Quarterly Report (10-q)

Date : 11/06/2019 @ 9:16PM
Source : Edgar (US Regulatory)
Stock : PDL BioPharma Inc (PDLI)
Quote : 3.36  -0.07 (-2.04%) @ 4:59AM
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Quarterly Report (10-q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
 (Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2019
OR
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For transition period from               to            
Commission File Number: 000-19756
 
PDLLOGOA28.JPG
PDL BIOPHARMA, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
94-3023969
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
932 Southwood Boulevard
Incline Village, Nevada 89451
(Address of principal executive offices and Zip Code)

(775) 832-8500
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of each class
Trading symbol
Name of each exchange on which registered
Common Stock, par value $0.01 per share
PDLI
The Nasdaq Stock Market LLC

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ý    No   ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer ý
Non-accelerated filer ¨
Smaller reporting company ¨
Emerging growth company ¨
 
 
 
 
 
If an emerging growth company, indicated by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  ý
As of October 31, 2019, there were 114,184,610 shares of the registrant’s Common Stock outstanding.




 PDL BIOPHARMA, INC.
2019 Form 10-Q
Table of Contents
 
Page
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
FINANCIAL STATEMENTS (unaudited)
3
 
 
 
 
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2019 and 2018
3
 
 
 
 
Condensed Consolidated Statements of Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2019 and 2018
4
 
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018
5
 
 
 
 
Condensed Consolidated Statements of Stockholders Equity for the Nine Months Ended September 30, 2019 and 2018
6
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018
8
 
 
 
 
Notes to the Condensed Consolidated Financial Statements
10
 
 
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
46
 
 
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
62
 
 
 
ITEM 4.
CONTROLS AND PROCEDURES
63
 
PART II - OTHER INFORMATION
 
 
 
ITEM 1.
LEGAL PROCEEDINGS
64
 
 
 
ITEM 1A.
RISK FACTORS
64
 
 
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
67
 
 
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
67
 
 
 
ITEM 4.
MINE SAFETY DISCLOSURES
67
 
 
 
ITEM 5.
OTHER INFORMATION
67
 
 
 
ITEM 6.
EXHIBITS
67
 
 
SIGNATURES
69
We own or have rights to certain trademarks, trade names, copyrights and other intellectual property used in our business, including PDL BioPharma and the PDL logo, each of which is considered a trademark. All other company names, product names, trade names and trademarks included in this Quarterly Report on Form 10-Q are trademarks, registered trademarks or trade names of their respective owners.

2



PART I. FINANCIAL INFORMATION

ITEM  1.         FINANCIAL STATEMENTS

PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2019
 
2018
 
2019
 
2018
Revenues
 
 
 
 
 
 
 
 
Product revenue, net
 
$
20,345

 
$
24,387

 
$
64,868

 
$
79,472

Royalty rights - change in fair value
 
23,865

 
42,184

 
(4,277
)
 
66,117

Royalties from Queen et al. patents
 

 
533

 
9

 
4,534

Interest revenue
 

 
754

 

 
2,254

License and other
 
(45
)
 
40

 
(48
)
 
614

Total revenues
 
44,165

 
67,898

 
60,552

 
152,991

Operating expenses
 
 

 
 

 
 

 
 

Cost of product revenue (excluding intangible asset amortization and impairment)
 
15,033

 
11,926

 
40,191

 
37,016

Amortization of intangible assets
 
1,575

 
1,577

 
4,745

 
14,254

General and administrative
 
12,092

 
13,211

 
33,037

 
39,401

Sales and marketing
 
1,712

 
3,469

 
6,515

 
14,367

Research and development
 
4,310

 
672

 
6,065

 
2,149

Impairment of intangible assets
 

 

 

 
152,330

Change in fair value of contingent consideration
 

 
302

 

 
(22,433
)
Total operating expenses
 
34,722

 
31,157

 
90,553

 
237,084

Operating income (loss)
 
9,443

 
36,741

 
(30,001
)
 
(84,093
)
Non-operating (expense) income, net
 
 

 
 

 
 

 
 

Interest and other income, net
 
1,460

 
1,581

 
4,984

 
4,871

Interest expense
 
(3,011
)
 
(2,866
)
 
(8,950
)
 
(9,262
)
Equity affiliate - change in fair value
 
(27,378
)
 

 
18,109

 

Gain on sale of intangible assets
 
3,476

 

 
3,476

 

Loss on exchange of convertible notes
 
(3,900
)
 

 
(3,900
)
 

Total non-operating (expense) income, net
 
(29,353
)
 
(1,285
)
 
13,719

 
(4,391
)
(Loss) income before income taxes
 
(19,910
)
 
35,456

 
(16,282
)
 
(88,484
)
Income tax (benefit) expense
 
(1,944
)
 
9,900

 
(419
)
 
(3,346
)
Net (loss) income
 
(17,966
)
 
25,556

 
(15,863
)
 
(85,138
)
Less: Net loss attributable to noncontrolling interests
 
(182
)
 

 
(340
)
 

Net (loss) income attributable to PDL’s shareholders
 
$
(17,784
)
 
$
25,556

 
$
(15,523
)
 
$
(85,138
)
 
 
 
 
 
 
 
 
 
Net (loss) income per share
 
 

 
 

 
 

 
 

Basic
 
$
(0.16
)
 
$
0.18

 
$
(0.13
)
 
$
(0.58
)
Diluted
 
$
(0.16
)
 
$
0.18

 
$
(0.13
)
 
$
(0.58
)
Weighted-average shares outstanding
 
 

 
 

 
 

 
 

Basic
 
112,986

 
143,171

 
119,966

 
147,159

Diluted
 
112,986

 
144,224

 
119,966

 
147,159

 
See accompanying notes.

3



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited)
(In thousands)

 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
 
 
2019
 
2018
 
2019
 
2018
 
 
 
 
 
 
 
 
 
 
 
Net (loss) income
 
$
(17,966
)
 
$
25,556

 
$
(15,863
)
 
$
(85,138
)
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss, net of tax
 
 

 
 

 
 

 
 

 
Change in unrealized gains (losses) on investments in available-for-sale securities:
 
 
 
 
 
 
 
 
 
Change in fair value of investments in available-for-sale securities, net of tax
 

 

 

 
(578
)
 
Adjustment for net gains realized and included in net loss, net of tax
 

 

 

 
(603
)
 
Total change in unrealized gains on investments in available-for-sale securities, net of tax
 

 

 

 
(1,181
)
(a) 
Total other comprehensive loss, net of tax
 

 

 

 
(1,181
)
 
Comprehensive (loss) income
 
(17,966
)
 
25,556

 
(15,863
)
 
(86,319
)
 
Less: Comprehensive loss attributable to noncontrolling interests
 
(182
)
 

 
(340
)
 

 
Comprehensive (loss) income attributable to PDL’s shareholders
 
$
(17,784
)
 
$
25,556

 
$
(15,523
)
 
$
(86,319
)
 
 ______________________________________________
(a) Net of tax of $314 for the nine months ended September 30, 2018.


See accompanying notes.

4



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts) 
 
September 30,
 
December 31,
 
2019
 
2018
 
(unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
294,270

 
$
394,590

Accounts receivable, net
12,581

 
21,648

Notes receivable
63,317

 
63,042

Inventory
20,942

 
18,942

Prepaid and other current assets
15,779

 
18,995

Total current assets
406,889

 
517,217

Property and equipment, net
6,576

 
7,387

Royalty rights - at fair value
313,943

 
376,510

Investment in equity affiliate
67,200

 

Notes receivable, long-term
691

 
771

Intangible assets, net
47,349

 
51,319

Other assets
22,497

 
10,532

Total assets
$
865,145

 
$
963,736

 
 
 
 
Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
13,256

 
$
13,142

Accrued liabilities
27,653

 
39,312

Accrued income taxes
17

 
16

Total current liabilities
40,926

 
52,470

Convertible notes payable
132,484

 
124,644

Other long-term liabilities
54,301

 
56,843

Total liabilities
227,711

 
233,957

 
 
 
 
Commitments and contingencies (Note 12)


 


 
 
 
 
Stockholders’ equity:
 

 
 

Preferred stock, par value $0.01 per share, 10,000 shares authorized; no shares issued and outstanding

 

Common stock, par value $0.01 per share, 350,000 shares authorized; 114,185 and 136,513 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively
1,142

 
1,365

Additional paid-in capital
(100,419
)
 
(98,030
)
Treasury stock, at cost; zero and 750 shares held at September 30, 2019 and December 31, 2018, respectively

 
(2,103
)
Retained earnings
736,695

 
828,547

Total PDL stockholders’ equity
637,418

 
729,779

Noncontrolling interests
16

 

Total stockholders’ equity
637,434

 
729,779

Total liabilities and stockholders’ equity
$
865,145

 
$
963,736


See accompanying notes.

5



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share amounts)
(Unaudited)

 
PDL Stockholders’ Equity
 
 
 
 
 
Common Stock
 
Treasury Stock
 
Additional
Paid-In
Capital
 
Retained Earnings
 
Non-controlling Interest
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2018
136,512,522

 
$
1,365

 
$
(2,103
)
 
$
(98,030
)
 
$
828,547

 
$

 
$
729,779

Issuance of common stock, net of forfeitures
764,785

 
8

 

 
(8
)
 

 

 

Stock-based compensation expense

 

 

 
1,169

 

 

 
1,169

Repurchase and retirement of common stock
(13,460,164
)
 
(135
)
 
613

 

 
(44,831
)
 

 
(44,353
)
Transfer of subsidiary shares to non-controlling interest

 

 

 

 

 
572

 
572

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)

 

 

 

 
6,680

 
(63
)
 
6,617

Total comprehensive income

 

 

 

 

 

 
6,617

Balance at March 31, 2019
123,817,143

 
1,238

 
(1,490
)
 
(96,869
)
 
790,396

 
509

 
693,784

Issuance of common stock, net of forfeitures
37,996

 

 

 

 

 

 

Stock-based compensation expense

 

 

 
2,175

 

 

 
2,175

Repurchase and retirement of common stock
(8,185,970
)
 
(81
)
 
944

 

 
(26,897
)
 

 
(26,034
)
Transfer of subsidiary shares to non-controlling interest

 

 

 
229

 

 
(216
)
 
13

Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss

 

 

 

 
(4,419
)
 
(95
)
 
(4,514
)
Total comprehensive loss

 

 

 

 

 

 
(4,514
)
Balance at June 30, 2019
115,669,169

 
1,157

 
(546
)
 
(94,465
)
 
759,080

 
198

 
665,424

Issuance of common stock, net of forfeitures
(18,061
)
 

 

 

 
8

 

 
8

Stock-based compensation expense

 

 

 
2,059

 

 

 
2,059

Repurchase and retirement of common stock
(1,466,498
)
 
(15
)
 
546

 

 
(4,609
)
 

 
(4,078
)
Exchange of convertible notes

 

 

 
(8,013
)
 

 

 
(8,013
)
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss

 

 

 

 
(17,784
)
 
(182
)
 
(17,966
)
Total comprehensive loss

 

 

 

 

 

 
(17,966
)
Balance at September 30, 2019
114,184,610

 
$
1,142

 
$

 
$
(100,419
)
 
$
736,695

 
$
16

 
$
637,434



6



 
PDL Stockholders’ Equity
 
 
 
 
 
Common Stock
 
Treasury Stock
 
Additional
Paid-In
Capital
 
Retained Earnings
 
Accumulated
Other Comprehensive
 Income (Loss)
 
Non-controlling Interest
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
Balance at December 31, 2017
153,774,756

 
$
1,538

 
$

 
$
(102,443
)
 
$
945,614

 
$
1,181

 
$

 
$
845,890

Issuance of common stock
37,500

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

 
957

 

 

 

 
957

Repurchase and retirement of common stock
(1,000,000
)
 
(10
)
 
(1,188
)
 

 
(2,961
)
 

 

 
(4,159
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 
1,602

 

 

 
1,602

Change in unrealized gains on investments in available-for-sale securities, net of tax

 

 

 

 

 
(1,181
)
 

 
(1,181
)
Total comprehensive income

 

 

 

 

 

 

 
421

Balance at March 31, 2018
152,812,256

 
1,528

 
(1,188
)
 
(101,486
)
 
944,255

 

 

 
843,109

Issuance of common stock, net of forfeitures
324,591

 
4

 

 
(3
)
 
3

 

 

 
4

Stock-based compensation expense

 

 

 
1,260

 

 

 

 
1,260

Repurchase and retirement of common stock
(7,165,415
)
 
(72
)
 
1,188

 

 
(20,565
)
 

 

 
(19,449
)
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss

 

 

 

 
(112,296
)
 

 

 
(112,296
)
Total comprehensive loss

 

 

 

 

 

 

 
(112,296
)
Balance at June 30, 2018
145,971,432

 
1,460

 

 
(100,229
)
 
811,397

 

 

 
712,628

Issuance of common stock, net of forfeitures
575,831

 
6

 

 
(6
)
 

 

 

 

Stock-based compensation expense

 

 

 
2,595

 

 

 

 
2,595

Repurchase and retirement of common stock
(571,051
)
 
(6
)
 

 

 
(1,386
)
 

 

 
(1,392
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 
25,556

 

 

 
25,556

Total comprehensive income

 

 

 

 

 

 

 
25,556

Balance at September 30, 2018
$
145,976,212

 
$
1,460

 
$

 
$
(97,640
)
 
$
835,567

 
$

 
$

 
$
739,387


See accompanying notes.

7



PDL BIOPHARMA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2019
 
2018
Cash flows from operating activities
 
 
 
Net loss
$
(15,863
)
 
$
(85,138
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 

Amortization of convertible notes conversion option and debt issuance costs
5,776

 
5,745

Accreted interest on convertible note principal
79

 

Amortization of intangible assets
4,745

 
14,254

Amortization of right-of-use assets
662

 

Impairment of intangible assets

 
152,330

Change in fair value of royalty rights - at fair value
4,277

 
(66,117
)
Change in fair value of equity affiliate
(16,574
)
 

Change in fair value of derivative assets
(1,487
)
 
(114
)
Change in fair value of contingent consideration

 
(22,433
)
Other amortization and depreciation
2,295

 
3,061

Loss on exchange of convertible notes
3,900

 

Gain on sale of available-for-sale securities

 
(764
)
Loss on disposal of property and equipment

 
66

Gain on sale of intangible assets
(3,476
)
 

Provision for bad debts
(23
)
 

Stock-based compensation expense
5,403

 
4,814

Deferred income taxes
(3,272
)
 
(3,285
)
Changes in assets and liabilities:
 

 
 

Accounts receivable
8,815

 
15,752

Prepaid and other current assets
3,215

 
(4,557
)
Accrued interest on notes receivable

 
(230
)
Inventory
(2,787
)
 
(3,471
)
Other assets
358

 
(1,805
)
Accounts payable
113

 
(10,774
)
Accrued liabilities
(9,949
)
 
(8,687
)
Accrued income taxes
1

 
(1,286
)
Other long-term liabilities
493

 
1,280

Net cash used in operating activities
(13,299
)
 
(11,359
)
Cash flows from investing activities
 

 
 

Proceeds from sales of available-for-sale securities

 
4,116

Proceeds from royalty rights - at fair value
58,290

 
57,049

Purchase of royalty rights

 
(20,000
)
Proceeds from the sale of intangible assets
5,000

 

Purchase of intangible assets
(1,700
)
 

Investment in equity affiliate
(60,000
)
 

Purchase of property and equipment
(504
)
 
(4,641
)
Net cash provided by investing activities
1,086

 
36,524

Cash flows from financing activities
 

 
 

Repayment of convertible notes

 
(126,447
)
Payment to exchange convertible notes
(7,451
)
 

Net payments for capped call transactions
(3,694
)
 

Payment of contingent consideration
(1,071
)
 

Repurchase of Company common stock
(75,891
)
 
(25,000
)
Net cash used in financing activities
(88,107
)
 
(151,447
)
Net decrease in cash and cash equivalents
(100,320
)
 
(126,282
)
Cash and cash equivalents at beginning of the period
394,590

 
527,266

Cash and cash equivalents at end of period
$
294,270

 
$
400,984

 
 
 
 
Supplemental cash flow information
 

 
 

Cash (refunded) paid for income taxes
$
(2,685
)
 
$
4,019

Cash paid for interest
$
2,063

 
$
4,591

 
 
 
 

8



 
Nine Months Ended September 30,
 
2019
 
2018
Supplemental schedule of non-cash investing and financing activities
 
 
 
December 2021 Notes exchanged for convertible notes due December 2024
$
86,053

 
$

Assets held for sale reclassified from other assets to intangible assets
$

 
$
1,811

See accompanying notes.

9

PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



1. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited Condensed Consolidated Financial Statements of PDL Biopharma, Inc. and its subsidiaries (collectively, the “Company” or “PDL”) have been prepared in accordance with Generally Accepted Accounting Principles (United States) (“GAAP”) for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments), that management of the Company believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year.
 
The accompanying unaudited Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the Company’s audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2018, included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the Securities and Exchange Commission (“SEC”) on March 15, 2019. The Condensed Consolidated Balance Sheet at December 31, 2018, included herein, has been derived from the audited Consolidated Financial Statements at that date, but does not include all disclosures required by GAAP.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying Notes to the Condensed Consolidated Financial Statements. The accounting estimates that require management’s most significant, difficult and subjective judgments include the valuation of royalty rights - at fair value, product revenue recognition and allowance for customer rebates and allowances, the valuation of notes receivable and inventory, the assessment of recoverability of intangible assets and their estimated useful lives, the valuation and recognition of stock-based compensation, the recognition and measurement of current and deferred income tax assets and liabilities, and the valuation of warrants to acquire shares of common stock. Actual results could differ from those estimates.

The Condensed Consolidated Financial Statements included herein include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Based on the nature of the Company’s existing investments and how they are managed, the Company structured its operations in four segments designated as Medical Devices, Strategic Positions, Pharmaceutical and Income Generating Assets. During the second quarter of 2019 the Company made an investment in Evofem Biosciences, Inc. (“Evofem”) (NASDAQ: EVFM) and added a new segment designated as Strategic Positions. This had no impact on its prior segment reporting structure.

The Company’s Medical Devices segment consists of revenue derived from the LENSAR® Laser System sales made by the Company’s subsidiary, LENSAR, Inc. (“LENSAR”), which may include equipment, Patient Interface Devices (“PIDs” or “consumables”), procedure licenses, training, installation, warranty and maintenance agreements.
The Company’s Strategic Positions segment consists of an investment in Evofem. The Company’s investment includes shares of common stock and warrants to purchase additional shares of common stock. Evofem is a publicly-traded clinical-stage biopharmaceutical company committed to developing and commercializing innovative products to address unmet needs in women's sexual and reproductive health. Evofem is leveraging its proprietary Multipurpose Vaginal pH Regulator (MVP-R™) platform to develop Amphora® (L-lactic acid, citric acid and potassium bitartrate) for hormone-free birth control.
The Company’s Pharmaceutical segment consists of revenue derived from branded prescription medicine products sold under the name Tekturna® and Tekturna HCT® in the United States and Rasilez® and Rasilez HCT® in the rest of the world and an authorized generic form of Tekturna sold in the United States (collectively, the “Noden Products”). The branded prescription Noden Products were acquired from Novartis in July 2016 (the “Noden Transaction”) by the Company’s wholly-owned subsidiary, Noden Pharma DAC (“Noden DAC”). The Company, through its wholly-owned subsidiary, Noden Pharma USA Inc. (“Noden USA”) launched its authorized generic form of Tekturna in the United States in March 2019.
The Company’s Income Generating Assets segment consists of revenue derived from (i) royalty rights - at fair value, (ii) notes and other long-term receivables, (iii) equity investments and (iv) royalties from issued patents in the United States and elsewhere covering the humanization of antibodies (“Queen et al. patents”).


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PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


Significant Accounting Policies

The Company’s significant accounting policies are described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018. Summarized below and in Note 2, Investment in Evofem Biosciences, Inc., are the accounting pronouncements and policies adopted subsequent to December 31, 2018.

Adopted Accounting Pronouncements

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases, that supersedes Accounting Standards Codification (“ASC”) 840, Leases. Subsequently, the FASB issued several updates to ASU No. 2016-02, codified in ASC Topic 842 (“ASC 842”). The Company adopted ASC 842, Leases, on January 1, 2019 using the modified retrospective method for all leases not substantially completed as of the date of adoption. The reported results for the three and nine month periods ended September 30, 2019 reflect the application of ASC 842 guidance while the reported results for the three and nine month periods ended September 30, 2018 were prepared under the guidance of ASC 840, which is also referred to herein as “legacy GAAP” or the “previous guidance”. The cumulative impact of the adoption of ASC 842 was not material, therefore, the Company did not record any adjustments to retained earnings. As a result of adopting ASC 842, the Company recorded operating lease right-of-use (“ROU”) assets of $2.1 million and operating lease liabilities of $2.1 million, primarily related to corporate office leases, based on the present value of the future lease payments on the date of adoption. Changes to lessor accounting focused on conforming with certain changes made to lessee accounting and the recently adopted revenue recognition guidance. The adoption of ASC 842 did not materially change how the Company accounts for lessor arrangements.
Policy Elections and Practical Expedients Taken
For leases that commenced before the effective date of ASC 842, the Company elected the practical expedients to not reassess the following: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and (iii) initial direct costs for any existing leases.
The Company adopted a policy of expensing short-term leases, defined as 12 months or less, as incurred.
The Company has a policy to exclude from the consideration in a lessor contract all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific lease revenue-producing transaction and collected by the Company from a lessee.
General
The Company determines if an arrangement is a lease or contains an embedded lease at inception. The Company has lease arrangements with lease and non-lease components, which are accounted for separately.
Lessee arrangements
Lessee operating leases are included in Other assets, Accrued liabilities, and Other long-term liabilities in the Company’s Condensed Consolidated Balance Sheet. The Company does not have lessee financing leases.
Operating lease ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company uses the implicit rate when readily determinable at lease inception. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Company’s remaining lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line basis as operating expense in the Condensed Consolidated Statements of Operations over the lease term.
Lessor arrangements
The Company leases medical device equipment to customers in both operating lease and sales-type lease arrangements generated from its Medical Devices segment.

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PDL BIOPHARMA, INC.
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(Unaudited)


For sales-type leases, the Company derecognizes the carrying amount of the underlying asset and capitalizes the net investment in the lease, which consists of the total minimum lease payments receivable from the lessee, at lease inception. The Company does not estimate an unguaranteed residual value of the equipment at lease termination because the equipment transfers to the lessee upon completion of the lease. Selling profit or loss is recognized at lease inception. Initial direct costs are recognized as an expense, unless there is no selling profit or loss. If there is no selling profit or loss, initial direct costs are deferred and recognized over the lease term. The Company recognizes interest income from the lease receivable over the lease term in Interest and other income, net in the Condensed Consolidated Statements of Operations.
 
For operating leases, rental income is recognized on a straight-line basis over the lease term. The cost of customer-leased equipment is recorded within Property and equipment, net in the accompanying Condensed Consolidated Balance Sheets and depreciated over the equipment’s estimated useful life. Depreciation expense associated with the leased equipment under operating lease arrangements is reflected in Cost of product revenue in the accompanying Condensed Consolidated Statements of Operations. Some of the Company’s operating leases include a purchase option for the customer to purchase the leased asset at the end of the lease arrangement. The Company manages its risk on its investment in the equipment through pricing and the term of the leases. Lessees do not provide residual value guarantees on leased equipment. Equipment returned to the Company may be leased or sold to other customers. Initial direct costs are deferred and recognized over the lease term.

Leases are generally not cancellable until after an initial term and may or may not require the customer to purchase a minimum number of procedures and consumables throughout the contract term.

For lease arrangements with lease and non-lease components where the Company is the lessor, the Company allocates the contract’s transaction price to the lease and non-lease components on a relative standalone selling price basis using the Company’s best estimate of the standalone selling price of each distinct product or service in the contract. Allocation of the transaction price is determined at the inception of the lease arrangement. The Company’s leases primarily consist of leases with fixed lease payments. For those leases with variable lease payments, the variable lease payment is typically based upon use of the leased equipment or the purchase of procedure licenses and consumables used with the leased equipment. Non-lease components are accounted for under ASC 606, Revenue from Contracts with Customers. For additional information regarding ASC 606, see Note 15, Revenue from Contracts with Customers.
Intangibles-Goodwill and Other
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other: Simplifying the Test for Goodwill Impairment, to simplify the subsequent measurement of goodwill by eliminating step two from the goodwill impairment test. Under the amendments, an entity will recognize an impairment charge for the amount by which the carrying value exceeds the fair value. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2019 on a prospective basis and early adoption is permitted. The Company adopted the requirements of ASU No. 2017-04 on January 1, 2019. The adoption did not have an effect on the Company’s Consolidated Financial Statements on the adoption date.

Recently Issued Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. The new guidance amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in more timely recognition of losses. ASU No. 2016-13 has an effective date of the fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the impact of this guidance on its Consolidated Financial Statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement. The new guidance modifies disclosure requirements related to fair value measurement. The amendments in ASU No. 2018-13 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Implementation on a prospective or retrospective basis varies by specific disclosure requirement. Early adoption is permitted. The standard also allows for early adoption of any removed or modified disclosures upon issuance of ASU No. 2018-13 while delaying adoption of the additional disclosures until their effective date. The Company is currently evaluating the impact of this guidance on its Consolidated Financial Statement disclosures.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software. The new guidance reduces complexity for the accounting for costs of implementing a cloud computing service arrangement and aligns the

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PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). For public companies, the amendments in ASU No. 2018-15 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. Implementation should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact of this guidance on its Consolidated Financial Statements.

2. Investment in Evofem Biosciences, Inc.

Equity Investment in Evofem Biosciences, Inc.

On April 10, 2019, the Company entered into a securities purchase agreement with Evofem and two other purchasers, pursuant to which the Company purchased $60.0 million of Evofem securities in a private placement. The transaction was structured in two tranches.

The first tranche closed on April 11, 2019, pursuant to which the Company invested $30.0 million to purchase 6,666,667 shares of Evofem common stock at $4.50 per share and was also issued warrants to purchase up to 1,666,667 shares of Evofem common stock exercisable for seven years beginning six months after the issuance date at an exercise price of $6.38 per share.

The second tranche closed on June 10, 2019, pursuant to which the Company invested an additional $30.0 million to purchase an additional 6,666,667 shares of Evofem common stock at $4.50 per share and was also issued warrants to purchase up to an additional 1,666,667 shares of Evofem common stock with the same terms as the warrants issued in the first tranche. Following the closing of the second tranche, the Company appointed one member to Evofem’s Board of Directors and has a limited right to have one board observer participate in Evofem board meetings.

The Company has registration rights on customary terms for all Evofem shares issued under the securities purchase agreement, including the shares underlying the warrants.

As of September 30, 2019, the Company owned approximately 29% of Evofem’s common stock. The Company’s investment in Evofem qualifies for equity method accounting given its percentage ownership in Evofem and the ability to exercise significant influence. The Company elected the fair value method to account for its investment in Evofem as it believes it better reflects economic reality, the financial reporting of the investment and the current value of the asset. Changes in fair value of the Evofem equity investment are presented in Non-operating (expense) income, net on the Condensed Consolidated Statements of Operations. Because the mark to market valuation will occur at the end of each quarterly reporting period, changes in fair value will vary based upon the volatility of the stock price. The Evofem equity investment is presented on the Condensed Consolidated Balance Sheet as an Investment in equity affiliate and reflects the fair value of the equity investment at the end of the reporting period.

For the three months ended September 30, 2019, the Company recognized an unrealized loss of $27.4 million, of which $21.4 million was related to Evofem common stock and $6.0 million was related to Evofem warrants. For the nine months ended September 30, 2019, the Company recognized an unrealized gain of $18.1 million, of which $16.6 million was related to Evofem common stock and $1.5 million was related to Evofem warrants.

The latest Evofem financial statements can be found on their corporate website at www.evofem.com or filed with the SEC at www.sec.gov.

3. Cash and Cash Equivalents
 
As of September 30, 2019 and December 31, 2018, the Company had invested its excess cash balances primarily in money market funds. The fair values of cash equivalents approximate their carrying values due to the short-term nature of such financial instruments.

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PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)



The following table summarizes the Company’s cash and cash equivalents by significant investment category as of September 30, 2019 and December 31, 2018:
(in thousands)
 
September 30, 2019
 
December 31, 2018
 
 
 
 
 
Cash
 
$
64,039

 
$
167,871

Money market funds
 
230,231

 
226,719

Total
 
$
294,270

 
$
394,590


The Company recognized zero and $0.8 million of gains on sales of available-for-sale securities in the three and nine months ended September 30, 2018, respectively. As of September 30, 2019 and December 31, 2018 the Company had no available-for-sale securities.

4. Inventories

Inventories consisted of the following:
(in thousands)
 
September 30, 2019
 
December 31, 2018
 
 
 
 
 
Raw materials
 
$
6,132

 
$
6,214

Work in process
 
3,087

 
549

Finished goods
 
11,723

 
12,179

Total inventory
 
$
20,942

 
$
18,942


As of September 30, 2019 and December 31, 2018, the Company deferred approximately $0.1 million and $0.5 million, respectively, of costs associated with inventory transfers made under the Company’s third-party logistic provider service arrangement. These costs have been recorded as Prepaid and other current assets on the Company’s Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018. The Company will recognize the cost of product sold as inventory is transferred from its third-party logistics provider to the Company’s customers.

5. Fair Value Measurements

The fair value of the Company’s financial instruments are estimates of the amounts that would be received if the Company were to sell an asset or pay to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The assets and liabilities are categorized and disclosed in one of the following three categories:

Level 1 – based on quoted market prices in active markets for identical assets and liabilities;
 
Level 2 – based on observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
Level 3 – based on unobservable inputs using management’s best estimate and assumptions when inputs are unavailable.


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PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


Assets/Liabilities Measured and Recorded at Fair Value on a Recurring Basis

The following table presents the fair value of the Company’s financial instruments measured at fair value on a recurring basis by level within the valuation hierarchy:
 
 
September 30, 2019
 
December 31, 2018
(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
230,231

 
$

 
$

 
$
230,231

 
$
226,719

 
$

 
$

 
$
226,719

Corporate securities(1)
 
67,200

 

 

 
67,200

 

 

 

 

Warrants(2)
 

 
10,923

 

 
10,923

 

 
62

 

 
62

Royalty rights - at fair value
 

 

 
313,943

 
313,943

 

 

 
376,510

 
376,510

Total
 
$
297,431

 
$
10,923

 
$
313,943

 
$
622,297

 
$
226,719

 
$
62

 
$
376,510

 
$
603,291

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 
 
 

 
 

 
 

 
 
 
 

Contingent consideration, current(3)
 
$

 
$

 
$

 
$

 
$

 
$

 
$
1,071

 
$
1,071

Total
 
$

 
$

 
$

 
$

 
$

 
$

 
$
1,071

 
$
1,071

___________________
(1) 
Corporate securities are classified as “Investment in equity affiliate” on the Condensed Consolidated Balance Sheet.
(2) 
Warrants are included in “Other assets” on the Condensed Consolidated Balance Sheets.
(3) 
Contingent consideration, current is classified as “Accrued liabilities” on the Condensed Consolidated Balance Sheet.

There have been no transfers between levels during the periods presented in the table above. The Company recognizes transfers between levels on the date of the event or change in circumstances that caused the transfer.

Money Market Funds - The fair values of cash equivalents approximate their carrying values due to the short-term nature of such financial instruments.

Corporate Securities - Corporate securities consists of common stock shares of Evofem, a clinical-stage biopharmaceutical company listed on Nasdaq. For additional information on the Evofem investment, see Note 2, Investment in Evofem.

Warrants - Warrants consist of rights to purchase shares of common stock in Evofem and CareView Communications, Inc. (“CareView”), see Note 2, Investment in Evofem, and Note 6, Notes and Other Long-Term Receivables. The fair value of the warrants is estimated using recently quoted market prices of the underlying equity security and the Black-Scholes option pricing model.

Royalty Rights - At Fair Value

Assertio (Depomed) Royalty Agreement

On October 18, 2013, the Company entered into the Royalty Purchase and Sale Agreement (the “Assertio Royalty Agreement”) with Assertio Therapeutics, Inc. (formerly known as Depomed, Inc.), and Depo DR Sub, LLC (together, “Assertio”), whereby the Company acquired the rights to receive royalties and milestones payable on sales of five Type 2 diabetes products licensed by Assertio in exchange for a $240.5 million cash payment. Total consideration was $241.3 million, which was comprised of the $240.5 million cash payment to Assertio and $0.8 million in transaction costs.

The rights acquired include Assertio’s royalty and milestone payments accruing from and after October 1, 2013: (a) from Santarus, Inc. (“Santarus”), which was subsequently acquired by Salix Pharmaceuticals, Inc. (“Salix”), which itself was acquired by Valeant Pharmaceuticals International, Inc. (“Valeant”), which, in July 2018, changed its name to Bausch Health Companies Inc. (“Bausch Health”) with respect to sales of Glumetza (metformin HCL extended-release tablets) in the United States; (b) from Merck & Co., Inc. with respect to sales of Janumet® XR (sitagliptin and metformin HCL extended-release

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PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


tablets); (c) from Janssen Pharmaceutica N.V. with respect to potential future development milestones and sales of its approved fixed-dose combination of Invokana® (canagliflozin, a sodium glucose cotransporter 2 (SGLT2) inhibitor) and extended-release metformin tablets, marketed as Invokamet XR®; (d) from Boehringer Ingelheim and Eli Lilly and Company with respect to potential future development milestones and sales of the investigational fixed-dose combinations of drugs and extended-release metformin subject to Assertio’s license agreement with Boehringer Ingelheim, including its approved products, Jentadueto XR® and Synjardy XR®; and (e) from LG Life Sciences and Bausch Health for sales of extended-release metformin tablets in Korea and Canada, respectively.

In February 2013, a generic equivalent to Glumetza was approved by the U.S. Food and Drug Administration (“FDA”) and in August 2016, two additional generic equivalents to Glumetza were approved by the FDA. In February 2016, Lupin Pharmaceuticals, Inc., in August 2017, Teva Pharmaceutical Industries Ltd., and in July 2018, Sun Pharmaceutical, Inc. (“Sun”) each launched a generic equivalent approved product. In May 2017, the Company received notification that a subsidiary of Valeant had launched an authorized generic equivalent product in February 2017, and the Company received royalties on such authorized generic equivalent product under the same terms as the branded Glumetza product, retroactive to February 2017. The Company continues to monitor whether the generic competition further affects sales of Glumetza and thus royalties on such sales paid to the Company, and the impact of the launched authorized generic equivalent. Due to the uncertainty around Bausch Health’s marketing and pricing strategy, as well as Sun’s recently launched generic product and limited historical demand data after generic market entrance, the Company may need to further evaluate future cash flows in the event of more rapid reduction or increase in market share of Glumetza and its authorized generic equivalent product and/or a further erosion in net pricing.

The Company determined that its royalty purchase interest in Depo DR Sub, LLC represented a variable interest in a variable interest entity. However, the Company did not have the power to direct the activities of Depo DR Sub, LLC that most significantly impact Depo DR Sub, LLC’s economic performance and was not the primary beneficiary of Depo DR Sub, LLC; therefore, Depo DR Sub, LLC was not subject to consolidation by the Company.

On August 2, 2018, PDL Investment Holding, LLC (“PDLIH”), a wholly-owned subsidiary of the Company and assignee from the Company under the Assertio Royalty Agreement, entered into an amendment to the Assertio Royalty Agreement with Assertio. Pursuant to the amendment, PDLIH purchased all of Assertio’s remaining interests in royalty and milestone payments payable on sales of Type 2 diabetes products licensed by Assertio for $20.0 million. Prior to the amendment, the Assertio Royalty Agreement provided that the Company would have received all royalty and milestone payments due under license agreements between Assertio and its licensees until the Company received payments equal to two times the cash payment it made to Assertio, or approximately $481.0 million, after which all net payments received by Assertio would have been shared equally between the Company and Assertio. Following the amendment, the Assertio Royalty Agreement provides that the Company will receive all royalty and milestone payments due under the license agreements between Assertio and its licensees. The Company has elected to continue to follow the fair value option and carry the financial asset at fair value.

The Assertio Royalty Agreement terminates on the third anniversary following the date upon which the later of the following occurs: (a) October 25, 2021, or (b) at such time as no royalty payments remain payable under any license agreement and each of the license agreements has expired by its terms.

As of December 31, 2018, in conjunction with the amendment described above, the Company was provided the power to direct the activities of Depo DR Sub, LLC and is the primary beneficiary of Depo DR Sub, LLC; therefore, Depo DR Sub, LLC is subject to consolidation by the Company. As of September 30, 2019, Depo DR Sub, LLC did not have any assets or liabilities of value for consolidation with the Company.

In October 2018, PDL submitted notice of its intent to exercise its audit right under the Assertio Royalty Agreement with respect to Glumetza royalties for the period beginning January 1, 2016 and ending December 31, 2018. No material adjustments were identified in connection with this audit.

The financial asset acquired represents a single unit of accounting. This financial asset is classified as a Level 3 asset within the fair value hierarchy, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future commercialization for products not yet approved by regulatory agencies outside of the United States. The estimated fair value of the financial asset acquired was determined by using a discounted cash flow analysis related to the expected future cash flows to be generated by each licensed product. The discounted cash flows are based upon expected royalties from sales of licensed products over approximately an eight-year period. The estimated fair value of the asset is

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(Unaudited)


subject to variation should those cash flows vary significantly from the Company’s estimates. The Company periodically assesses the expected future cash flows and to the extent such payments are greater or less than its initial estimates, or the timing of such payments is materially different than the original estimates, the Company will adjust the estimated fair value of the asset. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $6.6 million, respectively. Significant judgment is required in selecting appropriate discount rates. The discount rates utilized range from 10% to 24%. Should these discount rates increase or decrease by 2.5%, the fair value of the asset could decrease by $21.9 million or increase by $25.8 million, respectively.

As of September 30, 2019, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date for the above described royalty streams.

As of September 30, 2019, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $265.0 million and the maximum loss exposure was $265.0 million.

Viscogliosi Brothers Royalty Agreement

On June 26, 2014, the Company entered into a Royalty Purchase and Sale Agreement (the “VB Royalty Agreement”) with Viscogliosi Brothers, LLC (“VB”), whereby VB conveyed to the Company the right to receive royalties payable on sales of a spinal implant that has received pre-market approval from the FDA held by VB and commercialized by Paradigm Spine, LLC (“Paradigm Spine”), in exchange for a $15.5 million cash payment, less fees. Paradigm Spine was acquired in March 2019 by RTI Surgical Holdings, Inc.

The royalty rights acquired include royalties accruing from and after April 1, 2014. Under the terms of the VB Royalty Agreement, the Company receives all royalty payments due to VB pursuant to certain technology transfer agreements between VB and Paradigm Spine until the Company has received payments equal to 2.3 times the cash payment made to VB, after which all rights to receive royalties will be returned to VB. VB’s ability to repurchase the royalty right for a specified amount expired on June 26, 2018.

The estimated fair value of the royalty rights at September 30, 2019, was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of licensed product over approximately a nine-year period. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. The Company periodically assesses the expected future cash flows and to the extent such payments are greater or less than its initial estimates, or the timing of such payments is materially different than the original estimates, the Company will adjust the estimated fair value of the asset. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $0.4 million, respectively. Significant judgment is required in selecting the appropriate discount rate. The discount rate utilized was 15.0%. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $1.3 million or increase by $1.5 million, respectively.

As of September 30, 2019, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date.

As of September 30, 2019, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $14.5 million and the maximum loss exposure was $14.5 million.

University of Michigan Royalty Agreement

On November 6, 2014, the Company acquired a portion of all royalty payments of the Regents of the University of Michigan’s (“U-M”) worldwide royalty interest in Cerdelga® (eliglustat) for $65.6 million pursuant to the Royalty Purchase and Sale Agreement with U-M (the “U-M Royalty Agreement”). Under the terms of the U-M Royalty Agreement, the Company receives 75% of all royalty payments due under U-M’s license agreement with Genzyme Corporation, a Sanofi company (“Genzyme”) until expiration of the licensed patents, excluding any patent term extension. Cerdelga, an oral therapy for adult patients with Gaucher disease type 1, was developed by Genzyme. Cerdelga was approved in the United States in August 2014, in the

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PDL BIOPHARMA, INC.
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(Unaudited)


European Union in January 2015, and in Japan in March 2015. In addition, marketing applications for Cerdelga are under review by other regulatory authorities. While marketing applications have been approved in the United States, the European Union and Japan, national pricing and reimbursement decisions are delayed in some countries.

The estimated fair value of the royalty right at September 30, 2019 was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of licensed product over approximately a three-year period. Based on the results of the Company’s analysis, which considered input from a third-party expert and the variance between the Company’s forecast model and actual results, the Company wrote down the fair value of the royalty asset by $3.1 million in the third quarter ended September 30, 2019. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. An evaluation of those estimates, discount rate utilized and general market conditions affecting fair market value is performed in each reporting period. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $0.5 million, respectively. Significant judgment is required in selecting the appropriate discount rate. The discount rate utilized was approximately 12.8%. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease or increase by $0.7 million, respectively.

As of September 30, 2019, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows.

As of September 30, 2019, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $21.2 million and the maximum loss exposure was $21.2 million.

AcelRx Royalty Agreement

On September 18, 2015, the Company entered into a royalty interest assignment agreement (the “AcelRx Royalty Agreement”) with ARPI LLC, a wholly-owned subsidiary of AcelRx Pharmaceuticals, Inc. (“AcelRx”), whereby the Company acquired the rights to receive a portion of the royalties and certain milestone payments on sales of Zalviso® (sufentanil sublingual tablet system) in the European Union, Switzerland and Australia by AcelRx’s commercial partner, Grünenthal, in exchange for a $65.0 million cash payment. Under the terms of the AcelRx Royalty Agreement, the Company receives 75% of all royalty payments and 80% of the first four commercial milestone payments due under AcelRx’s license agreement with Grünenthal until the earlier to occur of (i) receipt by the Company of payments equal to three times the cash payments made to AcelRx and (ii) the expiration of the licensed patents. Zalviso received marketing approval by the European Commission in September 2015. Grünenthal launched Zalviso in the second quarter of 2016 and the Company started to receive royalties in the third quarter of 2016.

As of September 30, 2019, and December 31, 2018, the Company determined that its royalty rights under the AcelRx Royalty Agreement represented a variable interest in a variable interest entity. However, the Company does not have the power to direct the activities of ARPI LLC that most significantly impact ARPI LLC’s economic performance and is not the primary beneficiary of ARPI LLC; therefore, ARPI LLC is not subject to consolidation by the Company.

Due to the slower than expected adoption of the product since its initial launch relative to the Company’s estimates and the increased variance noted between the Company’s forecast model and actual results in the three months ended June 30, 2019, the Company utilized a third-party expert in the second quarter of 2019 to reassess the market and expectations for the Zalviso product. Key findings from the third-party study included: the post-surgical PCA (Patient-Controlled Analgesia) market being smaller than previously forecasted; the higher price of the product relative to alternative therapies, the product not being used as a replacement for systemic opioids and the design of the delivery device, which is pre-filled for up to three days of treatment, which restricts its use for shorter recovery time procedures. Based on this analysis and the impact to the projected sales-based royalties and milestones, the Company wrote down the fair value of the royalty asset by $60.0 million in the second quarter of 2019.

The estimated fair value of the royalty right at September 30, 2019 was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed

18

PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


product. The discounted cash flow was based upon expected royalties from sales of licensed product over approximately a thirteen-year period. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. An evaluation of those estimates, discount rate utilized and general market conditions affecting fair market valuation is performed for each reporting period. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by $0.3 million, respectively. Significant judgment is required in selecting the appropriate discount rate. The discount rate utilized was approximately 13.4%. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease by $1.2 million or increase by $1.5 million, respectively.

As of September 30, 2019, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date.

As of September 30, 2019, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $12.7 million and the maximum loss exposure was $12.7 million.

Kybella Royalty Agreement

On July 8, 2016, the Company entered into a royalty purchase and sales agreement with an individual, whereby the Company acquired that individual’s rights to receive certain royalties on sales of KYBELLA® by Allergan plc in exchange for a $9.5 million cash payment and up to $1.0 million in future milestone payments based upon product sales targets. The Company started to receive royalty payments during the third quarter of 2016.

The estimated fair value of the royalty right at September 30, 2019, was determined by using a discounted cash flow analysis related to the expected future cash flows to be received. This asset is classified as a Level 3 asset, as the Company’s valuation utilized significant unobservable inputs, including estimates as to the probability and timing of future sales of the licensed product. The discounted cash flow was based upon expected royalties from sales of a licensed product over approximately a six-year period. The estimated fair value of the asset is subject to variation should those cash flows vary significantly from the Company’s estimates. An evaluation of those estimates, discount rate utilized and general market conditions affecting fair market value is performed in each reporting period. A third-party expert is engaged to assist management with the development of its estimate of the expected future cash flows, when deemed necessary. Should the expected royalties increase or decrease by 2.5%, the fair value of the asset could increase or decrease by less than $0.1 million, respectively. Significant judgment is required in selecting the appropriate discount rate. The discount rate utilized was approximately 14.4%. Should this discount rate increase or decrease by 2.5%, the fair value of this asset could decrease or increase by less than $0.1 million, respectively.

As of September 30, 2019, the Company’s discounted cash flow analysis reflects its expectations as to the amount and timing of future cash flows up to the valuation date.

As of September 30, 2019, the fair value of the asset acquired as reported in the Company’s Condensed Consolidated Balance Sheet was $0.6 million and the maximum loss exposure was $0.6 million.


19

PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


The following tables summarize the changes in Level 3 Royalty Right Assets and the gains and losses included in earnings for the nine months ended September 30, 2019:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Royalty Rights Assets
 
 
 
 
 
 
 
(in thousands)
 
Royalty Rights -
At Fair Value
Fair value as of December 31, 2018
 
 
 
$
376,510

 
 
 
 
 
 
 
 
Total net change in fair value for the period
 
 
 
 
 
 
Change in fair value of royalty rights - at fair value
 
$
(4,277
)
 
 
 
 
Proceeds from royalty rights - at fair value
 
$
(58,290
)
 
 
 
 
Total net change in fair value for the period
 
 
 
(62,567
)
 
 
 
 
 
 
 
Fair value as of September 30, 2019
 


 
$
313,943


Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Royalty Rights Assets
 
 
 
 
 
 
 
 
 
Fair Value as of
 
Royalty Rights -
 
Fair Value as of
(in thousands)
 
December 31, 2018
 
Change in Fair Value
 
September 30, 2019
 
 
 
 
 
 
 
Assertio (Depomed)
 
$
264,371

 
$
599

 
$
264,970

VB
 
14,108

 
354

 
14,462

U-M
 
25,595

 
(4,379
)
 
21,216

AcelRx
 
70,380

 
(57,650
)
 
12,730

KYBELLA
 
2,056

 
(1,491
)
 
565

 
 
$
376,510

 
$
(62,567
)
 
$
313,943



20

PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


The following table summarizes the changes in Level 3 Liabilities and the gains and losses included in earnings for the nine months ended September 30, 2019:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) - Liabilities
 
 
 
(in thousands)
 
Contingent Consideration
Fair value as of December 31, 2018
 
$
(1,071
)
 
 
 
 
 
 
Financial instruments purchased
 

 
Settlement of financial instrument(1)
 
1,071

 
 
 
 
 
Fair value as of September 30, 2019
 
$

______________
(1) 
Represents the final conversion consideration and earn out liability for the LENSAR acquisition of assets from Precision Eye Services.

Gains and losses from changes in Level 3 assets included in earnings for each period are presented in “Royalty rights - change in fair value” and gains and losses from changes in Level 3 liabilities included in earnings for each period are presented in “Change in fair value of anniversary payment and contingent consideration” as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands)
 
2019
 
2018
 
2019
 
2018
 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for royalty right assets held at the end of the reporting period
 
$
23,865

 
$
42,184

 
$
(4,277
)
 
$
66,117

 
 
 
 
 
 
 
 
 
Total change in fair value for the period included in earnings for liabilities held at the end of the reporting period
 
$

 
$
(302
)
 
$

 
$
22,433


Assets/Liabilities Measured and Recorded at Fair Value on a Nonrecurring Basis

The Company remeasures the fair value of certain assets and liabilities upon the occurrence of certain events. Such assets consist of long-lived assets, including property and equipment and intangible assets and the shares of Alphaeon Class A common stock, received in connection with loans made to LENSAR by the Company prior to its acquisition of LENSAR. During the three months ended June 30, 2018, the Company recorded an impairment charge of $152.3 million for the Noden intangible assets related to the increased probability of a generic form of aliskiren being launched in the United States. As a result of this impairment charge, which was based on the estimated fair value of the assets, the remaining carrying value of these intangible assets was determined to be $40.1 million. The fair value calculation included level 3 inputs. The Company’s carrying value of the 1.7 million shares of Alphaeon common stock as of both September 30, 2019 and December 31, 2018 is $6.6 million based on an estimated per share value of $3.84, which was established by a valuation performed when the shares were acquired. The value of the Company’s investment in Alphaeon is not readily determinable as Alphaeon’s shares are not publicly traded. The Company evaluates the fair value of this investment by performing a qualitative assessment each reporting period. If the results of this qualitative assessment indicate that the fair value is less than the carrying value, the investment is written down to its fair value. There have been no such write downs since the Company acquired these shares. This investment is included in Other long-term assets. For additional information on the Alphaeon investment, see Note 6, Notes and Other Long-Term Receivables.


21

PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


Assets/Liabilities Not Subject to Fair Value Recognition

The following tables present the fair value of assets and liabilities not subject to fair value recognition by level within the valuation hierarchy:
 
 
September 30, 2019
 
December 31, 2018
(in thousands)
 
Carrying Value
 
Fair Value
Level 2
 
Fair Value
Level 3
 
Carrying Value
 
Fair Value
Level 2
 
Fair Value
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics note receivable
 
$
50,191

 
$

 
$
52,690

 
$
50,191

 
$

 
$
57,322

Hyperion note receivable
 
1,200

 

 
1,200

 
1,200

 

 
1,200

CareView note receivable
 
11,458

 

 
11,458

 
11,458

 

 
11,458

Total
 
$
62,849

 
$

 
$
65,348

 
$
62,849

 
$

 
$
69,980

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

December 2021 Notes
 
$
55,652

 
$
61,984

 
$

 
$
124,644

 
$
151,356

 
$

December 2024 Notes
 
76,832

 
81,034

 

 

 

 

Total
 
$
132,484

 
$
143,018

 
$

 
$
124,644

 
$
151,356

 
$


During the year ended December 31, 2018 the Company recorded an impairment loss of $8.2 million for the note receivable with CareView Communications, Inc. (“CareView”). There were no impairment losses on notes receivable in the three and nine month periods ended September 30, 2019.

As of September 30, 2019 and December 31, 2018, the estimated fair value of the CareView note receivable was determined using discounted cash flow models, incorporating expected principal and interest payments and also considered the recoverability of the note receivable balance utilizing third-party revenue multiples for small cap healthcare technology companies. As of September 30, 2019 and December 31, 2018, the estimated fair value of the Wellstat Diagnostics and Hyperion Catalysis International, Inc. (“Hyperion”) notes receivable were determined by using an asset approach and discounted cash flow model related to the underlying collateral and adjusted to consider estimated costs to sell the assets.

The Company determined its notes receivable assets are Level 3 assets as the Company’s valuations utilized significant unobservable inputs, including estimates of future revenues, discount rates, expectations about settlement, terminal values, required yield and the value of underlying collateral. The Company engages third-party valuation experts when deemed necessary to assist in evaluating its investments and the related inputs needed to estimate the fair value of certain investments.

The CareView note receivable is secured by substantially all assets of, and equity interests in CareView. The Wellstat Diagnostics note receivable is secured by substantially all assets of Wellstat Diagnostics and is supported by a guaranty from the Wellstat Diagnostics Guarantors (as defined in Note 6, Notes and Other Long-Term Receivables).

On September 30, 2019, the carrying value of one of the Company’s notes receivable assets differed from its estimated fair value. This is the result of inputs used in estimating the fair value of the collateral, including appraisals, projected cash flows of collateral assets and discount rates used when performing a discounted cash flow analysis.

The fair values of the Company’s convertible senior notes were determined using quoted market pricing.


22

PDL BIOPHARMA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)


The following table represents significant unobservable inputs used in determining the estimated fair value of impaired notes receivable investments:
Asset
 
Valuation
Technique
 
Unobservable
Input
 
September 30, 2019
 
December 31, 2018
 
 
 
 
 
 
 
 
 
Wellstat Diagnostics
 
 
 
 
 
 
 
 
Wellstat Guarantors intellectual property
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
12%
 
12%
 
 
 
 
Royalty amount
 
$21 million
 
$21 million
Settlement Amount
 
Income Approach
 
 
 
 
 
 
 
 
 
 
Discount rate
 
15%
 
15%
 
 
 
 
Settlement amount
 
$28 million
 
$34 million
 
 
 
 
 
 
 
 
 
Real Estate Property
 
Market Approach
 
 
 
 
 
 
 
 
 
 
Annual appreciation rate
 
4%
 
4%
 
 
 
 
Estimated realtor fee
 
6%
 
6%
 
 
 
 
Estimated disposal date
 
3/31/2020
 
9/30/2019
 
 
 
 
 
 
 
 
 
CareView