5.0 million retroactive payment in the first quarter of 2014 related to our settlement agreement with Genentech. This is offset by a higher foreign exchange loss and higher rebate paid to Novartis for Lucentis.

Our operating expenses in the second quarter of 2014 were $6.9 million, compared with $6.8 million in the second quarter of 2013. Operating expenses in the first six-months of 2014 were $11.5 million, compared with $14.0 million in the first six-months of 2013. The decrease in operating expenses for the first six-months ended June 30, 2014, was primarily due to a decrease in litigation legal expenses, partially offset by an increase in acquisition due diligence expenses.

Net income in the second quarter of 2014 was $92.1 million, or $0.52 per diluted share, as compared with net income in the second quarter of 2013 of $93.7 million, or $0.62 per diluted share. Net income for the first six-months of 2014 was a $164.9 million, or $0.94 per diluted share, as compared with net income in the first six-months of 2013 of $147.2 million, or $0.96 per diluted share. At June 30, 2014, we had cash, cash equivalents and investments of $217.8 million compared with $99.5 million at December 31, 2013.

I will now turn the call back over to John.

John P. McLaughlin

Thanks Pete. As a remainder as you’ll see on Slide 7, we have made it a priority PDL to return value to our shareholders to our regular quarterly dividend program. This year we either have paid or will pay dividends of $0.15 per share or total of $0.60 per share to our stockholders representing the highest dividend yields among biotech and pharma companies. In accordance with our dividend policy we paid the second of four dividends on June 12 to all stockholders of record as of June 5 for a total of $24 million.

Operator, at this time we’d like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Kim Lee with Janney Capital. Your line is now open. Please proceed with your question. One moment with your question please.

Kimberly Lee – Janney Capital Markets

Good afternoon.

John P. McLaughlin

Hi, Kim.

Kimberly Lee – Janney Capital Markets

Hi, can you hear me.

John P. McLaughlin

We can.

Kimberly Lee – Janney Capital Markets

Great, thanks. Just a couple of questions here, one on the Wellstat deals? What would you say is the worst-case as far as financial implications go for PDLI?

John P. McLaughlin

I think probably the most draconian situation is we wind up taking over the asset, we wind up selling it, and we sell it in the marketplace for what the marketplace goes, and we don't recover some – we don't recover the full value for the loan. And I think we are feeling pretty good about the quality of the asset both in terms of their hard assets but also their IT, so that's not what we're suggesting. But if you want to say what's the worst, the worst is we sell it in a public auction and we recover less in the auction than it's worth.

Kimberly Lee – Janney Capital Markets

Okay. And what would be the timing of or resolution of this issue with Wellstat?

John P. McLaughlin

Kim, it's hard to know. One of the reasons we gave a couple of examples was because we can't say at this point. I mean these folks are out looking at money. They are serial entrepreneurs. Previously they've had to go out and raise money and they have been successful at doing it. They are trying to do it again.

We just really don't have enough information to ascribe a probability of – are they going to be successful or not? So what we did was, in the absence of knowing whether it was going to be successful or not, we wanted to make sure we perfected our various first-priority claims against these assets, just to make sure, in case they didn't raise money, we could step in, take them over and, if necessary, sell them.

Kimberly Lee – Janney Capital Markets

Okay, great. And then based on your experience with Wellstat, does this change, if any, your strategy for doing these types of deals going forward?

John P. McLaughlin

No. I mean I think we are satisfied with the portfolio. The portfolio is performing nicely. I think we are generally satisfied with it. Some of them are doing well. Pete mentioned that in fact Depomed is actually beating our expectations. Wellstat – we are keeping an eye on them. Obviously, our goal is to make sure that we produce income to pay dividends. So, we are pretty vigilant about keeping an eye on it and we move aggressively to protect our shareholders' assets. And that's what we're doing.

Kimberly Lee – Janney Capital Markets

Okay, great. And then just to clarify for the Depomed royalties, the royalties that you received from Depomed – was that the $25.8 million?

Peter S. Garcia

That was the cash received, yes, Kim, for Q2.

Kimberly Lee – Janney Capital Markets

Okay, great. And then are you able to tell us what the royalties were for the other products from the Depomed transaction, I think the other one from Janssen?

Peter S. Garcia

I don't think we've disclosed that. But the total was $25.8 million. It was primarily, 98% Glumetza.

Kimberly Lee – Janney Capital Markets

Okay.

John P. McLaughlin

Just to give you a little guidance.

Kimberly Lee – Janney Capital Markets

Right, right. Okay, great. Appreciate the clarity. Thanks.

Peter S. Garcia

Sure.

Operator

Thank you. Our next question comes from the line of Adnan Butt with RBC Capital Markets. Your line is now open. Please proceed with your question.

Adnan Butt – RBC Capital Markets, LLC

Hey, good afternoon everybody, hope you can hear me. So first, just a follow-up question on just Depomed and other deals. You stated Depomed is doing better. Can you quantify that a bit better? And then any other deals that are performing either in line to better than you expected?

John P. McLaughlin

Yes, Adnan. So we typically don't release guidance in terms of – are they doing a little bit better or little bit worse? I think one of the reasons we wanted to call out Depomed was because it is performing better by a significant margin compared to what we determined internally and there has been a lot of focus on Depomed in terms of how is it going to go and what do the numbers look like.

So I don't know that we are prepared to be much more granular than that. I mean as Pete clarified for Kim, much of what is driving it right now are Glumetza royalties. There are royalties on other products, and some of those are approved by Janumet, some are not. And we are anticipating their approval and they will continue to provide revenues. But I don't know that we are going to provide much more detail than that.

Adnan Butt – RBC Capital Markets, LLC

John, for Wellstat you mentioned that all obviously it’s not performed as expected. So what is the specific, if you can give it, reason there that it has underperformed? And then secondly, you mentioned that any resolution potentially could be at the behest of the markets. The assets – I mean, do they have to come in below what the lending cost has been or could they also come in higher?

John P. McLaughlin

So, just to be clear, we actually don't know if that's going to underperform or not. The basis for filing the notices of default was they haven't been able to pay some of their bills. They may raise additional money and may be [fined] [ph] in the future. They may not raise additional money, in which case we will proceed forward with the notices of foreclosing on the assets of the company. How the asset is actually going to perform – it's not like with their current sales, for example. So, it's not a situation like Depomed where you can measure it and say, okay, we had an internal number X, and they are doing X plus Y, it's different.

To your point, when we sell that in the marketplace, to be clear, it could sell for more than we are carrying it on the books, the $54 million approximately that we are carrying it for. It could sell for less than that. I mean I think – we think it's a very valuable asset. They have a technology incorporating electrical chemical luminescence. They have a sublicense from Roche. Roche is the dominant player using that technology. It’s not likely they are going to grant other sublicenses to other parties. So it may be the only way to enter that field using that technology in diagnostics. So that could be quite valuable in addition to their underlying hardware and assays. To your point, though it could be upside, it could be….

Adnan Butt – RBC Capital Markets, LLC

Okay, last question and then I will get back in line. At this time what impact, if any, does it have on your ability to pay dividends?

John P. McLaughlin

None.

Adnan Butt – RBC Capital Markets, LLC

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Phil Nadeau with Cowen and Company. Your line is now open. Please proceed with your question.

Phil Nadeau – Cowen & Co.

Thanks for taking my questions. One more on Wellstat – John, can you give us some sense of when this will be resolved, when you will know what path you are going to go down or we will get additional information on what's likely to happen?

John P. McLaughlin

Sure, Phil. I think they are going to have to find some funding, some additional funding reasonably quickly, say in the next four weeks, six weeks. Pick a number like that, something like that. We would like to see them put in some longer-term funding so that we can have comfort that in fact it will be sustainable. My guess is we will probably see something in that timeframe, but that's a guess. There's no way to know, they may get stopgap funding and then get longer-term funding after that. I think this is something we're probably going to have a pretty good sense of between before the end of the third quarter.

Phil Nadeau – Cowen & Co.

Okay. And you mentioned that they are having trouble paying their bills and also that it was really their financial position that caused you to send them the notice. Could you give us maybe a bit more information on what their financial position is? Is it basically that they have four to six weeks of cash left? Or are you free to say anything about how much runway they have?

John P. McLaughlin

Yes, I don't know that we can say anything about it other than that we saw that there were some bills they were not paying, and that was enough to cause us to have concern. To be clear, the purpose here is to protect our rights. If we are not comfortable that in fact they are going to have enough money to be able to continue to go forward, there are additional steps we will take to protect those assets and secure them on behalf of PDL. We haven't taken all the steps we need to take yet. We've taken some, not all.

Phil Nadeau – Cowen & Co.

Okay, great. And then one on the Depomed accounting change – so it sounds like, Pete, if I interpreted your comments correctly, every quarter there will be about a $5 million non-cash charge for valuation adjustment for the next several quarters. Is that correct, based on the new accounting? And for how long will that persist? Will it go beyond 2015?

Peter S. Garcia

So the fair value model is we model it out for nine years. This would mean we will get royalties through the nine years. But the $5 million will be, I would say, for the next couple of years. It just – and it really is related to Glumetza, and then once it's off patent, then those numbers may change. But your comment about the $5 million per quarter now would be – and just to be clear, that would be netted against the cash receipts that we would receive from Depomed on the diabetes-related royalties. So as an example, if we got $25 million again next quarter, it would be netted, the $5 million would be netted and we would recognize $20 million on that particular line item in revenue.

Phil Nadeau – Cowen & Co.

Okay, great. That's very helpful. On the Durata transaction I believe you loaned another $15 million during the quarter. If memory serves me, there's still another $25 million that could be triggered. Is that correct? And when or if could that be extended to Durata?

John P. McLaughlin

Yes, so there's another $15…

Peter S. Garcia

$30 million.

John P. McLaughlin

$30 million excuse me $30 million that could be drawn down. And I think it’s in two parts. Is that right? One part. But I think it's at their option. Am I remembering correctly? So it's at their option as to whether or not they want to draw that money down or not. And I think they have another – how many months? Yes, they have got about another eight months to decide, Phil.

Phil Nadeau – Cowen and Co.

Okay.

John P. McLaughlin

It's not something they have to do immediately.

Phil Nadeau – Cowen and Co.

Okay, great. And then, sorry, one last question. And that's on the term loan facility. Am I correct in remembering that that needs to be paid off over the next couple quarters?

Peter S. Garcia

Oh, sorry, the $75 million that we took on RBC from…

Phil Nadeau – Cowen and Co.

Yes, I think…

Peter S. Garcia

Yes, yes, that will be paid off. There is one payment left. And we made the payment in July the last payment will be made in October.

Phil Nadeau – Cowen and Co.

Okay. Perfect.

Peter S. Garcia

[Indiscernible] yes.

Phil Nadeau – Cowen and Co.

That's great. That helps with modeling. Thanks a lot.

John P. McLaughlin

You’re welcome.

Peter S. Garcia

Thank you.

Operator

And with no further questions in the queue. I would like to turn the call back over to John McLaughlin for any closing remarks.

John P. McLaughlin

Thank you for joining us on the call this afternoon. We appreciate your participation. And have a good day all.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Have a good day everyone.

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