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Executives

Jennifer Williams – Cook Williams Communications, Inc.

John McLaughlin – President and Chief Executive Officer

Bruce Tomlinson – Vice President and Chief Financial Officer

Analysts

Adnan Butt – RBC Capital Markets

Philip Nadeau – Cowen and Company

Larkin Tinsley – Tinsley Family Partners

PDL BioPharma Inc (PDLI) Q3 2012 Earnings Call November 5, 2012 4:30 PM ET

Operator

Good afternoon and welcome to PDL BioPharma's Third Quarter 2012 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. I'd 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 McLaughlin

Thanks, Jennifer, and good afternoon everyone. Also with me today is Bruce Tomlinson, our Chief Financial Officer. As always in this call, I'll provide a summary of recent events, and then Bruce will review our quarterly financial results.

We have made solid progress in recent weeks and our initiative to bring additional revenue generating assets to PDL to create value for our shareholders. We were pleased to announce this afternoon a transaction with Wellstat Diagnostics, in early October, a transaction with AxoGen.

Before to discussing the specifics of these transactions, it may be useful to review why are considering such transactions. PDL's current revenues are generated by licenses under our Queen et al. patents. The last of those patents expire at the end of 2014.

PDL expect to be played for a period of time after patent expiration based on the sales of products made before the patents expired in those sales occur after patent expiration. At some point however almost all of PDL's licensees will no longer be obligated to pay royalties. In such event, PDL will be unable to pay further dividends and which is to operate.

As we have previously discussed our shareholders have told us that they want us to look for other revenue generating assets to allow us to continue to pay dividend beyond the expiration of the Queen et al. patents we have been doing so.

Some of the deals that we are evaluating are to buy royalties on drugs or medical devices while others are for loans secured by revenues generated by products, and still others are hybrid royalty loan structure. We are in different as to the structure what we are concerned about is the quality of revenue generating assets, the likelihood of being repaid and the return on investment for the benefit of our shareholders.

As you seen on slide 3, regarding today’s transaction, we loaned $40 million to Wellstat Diagnostics to be used in the development and commercialization of their small point of care diagnostic system. Wellstat is developing a small point of care diagnostic system that utilizes a disposable cartridge, requires no user interaction, relies on standard blood collection techniques and can achieve sensitivity comparable to or better than central testing laboratories.

It can be used to measure disease and monitor medical conditions consistent with the third generation of two previously successful iterations that was sold to Roche. Thus it is expected to be eligible for approval through the 510(k) process allowing for more rapid approval.

We like this transaction with Wellstat because of the impressive track record of their management team in creating value in the diagnostic space. Their founder, Sam Wohlstadter, the company’s Chief Executive Officer was also a founder of Amgen, Applied Biosystems which is now currently a division of Applera Corporation, IGEN International, BioVeris, and Hyperion Catalysis International.

Both IGEN and BioVeris are diagnostic systems companies and were sold to Roche for $1.4 billion and $600 million respectively. This loan matured upon certain events such as the sale of Wellstat Diagnostics. Upon sale of Wellstat Diagnostics, PDL will be paying a specific target internal rate of return that varies based upon repayment coursed before or after December 31, 2014.

Wellstat instead commercializes and sells the device. PDL will receive a low double digit royalty on Wellstat Diagnostics’ net revenues. Fred Frank, a PDL board member represented Wellstat in this transaction. Fred rescued himself from deliberations and resigned from the PDL Board prior to the completion of the transaction. We are pleased to announce that Fred has agreed to transition to a new role as special advisor to the Board. He will continue to participate in Board Meetings and will be focused on bringing new revenue-generating assets to PDL. Fred has over 50 years of experience on Wall Street and we greatly value his extensive connections. He will continue to help us create shareholder value.

In October, we announced a separate transaction in which we provided $20.8 million to AxoGen in return for royalties on certain of their products. AxoGen used $5.2 million for payoff their outstanding credit facility and we used the remainder to further their commercialization activities related to advanced NeuroGraph, Isobaric neuroprotector, and isobaric neuroconnector, which are all surgical solutions for peripheral nerve repair.

Our agreement has a term of eight years, subject to our ability to put the loan at the end of year ’04 and AxoGen’s ability to call the loan in years five through eight. We are pleased with the progress we have made to this year having closed three significant transactions for revenue generating assets. We need to complete more transactions.

As we have said previously, we view the results of this ongoing effort towards the end of 2013 or at the beginning of 2014 for the side if we have sufficient revenue generating assets to continue to pay dividends and operate beyond our patent expirations.

Before I turn the call over to Bruce to review our financial results, I’d like to touch on an article that appears last week on the website Seeking Alpha. This article became several factual in accuracies and appears to have caused a drop in PDL share price. The author, a self described short in PDL has since corrected the article.

We’d like to note few things about the article. First, the article stated that the Series 2012 notes could be convertible by the holders as of October 31. That is not correct. Certain requirements related to the closing price have to be met during the last three trading days of the prior quarter before conversion is allowed, contract to the statement in the article, they were not met and thus the notes are not convertible during the fourth quarter of 2012.

Second, the article stated that if the note holders converted, they will receive shares for the principle and interest due resulting in substantial solution to our shareholders. That is not correct. We modified the Series 2012 notes earlier this year to avoid such an outcome and have repeatedly disclosed this change in the terms of the 2012 notes. When our Series 2012 convertible notes settle, the principal of the notes will be settled in cash not shares, only the premiums of the base value could be paid in shares. As such, any share issuance in the events of a conversion would be significantly less than the amount of shares mentioned in the article.

Third and last, the article pointed to an August 2010 instance when PDL stock dropped by almost 20% and indicated the drop was due to the company’s issuance of shares in exchange for a convertible note that occurred in that month, and the article further suggested that this put hold a similar decline in PDL share price due to the erroneous belief that the Series 2012 note holders could convert now.

In August of 2012 PDL, received a fax from Genentech stating that Avastin, Herceptin, Lucentis and Xolair do not infringe PDL’s supplementary protection certificates for patent extensions in Europe. We believe that the August 2010 stock drop was a direct result of the Genentech assertions, a timing of the Genentech fax, the timing of then decline in PDL share price and the direct feedback from our shareholders and analyst at that time, support this conclusion.

At this time, I’d like to turn the call over to Bruce to discuss our financial results.

Bruce Tomlinson

Thanks, John. Beginning on slide 4, you can see that our royalty revenues for the third quarter of 2012 were $85.2 million, compared to $83.4 million for the third quarter of 2011, which represents a 2% increase. Royalty revenues for the third quarter of 2012 are based on second quarter 2012 sales by PDL’s licensees. Royalty revenue for the third quarter net of payments made under our February 2011 settlement agreement with Novartis.

The growth in revenue for the third quarter of 2012 is primarily driven by increased royalties on sales of Avastin, which is marketed by Genentech and Roche and Lucentis and Xolair, which are marketed by Genentech and Novartis.

We experienced increased royalties on Tysabri, which is marketed by Elan and Biogen Idec and Actemra which is marketed by Roche and Sugai. We experience decreased royalties on Herceptin, which is marketed by Genentech and Roche.

Roche reported the 43% of Herceptin was made and sold outside the Untied States in the third quarter of 2011 versus 37% in the same period of 2012. PDL receives the flat 3% royalty on product made and sold outside the U.S. versus a tiered royalty in all other situations. The tiered royalty tends to be less than the flat 3% leading to lower revenue received by TDL in the third quarter of 2012 when comparing the two quarters.

We believe no conclusions can be drawn from the comparison of these two quarters as the amount of product produced and sold outside the U.S. is reported by Roche has fluctuated significantly in the recent past.

Turning to costs, our general and administrative expenses for the third quarter of 2012 were $5.7 million compared with $4 million in 2011. Total cash equivalents and investments as of September 30, 2012 were $160.4 million compared to $227.9 million as of December 31, 2011. Net cash provided by operating activities in the first nine months of 2012 was $158.6 million compared with $124.6 million in the equivalent period of 2011.

Net income for the third quarter of 2012 was $48.6 million or $0.32 per diluted share as compared with net income of $45.9 million in the same period of 2011 or $0.28 per diluted share. In accordance with our regular quarterly dividend policy, we paid the third of four dividends on September 14 to all stockholders of record, as of September 7 for a total of $21 million.

You can see on slide 5 that in connection with this dividend payment, the conversion rates for our convertible notes adjusted for our May 2015 notes, the conversion price is now approximately $6.87 per share. For our February 2015 and the series 2012 notes, the conversion price is now approximately $6.01 per share.

At this time, operator, we are ready to open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from Adnan Butt of RBC Capital Markets. Your line is open.

Adnan Butt – RBC Capital Markets

RBC. Congrats on all the deals, the pace seems to be picking up, and I guess my question is in time (inaudible) when you might decide also seems to be getting pushed out a bit. My question is what’s the tipping point in terms of the company deciding when to change or update its business strategy is it a matter of the cash principality of less in terms of thing to invest or is it more the rate of return that you’re trying to generate?

John McLaughlin

So a couple of points, Adnan. I mean I think it’s a combination of both of those factors. So one it’s what we have in terms of free cash flow to invest, because we are cognizant of the fact that the overwhelming majority of our shareholders are in the stock for the dividend. So we want to be comfortable, so we can maintain our dividend policy. We also do have some convertible notes outstanding. We may decide to take some actions with them. Right now, we want to make sure that we have sufficient cash reserves for current and projected to make sure we can just sort those.

Third, it’s also – we’re trying to be careful about the assets that we are looking at. I mean we are screening a large number of transactions, the once we’ve announced already small fraction of that, because we are looking for high quality assets with an attractive return. So, yes, we are seeing a lot of transactions, but we are being very careful about, which ones we investing. We are cognizant on the fact that another way we can improve shareholder’s return is to simply return the money to them. That doesn’t help us in terms of meeting their request that we extend the duration of assets with a good improve the return of the assets. So we are always very careful to say, okay, we are really comfortable this is going to both extend the duration of royalties, but also improve their return.

Adnan Butt – RBC Capital Markets

Thanks. And can you remind me when the dividend policy for the coming year will be considered and updated. And secondly, is there an internal target has to how much to retain in terms of as the payout versus the freedom to invest?

John McLaughlin

So to answer the first question, we typically – the dividend policy for the year in our January Board Meeting, its my expectation for 2013 we’ll do that again and as you know we typically adopt it for the whole year, so we have quarterly regular dividend and its my expectation now will not change as well. We look at there is number of factors that influence how much dividend we’re going to pay, and other things we can do with the money, other better investments we can make with the money, but I would say having adopted a regular quarterly dividend of $0.60 per year paid an incremental $0.15 per quarter. We are targeting the fact that sellers don’t like to see the dividend go down.

Adnan Butt – RBC Capital Markets

Thanks John, I’ll get back in queue.

John McLaughlin

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Phil Nadeau of Cowen and Company. Your line is open.

Philip Nadeau – Cowen and Company

Thanks for taking my questions. First to couple on the Wellstat transaction you announced today, first in you prepared remarks and first we see make reference to internal IRR target that just set forth and needs to be hit before the loan is repaid. I was curios whether you do wanted to share with us what those IRR targets are always give some sense of what they are before 2014 or what they are afterwards?

John McLaughlin

Phil I apologize, we haven’t disclosed those and we’re going to disclose them. I understand right do you have interest to you. We haven’t disclosed these points. The second part of your question is when we make a decision to say, okay, we’re going to wrap up to our PDL or we’re going to go forward with PDL, where we make some additional disclosures in terms of how we put the basis for that decision and that’s something we have been thinking about recognizing the shareholders are going to run some long term transparency on that, and at that point we will probably make some additional disclosures. I don’t know that today we can tell you what they are going to look like, but we understand the nature of the question and why shareholders would be interested in that, we are not prepared to give you a much more granularity today, but we do recognize the responsibility at some future dates to provide that additional information.

Philip Nadeau – Cowen and Company

Okay. Fair enough. And then on Wellstat itself I was familiar with this company so what type of revenue or earnings do they have today and then on the loan is it securitized by all assets of Wellstat or is there some sort of cover?

John McLaughlin

At this point the product is not approved. As I mentioned in the remarks, this is sort of third generation of two products that they have previously sold in both cases to Roche and in the latest generation I think annual sales are well over $1 billion at this point. Our expectation is that probably will start selling the machines and conduct testing themselves, but obviously this is the diagnostics basis half right now point-of-care were you can have small machine that delivers results comparable to what you get from a central lab to get 5, 10, 15 minutes that pretty important in terms of allowing you to diagnose certain diseases, but also in terms of when you are administering various therapeutics to make sure that you’ve got efficacious doses, because obviously lots of for example chemotherapeutics on process the same particularly given the compromised systems in many cancer patients. So we think it’s a really a pretty interesting enterprise what they put together. What we like is, is the fact that is the third generation of two previously approved generations. Wellstat is a private company, to your point, it’s not real known and that’s one of the reasons why we are kind of proud of having identified this one, because it’s not well known and these will have a very impressive track record.

Philip Nadeau – Cowen and Company

Okay, great. And then just one last question on the financials for the quarter. You folks are kind enough to pass it along a sheet where you have the revenues that as reported to you by your partners every quarter, and we typically calculate the revenues also based on what the partners disclose publicly and the numbers are never exactly the same, and I was kind of curious as to your thinking as why that is? Is it simply a currency issue with Roche or is there something else going on between kind of the numbers report to you versus the numbers we see publicly and why there will be difference between those two?

John McLaughlin

So, Phil, I think there are probably three possibilities. One of which is you’ve identified which is the differences in currency. The second of which is also the percent of profits made – are sold in the U.S. versus the percent that both made and sold ex-U.S. which effects the royalty rate they pay to us. The third of which is we do provide a rebate to Novartis so that could affect the incentives numbers to some degree, if there is other variables, I cant think what they are, but Bruce, did I miss anything or something else keep want to mention.

Bruce Tomlinson

The only other thing is included in our revenue numbers is actually in gains and losses related to our foreign currency hedging activities, which can also affect the numbers a little bit.

Philip Nadeau – Cowen and Company

Okay, that makes sense. That could be it. Okay, perfect. Thanks for taking my questions.

John McLaughlin

Thank you, Phil. (Operator Instructions) Our next question comes from Larkin Tinsley, Tinsley Family Partners. Your question please.

Larkin Tinsley – Tinsley Family Partners

The book value of the common stock and the main assets that make up that value?

John McLaughlin

I’m sorry, could you ask the question one more time, I apologize it was coming through part it was truncated?

Larkin Tinsley – Tinsley Family Partners

What is the book value per common share of PDLI and what are the principle assets that make up that value?

John McLaughlin

Bruce you have that, I don’t have that in top of my head.

Bruce Tomlinson

No, we don’t actually measured that book value per common stock, so I don’t have that, I would say that our balance sheet is largely – our U.S. GAAP balance sheet is largely made up of the cash and investments that we hold the significant items that is not on our balance sheet is the value of the intellectual property of the relation to the royalties that we received into the future. So it’s quite difficult to look at the book value of our entity and try and generate what the real value is. Yeah, if you’d like, I can give you a call supplemental and we can talk through it.

Larkin Tinsley – Tinsley Family Partners

Okay.

Operator

And at this time I like to turn the call back over to Mr. John McLaughlin for closing remarks.

John McLaughlin

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

Operator

Thank you sir, and thank you ladies and gentlemen for your participation. That concludes your program. You may now disconnect your lines at this time. Have a great day.

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