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PDL Biopharma, Inc. (NASDAQ:PDLI)

F2Q11 Earnings Call

July 27, 2011 11:30 a.m. ET

Executives

John McLaughlin – President and CEO

Cris Larson – Vice President and CFO

Jennifer Williams – IR

Analysts

Joel Sendek – Lazard Capital Markets

Charles Duncan – JMP Securities

Jason Kantor – RBC Capital Markets

Phil Nadeau – Cowen & Company

Operator

Good afternoon and welcome to PDL Biopharma’s Second Quarter 2011 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

Thank you all for joining us today. 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 maybe obtained in the Investor 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 McLaughlin

Thank you Jennifer and good afternoon everyone. Also with me today is Cris Larson, our Vice President and Chief Financial Officer. I will begin with the business update and then turn the call over to Cris to discuss our financial results. I’d like to take a few minutes to take you on the Genentech Ruling dispute. By way of review, in August 2010, we received a letter from Genentech, sent on behalf of Roche and Novartis, asserting that Avastin, Herceptin, Lucentis and Xolair® do not infringe our supplementary protection certificates also known as (SPCs) granted to us by various countries in Europe for each of these products, they asked for response to these assertions.

The SPCs covering these products effectively extend the patent protection for our European Patent until December 2014, except that the SPCs for Herceptin will generally expire in July 2014. We responded to Genentech, stating that we believe its assertions of non-infringement are without merit and that we disagreed fundamentally with its assertions of non-infringement with respect to the Genentech Products.

In August 2010, we filed a complaint in the Second Judicial District of Nevada against Genentech and Roche seeking to enforce our rights under our 2003 settlement agreement with Genentech and seeking an order from the court declaring that Genentech is obligated to pay us royalties on sales of the Genentech Products that are manufactured and sold outside of the United States.

We’re pleased to report in July that the court ruled in favor on the two motions to dismiss filed by Genentech and Roche in our lawsuit related to 2003 settlement agreement. Specifically the court denied Roche and Genentech’s motion to dismiss four of the five claims for relief and, further, denied Roche’s separate motion to dismiss for lack of personal jurisdiction of Roche. The court did dismiss one of our claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing stating that, based on the current state of the pleadings, no “special relationship” had been established between Genentech and us, as required under Nevada law.

The effect of the Court’s July ruling is that we are permitted to continue to pursue its claims. First that Genentech is obligated to pay us royalties on international sales of the Genentech Products. Second, the Genentech, by challenging, at the behest of Roche and Novartis, whether our SPCs cover the Genentech Products breached its contractual obligations to us under the 2003 settlement agreement. Third, the Genentech breached the implied covenant of good faith and fair dealing with respect to the 2003 settlement agreement and announced that Roche intentionally and knowingly interfered with our contractual relationship with Genentech in conscious disregard of our rights.

We are seeking compensatory damages, including liquidated damages and other monetary remedies set forth in 2003 settlement agreement, punitive damages and attorney’s fees as a result of Genentech and Roche’s conduct. Its important to note that the ultimate outcome of this litigation is uncertain and we may not be successful in all our allegations.

During the second quarter, we continue pursue several royalty assets purchase opportunities that we believe would increase the return to our shareholders. While we are not reporting anything specific to-date, we look forward to keeping you apprised of our progress in the months ahead.

In addition, we issued new convertible notes due in May 2015 and with the proceeds from those notes, we’re deeming all of our convertible notes which were due in February 2012. While we could have retained the 2012 notes, we pursue these transactions to free of our cash for the purchase of new royalty assets.

At this time, I’d like to turn the call over to Cris Larson to discuss our second quarter financial results.

Cris Larson

Thank you, John. Total revenues for the second quarter of 2011 were $122.1 million compared with $120.3 million in second quarter of 2010. Royalty revenues for the second quarter increased 1% over the comparable quarter of 2010.

Total revenues for the six months ended June 30th, 2011 were $205.5 million compared with a $182.4 million with the same period in 2010. Including our six months results is a $10 million settlement payment from UCB Pharma resolving all disputes between the companies. Excluding this one-time payment, revenue was $195.5 million for the first six months of 2011 compared to a $182.4 million for the first six months of 2011, a 7% increase.

The growth in royalty revenues for both the three and six months ended June 30th, 2011 was primarily driven by increased sales by our licensees of Herceptin, Lucentis and Tysabri, offset in part by reduced royalties on sales of Avastin.

Turning to expenses, general and administrative expenses for the second quarter of 2011 were $3.8 million compared to $8.8 million for the second quarter of 2010. General and administrative expenses for the first six months of 2011 were $9.6 million compared to $18.2 million for the same period of 2010. The decrease in expenses for both the second quarter and the first six months of 2011 was primarily due to the conclusion of several legal matters in the first quarter of 2011 and the resulting reduction in our legal expense.

During the quarter, we continued to execute on our corporate objective to restructure our capital and increase our financial flexibility. In May, we issued a $155.25 million of new 3 and 3.25% convertible senior notes due in May 2015. The May, 2015 notes are fairly convertible on our after November 1st, 2014 or on the current of certain conditions as described in the indenture.

Importantly, these notes net share settle and unlike our other convertible notes, if converted we will pay the converted value in cash up to the amount of the principal outstanding and only issue shares to the extent of the conversion value exceeds the principal amount. As such, these notes are less dilutive and typical convertible notes which provides for physical settlement upon conversion. And they are excluded from our calculation of net income for diluted share.

At the same time, we completed the convertible note transaction, we entered into privately negotiated option and warrant transactions, which synthetically increased the initial conversion price of approximately $7.92 per share to approximately $9.31.5 per share of our common stock for each $1,000 of principal outstanding. The conversion price has subsequently been adjusted down with a payment of our June 15th dividend to approximately $7.74 and $9.10 respectively.

Using the proceeds from the issuance of these new convertible notes, at the end of June, we redeemed the remaining a $133.5 million of our 2% convertible senior notes due in February 2012, fully retiring notes. We also repaid $62.6 million of our securitization debt in the first six months of 2011.

As of June 30th, 2011, we have $477 million total debt outstanding. At December 31st, 2010, we had $517 million in total debt outstanding.

Net income for the second quarter of 2011 was $70 million or $0.38 per diluted share compared with net income of $50.1 million or $0.30 per diluted share for the second quarter of 2010.

Net income for the six months ended June 30th, 2011, was a $114.5 million or $0.63 per diluted share compared to $76.1 million or $0.44 per diluted share for the same period of 2010.

Adjusting for the convertible note repurchased transactions, and the amortization of non cash debt discount associated with our May 2015 notes, non-GAAP net income for the second quarter of 2011 was $70.8 million or $0.39 per diluted share compared with $64.9 million or $0.38 per diluted share in the second quarter of 2010.

Non-GAAP net income for the six months ended June 30th, 2011, was a $115.4 million or $0.63 per diluted share compared with $90.9 million or $0.52 per diluted share in the six months ended June 30th, 2010.

In accordance with regular quarterly dividend policy, we paid our second and fourth quarterly dividends on June 15th to all stockholders of record as of June 8th for a total of $21 million.

In connection with the dividend payment, the conversion ratios were outstanding 2.875 convertible notes due in 2015 was adjusted to a 147.887 shares per $1,000 principal amount of the convertible notes, or conversion price of approximately $6.76 per share of common stock effective June 9th, 2011.

For our May 2015 notes, the conversion ratio was adjusted to 129.274 shares per $1,000 principal amount or approximately $7.74 per share effective June 6th, 2011.

Net cash provided by operating activities for the second quarter of 2011 was $87.9 million compared with a $123.6 million provided by operating activities in the second quarter of 2010.

As of June 30th, 2011, PDLI cash, cash equivalent and investments of $236.3 million as compared with $248.2 million at December 31st, 2010.

Following our policy of providing quarterly revenue guidance in the third month of the quarter, we will be providing third quarter revenue guidance in early September.

I’ll now turn the call back to John.

John McLaughlin

Thanks Cris. Operator, at this time, we are ready to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Joel Sendek with Lazard Capital Markets, please proceed.

Joel Sendek – Lazard Capital Markets

Hi, thanks a lot. I just had a follow-up question on the litigation. It seems like you’re on the offensive here, looking for, I guess, damages. But I’m wondering what the, you know, parameters are around the potential outcomes. I mean, can Roche appeal the decision that was favorable to you? Is there still downside for you guys? Can you talk a little bit about, about the potential outcomes? Thanks.

John McLaughlin

Sure, absolutely Joel. And just let me jump into from answering your question great, and if I’m not interrupt me and I’ll try to get to where you want to go.

Joel Sendek – Lazard Capital Markets

Right.

John McLaughlin

So, this is the contract case, this is not pattern case, and it’s simply a question of whether or not the activities by setting the facts breached the agreement. As you point out, it is an offensive positive from our perspective what’s the risk at this point is really our attorney’s fees.

If, in fact they were found to have breached the settlement agreement, we publicly disclosed some of the damages involved, one of that involves an increase in the royalty rates on the product that it’s both made and sold in the United States to 3.75%. So, that’s retroactive to the time the product was approved and prospective until such time as the royalties are no longer due.

If you just do the math backwards, we’ll just do the backwards piece, because those are historical, that gets to you about $1 billion, and obviously, these products gets bigger going forward in time, so there is a good chunk of change on the other side of that equation as well and there were some other damages specified in the agreement that are not as the largest the ones I just identified. On a prospective basis, what will happen is, we’ll eventually start some discovery, some depositions, the court has not set a trial date on this and educated guess would be that this thing starts, goes to trial some point in 2012. But again that the guess, it isn’t, the schedule isn’t set yet. But, looking at how other cases of similar context proceeded, it’s probably not a bad guess.

These are preliminary motions, they’re motions to dismiss, I mean, we’re glad we won them, you don’t want to read too much into them because they are preliminary early motions and they are top motions to be successful on.

Joel Sendek – Lazard Capital Markets

Okay. Yeah, the one question I guess that I just want to make crystal clear is, I guess you kind of answered it, you said the downside is your attorney’s fees. Is that how you see it? Is there any way that Roche can appeal and try to still invalidate the contract?

John McLaughlin

That doesn’t seemed to be a direction, I mean, as we noticed, their focus seems to be an argument that says we don’t fringe the (FCCs), we’ve talked about –

Joel Sendek – Lazard Capital Markets

All right, yeah. Okay.

John McLaughlin

The quality of that argument, yes, I think it works, so here is the question of our attorney’s fees at this point. Probably the question I didn’t answer is this, if either party is successful in the state court litigation, it’s likely the other party would appeal and the appeal would go to Nevada Supreme Court, there is no intermediary court between this one and then Nevada Supreme Court.

Joel Sendek – Lazard Capital Markets

Okay, but that wouldn’t be the next move?

John McLaughlin

The next move is as I say, discovering, depositions and that this doesn’t have a problem so at some point in 2012 you get decisions shortly after the trial and then if either party wants to, then I suspect the consequences of bringing up either party would drop an appeal and of course follow that is assuming that there isn’t some interim settlements.

Joel Sendek – Lazard Capital Markets

And at the trial itself, will Roche make the argument with regard to the (FCCs) or is that argument overweighed given the decision that’s already been made?

John McLaughlin

We can speculate, we don’t know, but I would guess that they will continue to make the same argument.

Joel Sendek – Lazard Capital Markets

Got it. All right, thank you very much.

John McLaughlin

Sure. Thank you.

Operator

Our next question comes from the line of Charles Duncan with JMP Securities. Please proceed.

Charles Duncan – JMP Securities

Hi, John, good quarter. Thanks for taking my question. It’s on primarily the new royalty deals that you folks have been engaged in conducting diligence and you said in the next few months you might be able to give us an update. I’m wondering, you know, what’s kind of a rate limiting step on those, because I know, you’ve been doing some work and if you could provide us a little bit more enhance cover on what you are looking for as – if you’ve picked up any learnings in your diligence if you want to refine your search?

John McLaughlin

Absolutely Charles, thanks for your question. So, I think learnings for us really a couple of folks, one we’ve seen a bunch of deals, a large number of deals, we passed on some, we just don’t think they’re either the commercial case or the IT case in ultra property protecting the royalty assets is of sufficient quality and we passed and we have set high threshold, it’s probably a higher broad and you typically see for example the private equity groups that buy these things because we have other ways to enhance return. So, we schedule to give in for example $0.60 this year, when we look at one of these royalty assets we think it is, it is big sense on a standalone basis can we gather the good price. But then we do a comparison against what would happen if we increase the dividend we bought that more shares, repaid our some converts really, really get those sorts of things and it’s got to be that two part cash in a lot of them, frankly don’t be that two part cash. There is a couple we’ve seen where we just didn’t like the price, I mean, we were bidding in partly, we just didn’t like the price, we looked at the asset. At a certain price of good asset and another price, if we can get you a better, if we can get a better return to our shareholders. We are seeing some to be clear, but we are still active on a number and we hope we can report some positive progress for you as we’ve said we are focused on commercial stage products, have a preference for biologicals although we are looking at small markets too.

Charles Duncan – JMP Securities

And John, could you give us a sense as to the duration of some of the colored royalty streams that you’re looking at and whether or not you have any specific (rules) with regard to certain timelines, which you would like to see one done this year or you’re not making any specific, you know, setting any specific goals?

John McLaughlin

We are not setting any specific goals, I mean, obviously we would like to get one done as soon as we can get one done, and then we would like to work on number two and number three. So, we want to go as fast as we can, on the other hand when we talk to our shareholders, the consistent feedback we got was do a smart deal and we would like to honor that, so we are passing on things that we don’t form a category of smart deal. And that doesn’t mean if they are not good for other people but they just don’t need to high the bar we have, so we are not offering a specific timeframe, although we are conscious of the fact that we do need to get a couple of these done and in a certain point if we can get a couple of them done that’s the message for us and we already thinking about positioning company differently which means, expedite in the return of money to shareholders.

Charles Duncan – JMP Securities

Okay. And then, if I could ask Cris a question with regard to SG&A, you came in about, a bit lower then what we had projected and I’m just kind of wondering if $3.8 million SG&A is a good run rate?

Cris Larson

I used to think so, yes, there was some flip-flops, but legal expenses coming in significantly lower than the prior year, but it is coming in consistent with what we anticipate.

Charles Duncan – JMP Securities

And would you, do you project any changes in that run rate with –?

Cris Larson

Not at this time.

Charles Duncan – JMP Securities

Okay. Okay, good. Thanks for your time, good quarter.

John McLaughlin

Thank you.

Operator

Our next question comes from the line of Jason Kantor with RBC. Please proceed.

Jason Kantor - RBC Capital Markets

Thank you for taking my question, I guess, you know, the main ones have been addressed but perhaps you could, on the interest income and expense side, you have – there were some one time items obviously with the changing around of the debt structure, but how should we look at modeling that going forward as it just straight coupon cancellation or do you have other expenses that –?

Cris Larson

The one issue that you will see going forward in this new convertible note because of net shares settles, there is special accounting requirements with respect to that kind of debt, such that we rather than having interest expense charge equal to the coupon may – we actually had to look at the cash flows associated with that note and impute an interest rate of 7.5% which is what we considered our borrowing rate to be without conversion feature. So we will have – and that was a discount of $18.8 million that was calculated that actually gets booked with equity and then we will amortize that debt over the life of the transaction. In this current quarter we had about $500,000 additional non cash interest expense as a result of that accounting treatment and of course that was only for half a quarter so going forward that probably be about an additional million dollars of quarter in non cash interest expense.

Jason Kantor - RBC Capital Markets

So, to be clear for the new convertible now we should just from a P&L perspective treated like a 7.5% interest rate note, but –?

Cris Larson

That’s correct.

Jason Kantor - RBC Capital Markets

From a cash perspective it’s obviously different from that?

Cris Larson

Yes.

Jason Kantor - RBC Capital Markets

Okay. And then –

Cris Larson

It’s a whole lot of benefit in doing that transaction net share settle, because there is less dilution associated with it and then we also did call spread on top of that increasing the conversion price to approximately $9.10 at this time. And as it added the money it’s not included in the calculation of earnings per share.

Jason Kantor - RBC Capital Markets

And just to get you to reiterate this 3.8 million in G&A, that’s the right run rate going forward?

Cris Larson

That should be a good number, yes.

Jason Kantor - RBC Capital Markets

Perfect.

John McLaughlin

Anything else Jason?

Operator

And our next question comes from Phil Nadeau with Cowen & Company. Please proceed.

Phil Nadeau – Cowen & Company

Good afternoon and thanks for taking my questions. First a question on the potential upside from the Roche suit, you talked a little bit about what potential damages you could get, although that sound quite healthy given, what it seems like Roche has done ahead, could give us, could you talk a little bit more about what potential upside for you guys are is from this suit and some better understanding of what’s so, you know, reasonably likely outcome should you prevail?

John McLaughlin

Sure. So, maybe just start with the first part of your question. So, sometimes what you do is you put in a contract across where it’s difficult to specify what the damages are or you want to try and quantify ahead of times, you put a clause it says look in your debt there is a breach here, the damages are x, you don’t have to prove them, you just prove there was a breach. And so, that’s one of the features of 2003 settlement agreement is rather than sort of – it says look we’re going to say that, if there is a breach the harm is measured as follows and one of the measures is that retroactive and prospective increase in a royalty rate to 3.75% on profits both made and sold in the United States.

Now as a point of contrast, if you look at the, we are currently paying tiered royalties, which start at 3% and drop the sales increase. If you look at the effective royalty rate in calendar year 2010 it was about 1.5%. So, it’s a contrast between that 1.5 and 3.75 and you’ve got – how you get the number. If yes, your point gets to be a big number, but that’s what the agreement says. In terms of where it’s going to go, I don’t know at this point we are prepared to speculate in terms of what are likely outcomes or whatever. And I think, what we are comfortable in saying is it’s going to proceed, you’ve seen the arguments we’re making. We had made a copy of the 2003 settlement agreement available in the third quarter Q of last year. And that people evaluate for themselves, I think, we do need to bear a mind without coming on this case in particular in United States, you know, the overwhelming number of cases in the 90% have settled before they get the trial, we’ll see whether that’s true here or not, I’m not making a prediction, I’m just observing there is a pretty strong statistic as to how most of these things turnout, we’ll see, if it’s still pretty early.

Phil Nadeau – Cowen & Company

Okay. And just maybe initiatives too close to that trial that you don’t want to comment on it. But how clearly that there is breach here, is a breach simply the actions that they’ve taken or is it in the contract that they would breach on it, if they didn’t pay royalties versus specific period of time?

John McLaughlin

So, the allegation in our complaint is that the settlement agreement provides the Genentech and Roche challenge is (shift) anybody in challenging our patterns. And as we disclose previously the wording of the facts is, we Genentech are writing this questioning whether or not in fact your royalties are next to you out that would be ahead of Roche and Novartis, I mean, its their facts to tie, their conduct back to assisting a third party in this case Genentech – actually in this case Roche and Novartis obviously are not obviously but they are taking a position that doesn’t constitute a challenge in further that the agreement, the 2003 settlement agreement only applies to US patterns, that’s not our reading of it.

So, there is a dispute between the parties and it’s more complex not just to summarize but that’s a good thumbnail sketch.

Phil Nadeau – Cowen & Company

Okay, that’s makes a lot of sense. And second, in that notes that you guys have currently distributed you mentioned (inaudible) in there with an update. Can you manage this, what is J&J said about, whether (inaudible) falls under the Genentech, have they themselves acknowledge that?

John McLaughlin

Yeah, it’s a license product.

Phil Nadeau – Cowen & Company

It is, okay.

John McLaughlin

There is a license agreement between the parties.

Phil Nadeau – Cowen & Company

Okay. And then – but there is other experiment, step from the – and as J&J itself kind of bless the Genentech?

John McLaughlin

I don’t know they blessed it. But to be honest, I don’t know that they are required to bless it, what the agreement provides is that they have right, that is one has a right grant sub licenses, which is impact, what they have done here. And that is a part of accepting a sub licenses, the sub licenses each to accept all the terms of the underlying license. So, I don’t know they have blessed it, but to be honest, I had never been in a situation where I had sub licensee call up and sort of say, your pattern is safe anyway. So, it would be – it’s not typical course of conduct that we would expect to see.

Phil Nadeau – Cowen & Company

Okay. And then two clarification questions for Cris. Cris, first in that tables that you’ve sent around there is some sales figures in those tables from Roche and as also royalties recognized from Roche from two separate tables. And just on clear the sales figures that are less as Q2 2011 sales figures, are those the US dollar equivalent sort of Swiss franc figures that Roche reported last week or those for sales, which you’re recognizing Q2 royalties?

Cris Larson

There in the net sales from the first quarter on which we were recognizing Q2 royalties.

Phil Nadeau – Cowen & Company

Okay. So, the chronology in the table was from a PDO perspective in that.

Cris Larson

Yes.

Phil Nadeau – Cowen & Company

So, when they reported got it, okay.

Cris Larson

And that was reported to us by the legacy.

Phil Nadeau – Cowen & Company

Got it, okay. That’s very helpful and then last is in your prepared remarks you mentioned an amount that you paid down on the Genentech note. And I just missed the amount, could you repeat that?

Cris Larson

Sure. We paid in the current year $62.6 million of that debt.

Phil Nadeau – Cowen & Company

Okay, perfect. Thanks for taking my questions.

John McLaughlin

Thank you.

Operator

At this time there are no more questions and I would like to hand it back to John McLaughlin.

John McLaughlin

Thanks all of you for joining us on this call this afternoon and we look forward to seeing many of you at the up coming year UBS and JMP Securities conferences. Thanks again for participating and have a good day.

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