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PDL BioPharma (NASDAQ:PDLI)

Goldman Sachs 33rd Annual Global Healthcare Conference

June 7, 2012

Executives

John McLaughlin - President & CEO

Analysts

Sapna Srivastava - Goldman Sachs

Sapna Srivastava - Goldman Sachs

Good morning and thanks for joining us. I'm Sapna Srivastava, Biotech analyst at Goldman Sachs. And it's my pleasure to host John McLaughlin from PDLI to be here. And before we start, I'm required to read this out loud. We are required to make certain disclosures on public appearances about Goldman Sachs relationship with companies that we discuss. The disclosures are related to (inaudible) banking relationships, conferences, compensation received or one person or more ownership. I'm prepared to read disclosures if anyone would like me to. However, these disclosures are available in our most recent report available to you as clients on (inaudible). In view of this non-Goldman Sachs personnel may not represent the company views.

Staying with that, I'll just it off. I guess the one thing I'll start off with, John, is just like you've been with the company and really seen the transition of taking it – somehow taking it apart, breaking apart the company to create shareholder value. Can you help us describe the (inaudible) which led to it and how effective do you think that value creation has been?

John McLaughlin

So, the thought process behind it was that there was a sizable royalty stream and there was an R&D operation and that they weren't being appropriately valued. And so we went through the exercise of splitting the company in two. We spun off the R&D operation (inaudible) Biotech. The royalty operation maintained the name PDL BioPharma. And if you look at the time of the split off both were trading someplace around $10 a share. Subsequent to the split off both were trading someplace – one was around $7 or $8 a share and the other was trading around $10 to $12 a share. And in fact the fastest piece of the operation eventually sold for around $27 a share.

PDL currently trades at around $6.20, $6.30, $6.50 a share and that's after we paid out just about $4 in dividends since 2009. So there has been a significant amount of shareholder value creation, considerably more than we anticipated.

Sapna Srivastava - Goldman Sachs

And can you help us describe the current status of the company and with the Queen's patent going off in 2014. And you've spoken a lot about trying to do smaller acquisitions. How should we think about PDLI ahead of 2014? Or will there be a PDLI ahead of 2014?

John McLaughlin

Sure. So our patents do expire towards the end of 2014, in December. We'll probably get paid for a while longer on our royalties because product that's made while the patents are still extant [ph]. Even if it's sold afterwards we still get paid and as you well know it takes seven, eight months to make an antibody. That's why they call it campaigns to make them.

So we'll probably get paid through 2015, maybe even into 2016 or thereabouts.

Sapna Srivastava - Goldman Sachs

At the same royalty rate.

John McLaughlin

Correct. But to the point of your question, at a certain point that inventory will expire. It will be used all up. And our shareholder base is about 80% dividend-sensitive. And so they've come to us and said, look, we like the fact that you are paying about a $0.60 dividend on a stock that trades for around $6. That's yield depending on the share price kind of bounces between 9% and 11%. In today's yield-hungry market is there any way to keep that going?

So what we have done is we've looked out to commercial stage companies as well as universities to see if there are royalties we can buy from them. In some cases we create synthetic royalties. So interestingly enough a group of companies that we've had some conversations with are commercial stage companies where you would say to yourself, a public commercial stage company, if they have to raise capital they should be able to do it. But some of those have seen their share prices be down. They're not necessarily happy where their share prices are and so we engage in conversations with them. Potentially with either debt structures, security against their commercial assets. Or synthetic royalties. If they don't have a real royalty we will simply say, pay us back based on a couple of percent off your sales.

That's been an atypical source. So if a year ago you had asked me where do you think you're going to be able to acquire some of these assets I would not necessarily have picked that group out. But it's interesting that it is a very receptive discussion right now. We also reach out to sort of the traditional folks. We have a couple of conversations going on with universities as well as one with a large pharma where they're looking to monetize an asset that's not core to their business. We have seen a couple more of those than we've seen in past years, particularly with all the M&A activity in big pharma where A buys B. They bought it for a bunch of products and in the mix is some royalty from something and they want to monetize it. In some cases, to defray [ph] their acquisition cost.

Sapna Srivastava - Goldman Sachs

Then we think about the different structures you're describing, what falls under it? What kind of – you described some companies, universities, big pharma. And I guess what are they trying to do? Are they trying to sell you a part of the royalty stream and so you have to – how does that get extended? What kind of revenue stream can it bring you?

John McLaughlin

Sure. So it's going to vary from situation to situation. So obviously one of the things we're looking at is size. So we said commercial stage, we're looking for acquisitions where it's at least $75 million to $150 million per increment just because much smaller than that it doesn't move the needle for our shareholders. Another key element is duration. As you observe that is, we're more sensitive to royalties that are post-2014 through 2020, 2022, something like that’s a real key target.

Much beyond that we're agnostic as to therapeutic indication. It could be second in class. It could be first in class. What we're looking for is it could be the only one in class. That's one we're looking at right now. What we're looking for is a highly differentiated product profile where we can have some confidence that we've correctly assessed it. It might be that they sell 30% of it. It might be that they sell 100% of it. There might be milestones involved later on depending on where it goes.

So one of the things we try to do more so than some of the other royalty buyers to the point of your question is we don't have any particular mandates. We don't have limited's who want to return in one year or two years. We can be reasonably flexible in terms of the structure be it a royalty acquisition or be that we loan $50 million because they have a commercial stage product but it's not thrown off enough revenue to support their Phase 3 product that’s coming down the pike but it's secured against the royalty asset. So it might be a debt structure for example. And obviously what we're looking for there is a coupon rate; an interest that we think provides a satisfactory return for our shareholders.

Sapna Srivastava - Goldman Sachs

And when you talk about the $75 million to $150 million acquisition, do you think that’s sufficient to acquire something like that?

John McLaughlin

So to be clear, we have to acquire several of them and to your point our goal is to run this experiment for the next two years, through the end of 2013 and into 2014. We'd like to get a couple of deals done, about three deals done. And at that point we'll step back and say, okay. Do we have enough deals done that we think this has been a satisfactory experiment. That there's enough market potential out there we can acquire good products at good prices that this is worthwhile continuing?

We've said that if at the end of that experiment we're not satisfied we can, then we're probably going to wind the company down by 2016. And what we'll do is, we will just take all the cash and just gorge it. In some cases we'll buy shares. We'll clean up some of the debt. But we'll probably do a bunch of special dividends. As you know we do atypical of biotech, and frankly even pharma, we declare our dividends a year in advance. And they're regular dividends and we pay them quarterly. But we've always reserved the right to do some special dividends if we thought we had some excess cash we couldn’t deploy in a manner that rewards the shareholders.

Sapna Srivastava - Goldman Sachs

I guess coming to your current product portfolio, clearly there's a lot of different things, which have been happening. It would be helpful if you can describe what the product portfolio looks like. And I know the pressure of uncertain products and there's potential from other products coming and just help us give the picture where is your – how does it evolve for the next couple of years?

John McLaughlin

Sure. So I think with respect to the market of products, they're reasonably well known and well understood. So Avastin certainly has been under some pressure through much of 2011 when they lost the label for HER2 and negative breast cancer. And in fact we saw on a worldwide basis but particularly in the United States a declination in sales. Now, in the first quarter of 2012 we finally started to see some improvement. They were up about 1% on a worldwide basis on a currency neutral basis.

I'm sure you probably saw over the weekend they reported some interesting data from ASCO in both ovarian cancer on platinum resistant patients as well as colorectal cancer and the colorectal cancer data was actually a little more detailed where they provided some top line data earlier. They've got a nice approval ex-US and Europe for ovarian cancer. They're now talking about at least with respect to the platinum resistant patients going into the FDA and seeing if they can get it that way among [ph] the US. And that's reasonably interesting.

Herceptin is another one. It's been a good grower. It grew 7% in the quarter and over the last couple of years it's been growing between 10% and 20%. The label expansion into HER2-positive stomach cancer clearly has been a nice launch for them and they've done a very successful job of mating it to the HER2-diagnostic test. And they're now reporting in US and European Union adoption rates of the diagnostic of about 95%. Really pretty spectacular numbers.

Lucentis is the one that's getting beat up. And with the launch of Eylea they are clearly losing market share in the age-related macular degeneration market to Eylea. Right now typical of a chronic therapy what you're seeing is Eylea taking mostly patients, new patient starts, and Lucentis' failures. But it's very clear that the ophthalmology and retinal vitreal surgeon community is responding to Eylea because of the dosing advantage. Where after a month free you only need to use it every other month as apposed to Lucentis' monthly dosing. And eventually they probably will make some inroads on the diabetic macular edema markets in the retinal vitreal markets. Probably some of those losses will be offset when they pick up DME label for Lucentis in the United States where they have it already.

Xolair [ph] there's not much to say about it. It's been the steady Eddy in sort of the basket. It keeps growing nicely. Tysabri has had it's ups and downs but ever since the introduction of the JC virus assay, when you look at the net patients, so new patients the physicians feel comfortable putting on the drug versus those that probably because of they are seeing a positive response in the JC virus assay. In fact for the last – this is now the third quarter in a row where we've seen significant net patient adds and clearly the physicians are comfortable putting patients on the drug, the more severe patients, knowing that someplace around 24 months they should start screening them to determine whether or not they're at risk. And if they're at risk, pull them off.

Probably the ones that are not approved that are most interesting, certainly there was a fair amount of conversation about TDM1 over the weekend. Where you saw some of the data behind the top line disclosures by Genentech where you saw the PFS improved about 35%. We saw the diminution in Grade 3's that was fairly dramatic. You saw some interim data on (inaudible) survival at one year that was pretty impressive even though it's still interim and maturing. They've said they're going to file at the end of the year for second line in their February conference to the financial community. They described it as a billion dollar product and certainly the enthusiasm at (inaudible) community seems to support that.

Probably the one that gets lost a little bit and I'm still not quite sure why is the one that’s due for approval (inaudible) and that's Pertuzumab. And when you look at some of the data behind that it really is a very impressive product. It's used in conjunction with Herceptin. You look at the CR response rate in the neoaganin [ph] setting where you're jumping from Herceptin, (inaudible) someplace in the mid-20s to sort of low 40s. That’s a pretty big jump. You've got an improvement in PFS of six months. So if you think back for a second Herceptin was originally approved on a PFS improvement of about six months and you're adding six months on top of that all these years later. That's pretty impressive.

So I think we're reasonably optimistic. I think to some degree Pertuzumab may have been caught in the shadow of PDM1. I think we're reasonably optimistic it's going to move into first line therapy in conjunction with Herceptin. And the adoption rate is going to be reasonably steep.

The two that are starting to creep a little bit into our stock are the two Alzheimer antibodies both of which are under a license. So one is the Bapineuzumab, which comes from Elan. It is now being managed by a partnership, J&J and Pfizer. They've got four Phase IIIs going. Two of them are US Phase IIIs and Pfizer a couple of weeks ago announced that one of the Phase IIIs, so this is the one that are ApoE4 carriers, was about to be completed. Probably is complete about now. And that they anticipated the non-ApoE4 for a carrier trial would probably be completed some point around mid-summer or thereabouts.

They've announced that they're going to release both datasets simultaneously and they're probably trying to preserve the ability to integrate the databases if they want. As you well know one of the reasons they've done two separate trials stratifying for the allele ApoE status is because if you look at some of the post-hoc analysis done on the Phase II data on Bapineuzumab, they did see a nice response rate that was statistically significant on some of the cognitive measures in the non-ApoE4 carriers.

Similarly, the Eli Lilly antibody and Eli Lilly solely owns the rights to that, Solanezumab, they're saying their data is going to be out someplace between third and fourth quarter. We know a little bit less about the timing on that one other than they sort of said someplace between 3Q and 4Q. They also have two Phase IIIs and they've said they'll stratify for (inaudible) carrier status but we know less about that. Solanezumab is a little more interesting to us from a commercial perspective because we have a patent royalty on it and as we discussed at the beginning of this session our patents typically expire towards the end of December 2014. But in fact we have no how [ph] royalty on it that runs for 12.5 years after approval. And it's about 2%. I think it's probably fair to say that most of the world believes that if these products were to be approved each of them is probably $4 million to $6 million.

The part of the calculus where everybody is a little uncomfortable is is what's the likelihood of them hitting the data points and their target profile is slowing the progression of Alzheimer's in moderate, mild and moderate patients. And there you can see a range of probability of success is 15% to 50% depending on who you talk to.

Sapna Srivastava - Goldman Sachs

Help me understand on some newer products, which are coming, do you still have the same kind of call it 2014, 2015 or is there potential for any of these to have a more extended royalty stream?

John McLaughlin

No, there's not. So what we'd be counting on is basically whatever they make and sell between now and then. So for example with respect to the Alzheimer antibodies both consortiums have said they're going to make a substantial amount of the drug recognizing the demand would be great. Certainly with respect to Pertuzumab and TDM1 what we've seen Roche do is they haven't announced the quantity they're making but they spent about $190 million US to expand their plant in Germany, Penzberg, where they will probably be making some of these things. It's where they make Herceptin now. So certainly given the reception at Asco and other places for both of those products, they're probably going to have pretty decent sized inventory and they'll probably have a pretty decent ramp.

But to your point once that inventory has been used up we don't get paid anymore.

Sapna Srivastava - Goldman Sachs

So any inventory which is made before the expiration of the patent will get paid on?

John McLaughlin

Yes. As long as it's made in a patented territory, yes.

Sapna Srivastava - Goldman Sachs

And I guess the Lilly Solanezumab, I thought you had a different structure, normally when it's royalty or a different contract which potentially can take it…

John McLaughlin

You can. So there is a no how royalty there and as I say, so if the product were to be approved in say 2013 we'd actually get paid a patent royalty and a no how royalty. We haven’t disclosed what the patent royalty is but if it were to get approved we would – after the patent expires, we'd get a 2% royalty that runs for 12.5 years thereafter. So if – the big question is can it get approved? If it's approved though I think – and it can hit its product profile, it's a sizable product. Two percent royalty on that running for 12.5 years would be obviously a very significant revenue stream.

And to the point of your first or second question, it would change the profile of the company in terms of the ability to continue to pay dividends and also to have a revenue stream for an even longer period of time to acquire new assets.

Question-and-Answer Session

Unidentified Participant

Hi. Thanks. A couple of quick questions. One on a high level, I understand the value proposition clearly to the current shareholder base, but what would you say – what attracts basically the marginal investor who would argue that basically it's a DCF on royalty streams? What attracts them into the picture? And then number two, which are the royalty streams do you think is the most undervalued by The Street? Would you say it was Pertuzumab [ph] or is there something else that could deliver a surprise upside?

John McLaughlin

Sure. So to your point we are an atypical biotech company and we have an atypical investor base. So perhaps 20% to 30% of our investor base are biotech investors, healthcare investors. The remaining 60% to 70% are actually generalist investors and they are dividend-sensitive. So they have done a DCF as you suggest. They have said, here's what the share price is. Here's what my DCF shows this place is worth. These people have a track record the last couple of years of pumping out dough in the form of dividends or buying up shares or buying up converts if it's cheap.

And I'm seeing a return of 9% to 11% as a function of share price. So it's – these are not, they're not necessarily – they're not 5X investors. In fact sometimes when 5X investors show up I sort of begin the conversation by saying, hi. Great to see you. Why are you here? We're not a 5X – that's not the kind of return, it's not the appeal for us. But what we do see are very large generalist investors who are – whose exposure to healthcare might be 3%, 5%. So it is a very different profile as you're alluding to.

In terms of undervalued, I'd have to Pertuzumab [ph]. There's just been so much discussion about the excitement of drug conjugates. I sit on the Board of Seattle (inaudible) there's a lot of excitement about Adcetrus [ph] as well as a drug conjugate and clearly it's deserved. I do think Pertuzumab has gotten lost a little bit in the shadow of it and I do think the financial community is going to be surprised by the rapidity of uptake.

Sapna Srivastava - Goldman Sachs

Maybe just stepping away from the products, we've usually spoken about the Roche dispute. What is the status of that? I think you said came on August 10 or something (inaudible). Help us understand what is that and what are the ramifications of that can be?

John McLaughlin

Sure. So on August 10 of 2010 without any notice we got a fax from Genentech, which basically said we Genentech are writing on behalf of Roche and Novartis and we're not sure we owe you royalties on products sold in Europe based upon your patent extensions which are called SPCs. And so we're looking at this thing and we have a 2003 settlement agreement with Genentech, which says you're not supposed to challenge our patents and by the way, you're not supposed to help anybody challenge our patents.

And if you do, in fact, the royalty rates in the US jump from a tiered set of royalties, which for point of reference last year were about 1.5% when you got through all the tiering.

Sapna Srivastava - Goldman Sachs

How much, sorry?

John McLaughlin

It was about 1.5%. So one of the penalties that’s provided in this agreement is that retroactively and prospectively that royalty jumps to 3.75%. So it's – as of last year was over a $1.2 billion, $1.3 billion in terms of dollars. So the damages are pretty consequential. So we eventually wrote back to them and said, look, read the settlement agreement. Let's try and – we've publically said that our goal is to have amiable relations with them. But eventually we wound up filing a breach of contract case in the State court in Nevada. So a settlement agreement is a contract. It says, we had an argument. We've settled it and by the way typically in such agreements there are clauses in there that say there's pretty stiff penalties for me or pretty stiff penalties for you if you violate it. I just cited one of them.

So the question to state it in non-legal terms is, is when they sent that fax did it constitute a challenge or assistance a challenge, it violated the settlement agreement. So they're downside is all the remedies. I've cited some of them in the settlement agreement. Ours is really our legal fees. So this is not a patent case. It's not a challenge as to whether products infringe or not. It's really a question of whether or not that fax violated that settlement agreement.

Now, I should point out since we got that fax back in August of 2010, they have paid every single royalty statement in full for how ever many quarters now that is coming up on almost two years. So to be clear, they have been good about paying all the sums involved including the European royalties.

Sapna Srivastava - Goldman Sachs

In some ways that's kind of just done.

John McLaughlin

It'll go to trial some point in – it was scheduled to go to trial in the middle of 2013. It's now gotten pushed out I think until October of 2013. And I would say having been through a couple of these trials, my experience is trial dates in these sorts of things tend to go one way, out. They don't tend to come in. So it'll be a while before it actually gets in front of a jury. We're currently in discovery. We'll probably be in discovery for a while. There'll be some depositions. I don't even see any really significant motions coming up any time soon. Probably not in 2012.

Sapna Srivastava - Goldman Sachs

And do you think that if any of these Alzheimer's drugs come through, is there a potential that you'll see these companies back to the negotiating table trying to renegotiate royalties if that happened? It clearly seems to have happened to you more than once.

John McLaughlin

I think anytime anybody's writing you a big check they'd always like to come back and say, could I write you a smaller check? So is it a possibility? Sure. I think with respect to both of them these have been long standing agreements. They're pretty straightforward particularly with respect to Lilly Solanezumab. The reason PDL gets an no how royalty is because they helped design the antibody. So there's a fair – there's a number of basis there to support the royalty streams.

Sapna Srivastava - Goldman Sachs

And also maybe help us describe the structure of the company currently. As a royalty company you're still looking for assets. Help us understand what – who are the experts here? How are you achieving this?

John McLaughlin

Sure. So we're a reasonably small company. We're less than 10 people who are located in Cline Village, Nevada, which is up near Lake Tahoe. One of the advantages of relocating from California it's more friendly business clients not to mention the fact that there are no State income taxes. So obviously we generate significant royalties to the extent that we don't have to pay State income taxes on those things. It's revenue that we can redirect to the shareholders or redeploy for their benefit.

What we use is a series of outside experts, not much different from some of the private funds that in fact do the same thing. So we have two, Franklin Berger and Evan Bedil. Franklin's quite well known in the financial community having been an analyst for a number of years. Dr. Bedil has actually bought some of the royalty streams for some of these funds. And then much like any of those folks, what we do is we go through a series of steps of due diligence. We do an initial cut. We will talk to some experts.

If we're really serious we'll go out and do some surveys. There's one we're quite serious about right now. We probably did an initial survey of about 400 physicians in US and Europe and we're doing a quick update survey of maybe another 100 or so. So we have set aside a certain amount of cash to be able to do this. We've allowed some cash to accumulate on the balance sheet, just under $200 million to be able to move quickly on some of these assets if we want to.

But not dissimilar from how the other funds do it. We have some internal expertise but we also use some of the same groups. Frankly we used Genentech when were assessing products where I used to work for a number of years. That's to do market research. Very similar.

Sapna Srivastava - Goldman Sachs

Can you something about the company that you would like us to think about which we haven't really discussed as to how we should of value creation at PDLI?

John McLaughlin

So I think the important propositions we've all discussed, as I say most of the shareholders that are interested in PDLI, they're dividends-focused. I would probably say the one other distinguishing characteristic for PDLI compared to most of biotech is our volume runs someplace around 1.5 million, 1.6 million shares a day. So oftentimes we'll see a fund come in, which we had a conversation with them and they say, I'm going to take a small piece. And the next thing you know they've got a million shares or something. And they can enter and exit. So Baupost has been a shareholder of ours twice. And they've done round trips through the stock of upwards of 12 million to 16 million, 17 million, 18 million shares.

And they can move in. They come in – typically they would buy on dips. They'd sell sort of on highs. But with that kind of daily volume, institutional investors it's an easy entry point. But more importantly particularly with respect to bioteches, there's an easy exit point and frankly as long as they made money, we're happy.

Sapna Srivastava - Goldman Sachs

Okay. With that, we will thank you for your time. We much appreciate it. Appreciate you coming in for…

John McLaughlin

Thank you very much for the invitation to present. It was a lot of fun.

Sapna Srivastava - Goldman Sachs

Thank you. Thanks a lot.

John McLaughlin

Thank you, all.

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