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Executives

Jennifer Williams – IR

John McLaughlin – President and CEO

Christine Larson – VP and CFO

Analysts

Charles Duncan – JMP Securities

Brian Klein – Lazard Capital Markets

Phil Nadeau – Cowen & Co

Adnan Butt – RBC Capital Markets

PDL BioPharma Inc. (PDLI) Q3 2011 Earnings Call November 9, 2011 4:30 PM ET

Operator

Good afternoon, and welcome to PDL BioPharma’s Third Quarter 2011 Earnings Conference Call. Today’s call is being recorded. For opening remarks and introductions, I would 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 may be obtained in the Investor section on our Web site 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

Thanks, Jennifer, and good afternoon, everyone. Also with me today is Chris Larson, our Vice President and Chief Financial Officer. I’ll begin with a brief business update and then turn the call over to Chris to discuss our financial results.

During the third quarter, we continued to actively manage our intellectual property assets and evaluate new royalty assets, which would improve return to our stockholders. As we previously announced, we are pursuing commercial stage assets in the range of $75 million to $150 million in purchase price. We believe we are well positioned to execute this business strategy and we’ve retained two key consultants to expand our efforts.

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

Chris Larson

Thank you, John. Total revenues for the third quarter of 2011 were $83.8 million compared to $86.4 million in the third quarter of 2010, a 3% decrease. Total revenues for the nine months ended September 30, 2011, were $289.2 million compared to $268.8 million for the same period in 2010, an 8% increase.

Included in both the third quarter and the nine months ended September 30, 2011, is a $400,000 milestone payment from Roche for progress in the clinical trial. Also included in the nine months ended September 30, 2011, is a $10 million settlement from UCB Pharma resolving all disputes between our companies. Excluding these one-time payments, royalty revenue was $278.8 million for the first nine months of 2011 compared to $268.8 million for the first nine months of 2010, a 4% increase. The decrease in revenues for the third quarter was driven primarily by reduced sales of Avastin, partially offset by increased sales of Herceptin, Lucentis and Tysabri.

Also contributing to the decrease is a lower average royalty rate on sales of the Genentech products that were either made or sold in the United States due to the effects of the tier growth restructures that we have for these products and higher 2011 year-to-date sales.

Turning to expenses, general and administrative expenses for the third quarter of 2011 were $4 million compared to $11.1 million for the third quarter of 2010. General and administrative expenses for the nine months ended September 30, 2011, were $13.5 million compared to $29.3 million for the same period of 2010. The decrease in expenses for both the third quarter and the nine months ended September 30, 2011, was primarily due to the conclusion of several legal matters in early 2011 and the resulting reduction in our legal expenses.

Our total other expense net for the third quarter of 2011 was $8.9 million compared to $12.1 million for the third quarter of 2010. Total other expense net for the nine months ended September 30, 2011, was $28.2 million compared with $52.4 million for the same period of 2010. The reduction in our other expenses net for the third quarter and nine months ended September 30, 2011, is primarily due to lower interest expense on our non-recourse notes payable, for which the current balance is $115 million, as compared with $225 million at September 30, 2010.

Also contributing to the decrease on a year-to-date basis is $17.9 million year-over-year decrease in costs associated with retirement or conversion of our convertible notes.

Net income for the third quarter of 2011 was $45.9 million, or $0.28 per diluted share, compared with net income of $40.2 million, or $0.24 per diluted share, for the third quarter of 2010. Net income for the nine months ended September 30, 2011, was $160.4 million, or $0.88 per diluted share, compared to $116.3 million, or $0.67 per diluted share, for the same period of 2010.

On a non-GAAP basis, net income for the third quarter of 2011 was $46.6 million, or $0.28 per diluted share, compared with $42.5 million, or $0.25 per diluted share, in the third quarter of 2010. Non-GAAP net income for the nine months ended September 30, 2011, was $162 million, or $0.89 per diluted share, compared with $133.4 million, or $0.77 per diluted share, for the same period of 2010.

We believe that non-GAAP information is useful as it allows investors to better identify trends in our business and better understand how we evaluate the business internally. These non-GAAP measures have limitations, however, because they do not include all expense items that affects PDL. To derive non-GAAP net income, we adjusted our GAAP net income for transaction costs associated with our convertible note transactions and for noncash interest expense on our May 2015 notes.

In accordance with our regular quarterly dividend policy, we paid the third of four quarterly dividends on September 15 to all stockholders of record as of September 8 for a total of $21 million. In connection with the dividend payment, the conversion ratio for our outstanding February 2015 notes was adjusted to 151.713 shares per $1,000 principal amount, or a conversion price of approximately $6.59 per share of common stock effective September 9, 2011.

For our May 2015 notes, the conversion ratio was adjusted to 132.6682 shares per $1,000 principal amount, or approximately $7.54 per share, effective September 6, 2011.

Net cash provided by operating activities for the nine months ended September 30, 2011, was $124.6 million compared with $154.3 million provided by operating activities in the same period of 2010. As of September 30, 2011, PDL had cash, cash equivalents and investments of $225.3 million, as compared with $248.2 million at December 31, 2010.

Following our policy of providing quarterly revenue guidance in the third month of the quarter, we will be providing fourth quarter and year-end revenue guidance in early December.

I’ll now turn the call back to John.

John McLaughlin

Thanks, Chris. Operator, at this time, we’re ready to open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we have a question from the line of Charles Duncan with JMP Securities. Please go ahead.

Charles Duncan – JMP Securities

Hi, guys. Thanks for taking my question and congratulations on a nice quarter. John, I have a question for you, perhaps, if you could provide a little color on what the next steps are with the Roche interaction. I know that you have historically been fairly cautious about that, but what could we next see in terms of that situation?

John McLaughlin

Sure, Charles. And thanks for your question. So we’re in the midst of discovery right now between the parties. Each of the parties has made a submission to the Nevada State Court as to when – what they think an appropriate timetable would be. Each of the parties are signaling just based on calendars and the time for discovery, exchange of documents, a trial date some point in the second quarter of 2013. The court then looks at that submission and makes a determination based on its review of its own calendar. But it really looks like the trial date’s probably going to be some point late first quarter, second quarter of 2013 based on each of the submissions of the parties. We haven’t heard from the judge yet. Prior to that point, probably a quarter or two ago, there’ll be some more motions with respect to trying to narrow the case, some motions for summary of judgment would be our guess, things like that.

So there probably a lot of the activity for the next couple of quarters is going to be in the form of discovery, things like that, that are largely invisible to the financial markets and probably don’t drive much in terms of news with respect to the stock.

Charles Duncan – JMP Securities

Pete, would you anticipate that once you have a better idea of the trial date that you would somehow either a press release, probably not press release, but somehow communicate that to investors?

John McLaughlin

Yes, we would Charles. We think some sort of a disclosure, as you observed. I don’t know that we do a press release itself, but we certainly update in for example a Q.

Charles Duncan – JMP Securities

Right. Okay because it is possible that once that trial’s set, that something could happen beforehand whereby it settled or some negotiation happens, correct?

John McLaughlin

I agree completely and it goes to your point, that’s why we would try to be as transparent as we could just so people sort of new what the trial date looked like and could extrapolate from that if they wish.

Charles Duncan – JMP Securities

Then another question I had for you regarding Roche, have you conducted any recent audit of their activities in terms of ex-US manufacturing trends? And what’s your perspective on that?

John McLaughlin

Sure. So we are trying to get some insights on what the – what’s going on with respect to ex-US manufacturing activities. And just to summarize briefly for others, they have two plants in Singapore, one of which is capable of producing Avastin; (inaudible) Avastin’s clearly the initial product they’re going to try and supply from it, the second of which is capable of producing Lucentis, which is currently wholly produced in the United States.

Their goal was to get those plants produced to predominantly serve the European markets and as the secondary supply source for the US markets for commercial supply for Avastin and Lucentis. Interestingly enough, they have an approval for supplying the US market but have not received an approval yet at least they haven’t announced it for the European markets and we were listening to their pipeline update call on this previous Monday and they didn’t talk about it. The requirements for registration of a plant, whether it be for EU or for US, are very similar.

So there’s probably no negative essence there, but obviously to the point of your question, Charles, it’s something we’re keeping an eye on because once those plants are authorized for commercial supply for Europe, we would hope that they’d, as they’d said they would, start shipping supply for the European markets to those plants and that shifts us into the 3% flat royalty rate category, as opposed to the tiered royalty rate where at least in 2010 it was running about 1.5%. So it has a dramatic impact for us. We don’t have any insights as to sort of why it hasn’t been approved in the EU.

Charles Duncan – JMP Securities

Are you certain that they applied for EU approval? And if there’s any way that they could slow the process down?

John McLaughlin

So they said they have applied for it, Charles. As for whether they could slow the process down, there’s probably things they could do if they wanted to give the sizable investment they made in those plants in building one and acquiring the other one outright. And if there’s a certain number of – certain amount of tax efficiencies associated with that, it’s probably not in their business interests to do so, even though it means a modest step-up in the royalty to us.

Charles Duncan – JMP Securities

So the bottom line is the economics don’t work to save money paying – to not pay you the royalty?

John McLaughlin

Yeah. I think the other economic benefits are probably pretty significantly outweighed writing us a slightly bigger check.

Charles Duncan – JMP Securities

And then my final question for you is recently you hired an advisor, a well-respected ex-sell side analyst, to assist in the process with regard to identifying additional royalty-bearing assets. Can you give us an update on that? Was that the result of a lack of options or opportunities? Or was that a result of getting perhaps closer to being able to close a deal?

John McLaughlin

Two things that drove the decision, Charles, and thanks for asking the question. So one of which was, is we were seeing a significant number of opportunities which we weren’t out looking for; we were responding to overtures to participate in evaluating assets and we were seeing our bandwidth stretch there.

Second, because the bandwidth was stretched in terms of responding to passively to overtures that came to us, we were able to reach out actively with our certain assets that we think are interesting, we want to affirmatively reach out to those parties and say have you thought about this as an alternative source of financing. And so it was really to sort our handle a little bit of the more bandwidth that we had, just reacting to overtures. But also we want to be a fairly significant – we want to allocate fairly significant resources towards reaching out to some assets where they’re not in an auction process, they’re not in a bidding process, but where we think they’re attractive assets and they may have a financial need that we could help fill.

Charles Duncan – JMP Securities

That helps. One final question for Chris, kind of a housekeeping one, and that is related to the tax rate has moved around just a little bit. I know it’s kind in the noise, but my analysts are asking me if I could nail down whether or not you’d give guidance on tax rate? Or what’s really driving that difference quarter-to-quarter?

Chris Larson

It’s generally 35%. I would say if anything, some of the convertible note activity is not retirement or conversion of the costs associated, not deductible. And there’s some other factors involved, but that’s the larger one.

Charles Duncan – JMP Securities

So that hits the decimal points. All right. Good. I’ll hop back in the queue. Thanks for taking my questions.

John McLaughlin

Thank you.

Operator

Thank you. And our next question is from the line of Brian Klein with Lazard Capital Markets. Please go ahead.

Brian Klein – Lazard Capital Markets

Thanks, guys. Most of my questions have been answered. One for you Chris is in regards to your outstanding legal activities, can you give us a sense – I saw that you spent around $1.3 million this quarter. Is that a fair assessment of the next year’s spend on the legal fees? Or do you expect that to accelerate as we get closer to any kind of trial date?

Chris Larson

I do think that they will go up some, although they will not nearly be as significant as 2010. I would say they’d be more in line with our legal expenses in 2009, which is just over $10 million.

Brian Klein – Lazard Capital Markets

Great. Thanks. And also are you guys anticipating any other milestones over the next 12 months to 18 months from trial development and achievements, things like that?

Chris Larson

The milestones that we have are – we actually just recently done an analysis for improved disclosure. The milestone payments we receive are generally less than 1% of total revenues on an annual basis and they look to be that going forward.

Brian Klein – Lazard Capital Markets

Great. Thanks a lot.

Operator

Thank you. And our next question is from the line of Phil Nadeau with Cowen & Co. Please go ahead.

Phil Nadeau – Cowen & Co

Good afternoon. Thanks for taking my question. First one on the royalty stream itself. In the past, you’ve suggested that the royalty is due on product based on when the product’s manufactured, not necessarily when it’s sold suggesting that there’s going to be some tail off to your royalty stream, ever after the Queen patents expire. Could you give us some sense of how quickly or slowly that trail off will proceed? Do you have a reasonable sense of how much product that’s manufactured in 2014 is actually sold in 2015? Or maybe to ask a different way, how much of the product that’s sold in 2015 or 2016 was actually manufactured in 2014 or before?

John McLaughlin

Sure. So to the first part of your statement, yes. Yes, in fact when a product is made and the patents extend, we are owed a royalty. Bear in mind that we are the – most of the patents expire in the fourth quarter, that is December of 2014, and we’re a royalty play, which means we get paid a quarter in arrears. So that gets you to the first quarter of 2015 just by virtue of the mechanics of the license agreement.

To the point of your, the second part of your question now, there’s a reason they call the manufacturer of antibodies a campaign and that is because it takes a long time to make them and we do have a slide where we sort of show what are some of the average times for making a product at the bulk stage and then fill and finish. And if you were to take the absolute sort of minimums of those, so everything’s sequenced perfectly, everything ran perfectly, et cetera, it comes into about seven months.

For that reason, most of the manufacturers of antibodies and because there’s such a disparity between the cost of goods and what the selling price of the product, they keep fairly sizable inventory, sometimes as much as 24 months on hand. But let’s assume they wanted to make that smaller just because they didn’t want to pay us a big check anymore. So even if they – if they took it down say to 12 months, and again, we recognize that the minimum period of turnaround is about 7 months, that gets you up to about the first quarter of 2016.

Phil Nadeau – Cowen & Co

Okay. And when in the manufacturing process, what has to be completed in the manufacturing process before the patent expires for you to still get a royalty? Does the entire bulk production have to be completed? Or is there some step along the way where that’s with the gating factor?

John McLaughlin

Typically, it’s a couple of weeks into the bulk production cycle.

Phil Nadeau – Cowen & Co

Okay. And that’s I would imagine right at the beginning of the manufacturing process?

John McLaughlin

It is something at the very beginning of it; a couple of weeks from when bulk commences.

Phil Nadeau – Cowen & Co

Okay. That’s very helpful. And then, second on the royalty market, I was intrigued by the statement that you’re seeing a significant number of opportunities. It seems that you’ve been very disciplined in going after opportunities because you’ve I think had this idea now for a couple of years and you haven’t done anything sizable yet. I’m curious why that is. Is it that the prices are too high? Or the assets are too risky? Could you give us some sense of I guess why you haven’t found something attractive enough to pull the trigger on yet?

John McLaughlin

Sure. So there’s a fundamental difference between us and the other royalty buyers in the sense that we’re not a fund where we have to invest the size of our fund within a two-year, three-year, four-year period of time. And if we don’t, our limiteds don’t make money. I mean in our case, we have other ways to spend the money such as through dividends, share buybacks, whatever, to increase the return for our shareholders.

So we’re – as we said at the very outset, we are picky buyers. I mean we are. So we have been on a couple that we really liked, I would say we’ve looked at a bunch of products where either A, we did like the quality of the product; B, we didn’t like the commercialization team; or C, we couldn’t get it on a price that we thought was acceptable. We have seen a couple were they’ve met criteria of A, high-quality asset; B, good commercialization team; and it went for a price that we didn’t think was attractive and we’re just not going to bid a crazy price that there may be people willing to do that because they have to invest their funds or whatever; we’re not in that camp.

But what you do hear from us is we are seeing a significant flow in terms of number of assets, but what we really want to do is actually reach out to some folks who have some assets that we think should be thinking about monetization or at least considering as alternative and see if we can have some productive conversations with them to actually expand the deal flow.

Phil Nadeau – Cowen & Co

Okay. And have you ever publicly said or publicly suggested what type of IRR you’re seeking on these assets?

John McLaughlin

We haven’t, and for competitive reasons, we would prefer not to get into that conversation, if that’s all right.

Phil Nadeau – Cowen & Co

Okay, fine, understood. Thanks for taking my questions.

John McLaughlin

Thank you.

Operator

Thank you. And our next question is from the line of Jason Kantor with RBC Capital Markets. Please go ahead.

Adnan Butt – RBC Capital Markets

Hi, it’s Adnan on Jason’s behalf. A couple of questions. Roche basically held a late stage R&D pipeline update recently and I was wondering if there’s anything that jumped out in your eyes, whether in terms of timeline or market potential. And specifically, I had a question about the (inaudible), Herceptin. Would you be getting a royalty on the full price of the injection or a part of the injection?

John McLaughlin

So you got a couple of questions there, Adnan. Let me try and parse through them and if I accidently miss one, jump in and I’ll try and go back...

Adnan Butt – RBC Capital Markets

Sure.

John McLaughlin

So one, I guess we did listen to the presentation, as well as go through the slides. I guess what I was impressed about was for the first time, you heard a coherent explanation from Roche in terms of how they think about HER2-positive metastatic breast market. I mean they talked about, look; here’s how we’re thinking about Herceptin, here’s how we’re thinking about T-DM1, here’s how we’re thinking about subcu and here’s how we’re thinking about for Pertuzumab. And so they gave some guidance on that. It would have been nice to hear a little bit more about some of their thoughts on pricing on some of those things, but from a clinical update, it was a very nice exposition to sort of say look, here’s how we think all these could stack up, particularly when you think about the different approval times. So I thought that was interesting. I thought they’d probably spent – it was nice that they spent some time on T-DM1, but there’s a fair amount of exposure in T-DM1.

I thought it was nice that they focused a little bit on Pertuzumab, which has kind of sometimes gotten lost in the shadow of T-DM1. In subcu, they haven’t much attention on it and I think they sort of for the first time articulated here’s why this could be interesting and here’s how it could fit in our overall strategy. I think the second part of your question is do we expect to get paid a royalty on the subcu formulation of Herceptin; the answer is yes. Recognize it is a combination product, so they’re using some technology in it which allows it to be dosed subcu from Halozyme, if I’m recalling correctly. The agreement contemplates that in the context of a combination product, we get paid on that portion that’s associated with the antibody directed license antigen and there’s a formula in license agreement that says you look at the other part of it and you subtract it out. So for example, I’m just going to make up a number here.

If the subcu formulation sells for $100 and the cost of goods of Herceptin is $99 and the cost of goods of delivery technologies is $1. The royalty will run against the $99. And again, that’s not a real-life example; I’m just using it for purposes of illustration.

Adnan Butt – RBC Capital Markets

Sure. That’s helpful. In terms of a question perhaps for Chris. When you think about the dividend, when you think about raising the dividend, is that kind of a yearend consideration? Is that something bigger picture than that as you consider your in licensing of royalties ability? How should we think about that?

Chris Larson

Sure. I would say similar to this year. Typically in the first quarter of the year, the first Board meeting, we go through five-year cash flows and make some determination as to what the dividend will be for that year. And just like we did this year, we announced it in the first quarter and we paid quarterly dividends. And we’ll anticipate going through that exercise early next year.

Adnan Butt – RBC Capital Markets

And when do you give guidance about that? Is that the Q1 call?

Chris Larson

Well, we would like to do that – in the first quarter.

Adnan Butt – RBC Capital Markets

Okay.

Chris Larson

Certainly by our earnings call, I would think.

Adnan Butt – RBC Capital Markets

Thank you.

Operator

Thank you. This concludes the Q&A portion of the conference. At this time, I’d like to turn the call over to John McLaughlin, President and CEO of PDL BioPharma, for closing remarks. Sir?

John McLaughlin

Thank you for joining us this afternoon on the call and thanks to all for their questions. We look forward to seeing many of you at upcoming conferences, including the Lazard Capital Markets Conference next week. Thanks again for participating and have a good day, all.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a wonderful day.

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