NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

 

 

1. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments) the management of PDL BioPharma, Inc. (the Company, PDL, we, us or our) 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 or for any subsequent interim period.

 

The accompanying Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission. The Condensed Consolidated Balance Sheet at December 31, 2011, has been derived from the audited Consolidated Financial Statements at that date.

 

Principles of Consolidation

 

The Consolidated Financial Statements include the accounts of PDL and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

 

Foreign Currency Hedging

 

We hedge certain Euro-denominated currency exposures related to our licensees’ product sales with Euro forward contracts. In general, these contracts are intended to offset the underlying Euro market risk in our royalty revenues. We do not enter into speculative foreign currency transactions. We have designated the Euro forward contracts as cash flow hedges.

 

At the inception of the hedging relationship and on a quarterly basis, we assess hedge effectiveness. The fair value of the Euro forward contracts is estimated using pricing models with readily observable inputs from actively quoted markets and are disclosed on a gross basis. The aggregate unrealized gain or loss, net of tax, on the effective portion of the hedge is recorded in stockholders’ deficit as accumulated other comprehensive loss. Gains or losses on cash flow hedges are recognized as royalty revenue in the same period that the hedged transaction impacts earnings as royalty revenue. The ineffective portion of the change in fair value of the hedge is recognized in the period it occurs as interest and other income, net. Ineffectiveness, if any, resulting from lower than forecasted Euro based royalties is reclassified from other comprehensive loss and charged against earnings.

 

 

Comprehensive Income

 

In accordance with the Financial Accounting Standards Board (FASB) accounting standard update (ASU) 2011-05, we have presented the components of other comprehensive loss in the Condensed Consolidated Statements of Comprehensive Income in our first quarter of 2012. Also in accordance with this ASU, we have applied this guidance retrospectively to all periods presented. The adoption of the guidance was a change to the presentation of other comprehensive income and had no effect on our condensed consolidated financial statements. See Note 13 for our accumulated other comprehensive loss.

 

Recent Accounting Pronouncements

 

In December 2011, the FASB issued ASU 2011-11 that requires new disclosures associated with offsetting financial instruments and derivative instruments on the balance sheet that will enable users to evaluate the effect on an entity’s financial position. The ASU will be effective for our first quarter of 2013, but is not expected to have a material impact on our financial statements.

 

2. Net Income per Share

 

The computation for net income per basic and diluted share was:

 

 

We compute net income per basic share using the weighted-average number of shares of common stock outstanding during the period less the weighted-average number of restricted stock shares that are subject to repurchase.

 

We compute net income per diluted share using the sum of the weighted-average number of common and common equivalent shares outstanding. Common equivalent shares used in the computation of net income per diluted share include shares that may be issued under our restricted stock awards, our 2.875% Convertible Senior Notes due February 15, 2015 (February 2015 Notes), our 2.875% Series 2012 Convertible Notes due February 15, 2015 (Series 2012 Notes), our 3.75% Senior Convertible Notes due May 1, 2015 (May 2015 Notes) and in 2011, our 2.00% Convertible Senior Notes due February 15, 2012 (2012 Notes), on a weighted average basis for the period that the notes were outstanding, including the effect of adding back interest expense, net of tax, and the underlying shares using the if-converted method. Our 2012 Notes were fully retired as of June 30, 2011, and $179.0 million aggregate principal amount of our February 2015 Notes were exchanged for our Series 2012 Notes in the first quarter of 2012.

 

The weighted-average shares on our Series 2012 Notes include the assumed shares on the premium of the average market price over the conversion price as our Series 2012 Notes are net share settled, with the principal amount settled in cash and the excess settled in our common stock.

 

 

For further information related to our convertible notes, see Note 9.

 

We excluded 0.2 million and 0.3 million, of outstanding stock options from our net income per diluted share calculations for the three months ended March 31, 2012 and 2011, respectively, because their effect was anti-dilutive.

  3. Fair Value Measurements

 

The fair value of our financial instruments are estimates of the amounts that would be received if we were to sell an asset or we paid to transfer a liability in an orderly transaction between market participants at the measurement date or exit price. 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 quoted market prices for similar assets and liabilities, using observable market based inputs or unobservable market based inputs corroborated by market data; and

Level 3 – based on unobservable inputs using management’s best estimate and assumptions when inputs are unavailable. As of March 31, 2012, and December 31, 2011, we had no Level 3 assets or liabilities.

 

The following table summarizes assets and liabilities recorded at fair value by classification category:

 

 

The fair value of the foreign currency hedging contracts is estimated based on pricing models using readily observable inputs from actively quoted markets and are disclosed on a gross basis.

 

Corporate debt securities consist primarily of U.S. Corporate bonds. The fair value of corporate debt securities is estimated using recently executed transactions or market quoted prices, where observable. Independent pricing sources are also used for valuation.

 

The fair value of commercial paper is estimated based on observable inputs of the comparable securities.

 

 

The following table summarizes assets and liabilities that are not recorded at fair value by classification category: 

 

We do not estimate the fair value of our royalty assets for financial statement reporting purposes.

 

4. Cash Equivalents and Investments

 

As of March 31, 2012, and December 31, 2011, we had invested our excess cash balances primarily in money market funds, corporate debt securities, commercial paper, U.S. government sponsored agency bonds and U.S. treasury securities. Our securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses, net of estimated taxes, reported in accumulated other comprehensive loss in stockholders’ deficit. See Note 3 for fair value measurement information. The cost of securities sold is based on the specific identification method. To date, we have not experienced credit losses on investments in these instruments and we do not require collateral for our investment activities.

 

A summary of our available-for-sale securities at March 31, 2012, and December 31, 2011, is presented below:

 

 

 

We did not recognize any gains or losses on sales of available-for-sale securities for the three months ended March 31, 2012 and 2011, respectively.

 

A summary of our portfolio of available-for-sale debt securities by contractual maturity at March 31, 2012, and December 31, 2011, is presented below:

 

 

The net unrealized gain on investments, included in other comprehensive loss, net of tax, was approximately $58,000 as of March 31, 2012. No significant facts or circumstances have arisen to indicate that there has been any deterioration in the creditworthiness of the issuers of these securities. Based on our review of these securities, we believe we had no other-than-temporary impairments on these securities as of March 31, 2012, because our investments in a loss position at March 31, 2012, were less than $1,000, net of tax.

 

5. Foreign Currency Hedging

 

In January 2012, we modified our existing Euro forward and option contracts related to our licensees’ sales through December 2012 into Euro forward contracts with more favorable rates. Additionally, we entered into a series of Euro forward contracts covering the quarters in which our licensees’ sales occur through December 2013.

 

The foreign currency exchange contracts used to hedge royalty revenues based on underlying Euro-denominated sales are designated as cash flow hedges. Euro forward contracts are presented on a net basis on our Condensed Consolidated Balance Sheets as we have entered into a netting arrangement with the counterparty.

 

The notional amounts, Euro exchange rates, fair values of our Euro forward contracts at March 31, 2012, and Euro forward and option contracts at December 31, 2011, designated as cash flow hedges were:

 

The location and fair values of our Euro contracts in our Condensed Consolidated Balance Sheets were: 

 

 

The effect of derivative instruments designated as cash flow hedges in our Condensed Consolidated Statements of Income and our Condensed Consolidated Statements of Comprehensive Income were:

 

 

(1) Net change in the fair value of the effective portion of cash flow hedges classified in other comprehensive loss (OCL)

(2) Effective portion classified as royalty revenue

(3) Ineffective portion classified as interest and other income, net

For the three months ended March 31, 2012, we recognized a loss of approximately $55,000, net of tax, associated with the ineffectiveness of the modified 2012 foreign exchange hedge. There was no ineffectiveness related to forecasted transactions for the three months ended March 31, 2012 and 2011. Approximately $1.9 million, net of tax, is expected to be reclassified from other comprehensive loss against earnings in the next 12 months.

 

6. Note Receivable

 

In March 2012, the Company executed a $7.5 million two-year senior secured note receivable. In addition to interest, the note gives PDL certain rights to negotiate for certain royalty assets. The note was recorded net of origination fees that are accreted to the note receivable as interest income using the interest method. The note bears interest at 10% per annum, with interest due semi-annually and final interest due at maturity together with the principal. The Company has not assigned a risk grade to the receivable or recorded an allowance for credit loss as PDL anticipates all payments will be received in full when due. No impairment has been recorded as the payments on the note are current. For fair value information related to our note receivable, see Note 3.

 

7. Accrued Liabilities

 

 

If Genentech is successful in asserting this position, then under the terms of our license agreements with Genentech, it would not owe us royalties on sales of the Genentech Products that are both manufactured and sold outside of the United States. Royalties on sale of the Genentech Products that are made and sold outside of the United States (ex-U.S.-based Manufacturing and Sales) accounted for approximately 41% of our royalty revenues for the quarter ended March 31, 2012. Based on announcements by Roche regarding moving more manufacturing outside of the United States, we expect this amount to increase in the future.

 

We believe that the SPCs are enforceable against the Genentech Products, that Genentech’s letter violates the terms of the 2003 settlement agreement and that Genentech owes us royalties on sales of the Genentech Products on a worldwide basis. We intend to vigorously assert our SPC-based patent rights.

 

Nevada Litigation with Genentech, Roche and Novartis in Nevada State Court

 

In August 2010, we filed a complaint in the Second Judicial District of Nevada, Washoe County, naming Genentech, Roche and Novartis as defendants. We intend to enforce our rights under our 2003 settlement agreement with Genentech and are seeking an order from the court declaring that Genentech is obligated to pay royalties to us on ex-U.S.-based Manufacturing and Sales of the Genentech Products.

 

The 2003 settlement agreement was entered into as part of a definitive agreement resolving intellectual property disputes between the two companies at that time. The agreement limits Genentech’s ability to challenge infringement of our patent rights and waives Genentech’s right to challenge the validity of our patent rights. Certain breaches of the 2003 settlement agreement as alleged by our complaint require Genentech to pay us liquidated and other damages of potentially greater than one billion dollars. This amount includes a retroactive royalty rate of 3.75% on past U.S.-based Sales of the Genentech Products and interest, among other items. We may also be entitled to either terminate our license agreements with Genentech or be paid a flat royalty of 3.75% on future U.S.-based Sales of the Genentech Products.

 

  In November 2010, Genentech and Roche filed a motion to dismiss our complaint against them in which we seek to enforce our rights under the 2003 settlement agreement with Genentech. Genentech and Roche's motions to dismiss under Nevada Rule of Civil Procedure 12(b)(5) alleged that all of our claims for relief relating to the 2003 settlement agreement should be dismissed because the 2003 settlement agreement applies only to our U.S. patents. In addition, Roche filed a separate motion to dismiss our complaint under Nevada Rule of Civil Procedure 12(b)(2) on the ground that the Nevada court lacks personal jurisdiction over Roche. On July 7, 2011, the Second Judicial District Court of Nevada ruled in favor of us on the two motions to dismiss filed by Genentech and Roche. The court denied Genentech and Roche's motion to dismiss four of our five claims for relief and, further, denied Roche's separate motion to dismiss for lack of personal jurisdiction. The court dismissed one of our claims that Genentech committed a bad-faith breach of the covenant of good faith and fair dealing stating that, based on the current state of the pleadings, no "special relationship" had been established between Genentech and us as required under Nevada law. On November 1, 2011, the Nevada court issued an order accepting Roche’s stipulation of waiver to its personal jurisdiction defense. As a result of the order, Roche is foreclosed from reliance on lack of personal jurisdiction in defending against our claims.

 

 

On February 25, 2011, we reached a settlement with Novartis under which, among other things, we agreed to dismiss our claims against Novartis in the action in Nevada state court against Genentech, Roche and Novartis. Genentech and Roche continue to be parties to the Nevada suit.

 

Lease Guarantee

In connection with the spin-off of Facet Biotech Corporation (Facet) in 2008, we entered into amendments to the leases for our former facilities in Redwood City, California, under which Facet was added as a co-tenant under the leases, and a Co-Tenancy Agreement, under which Facet agreed to indemnify us for all matters related to the leases attributable to the period after the spin-off date. Should Facet default under its lease obligations, we would be held liable by the landlord as a co-tenant and, thus, we have in substance guaranteed the payments under the lease agreements for the Redwood City facilities. As of March 31, 2012, the total lease payments for the duration of the guarantee, which runs through December 2021, are approximately $108.2 million. We would also be responsible for lease-related costs including utilities, property taxes and common area maintenance which may be as much as the actual lease payments if Facet were to default. In April 2010, Abbott Laboratories acquired Facet and later renamed the company Abbott Biotherapeutics Corp.

 

As of March 31, 2012, and December 31, 2011, we had a liability of $10.7 million on our Condensed Consolidated Balance Sheets for the estimated fair value of this guarantee. In future periods, we may increase the recorded liability for this obligation if we conclude that a loss, which is larger than the amount recorded, is both probable and estimable.

 

9. Convertible Notes and Non-recourse Notes

 

 

As of March 31, 2012, PDL was in compliance with all applicable debt covenants, and embedded features of all debt agreements were evaluated and did not need to be accounted for separately. For fair value information on our convertible notes and Non-recourse Notes, see Note 3.

Series 2012 Notes

 

In January 2012, we exchanged $169.0 million aggregate principal of our February 2015 Notes for an identical principal amount of new Series 2012 Notes, plus a cash payment of $5.00 for each $1,000 principal amount tendered for a total cash incentive payment of approximately $845,000. The cash incentive payment was allocated to deferred issue costs of $765,000, additional paid-in capital of $52,000 and deferred tax assets of $28,000. The deferred issue costs will be recognized over the life of the Series 2012 Notes as interest expense. In February 2012, we entered into separate privately negotiated exchange agreements under which we exchanged $10.0 million aggregate principal amount of our February 2015 Notes for an identical principal amount of our Series 2012 Notes.

 

 

The initial conversion rate of the Series 2012 Notes was 155.396 shares of common stock per $1,000 principal amount, or approximately $6.44 per common share, subject to further adjustment upon certain events including dividend payments. Third party transaction costs of approximately $813,000 related to the exchange transactions have been recognized within general and administrative expense, of which $216,000 was recognized in the first quarter of 2012 and $597,000 was recognized during the year ended December 31, 2011.

 

Holders may convert their Series 2012 Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the stated maturity date of the Series 2012 Notes under the following circumstances:

 

·

During any fiscal quarter commencing after the fiscal quarter ending December 31, 2011, if the closing price of the Company’s common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the conversion price for the Series 2012 Notes on the last day of such preceding fiscal quarter;

 

·

During the five business-day period immediately after any five consecutive trading-day period in which the trading price per $1,000 principal amount of the Series 2012 Notes for each trading day of that measurement period was less than 98% of the product of the closing price of the Company’s common stock and the conversion rate for the Series 2012 Notes for that trading day;

 

·

Upon the occurrence of certain corporate transactions as provided in the Indenture; or

 

·

Anytime, at the holder’s option, beginning on August 15, 2014.

 

Holders of our Series 2012 Notes who convert their Series 2012 Notes in connection with a fundamental change may be entitled to a make-whole premium in the form of an increase in the conversion rate.

 

 

 

Interest expense for our Series 2012 Notes on the Condensed Consolidated Statements of Income was:

 

 

As of March 31, 2012, our Series 2012 Notes are convertible into 159.098 shares of the Company’s common stock per $1,000 of principal amount, or approximately $6.29 per common share, subject to further adjustment upon certain events including dividend payments. As of March 31, 2012, the remaining discount amortization period was 2.9 years.

 

 

For the quarter ended December 31, 2011, our common stock price did not exceed the conversion threshold price of $8.37 per common share for at least 20 days during the 30 consecutive trading days ended December 31, 2011. Accordingly the Series 2012 Notes were not convertible at the option of the holder during the quarter ended March 31, 2012. For the quarter ended March 31, 2012, our common stock did not exceed the conversion threshold price of $8.17 for at least 20 days during 30 consecutive trading days ended March 31, 2012. Accordingly the Series 2012 Notes are not convertible at the option of the holder during the quarter ended June 30, 2012. At March 31, 2012, the if-converted value of our Series 2012 Notes exceeded their principal amount by approximately $2.1 million.

 

May 2015 Notes

 

Our May 2015 Notes are convertible into 139.2165 shares of the Company’s common stock per $1,000 of principal amount, or approximately $7.18 per common share, subject to further adjustment upon certain events including dividend payments. If a conversion occurs, to the extent that the conversion value exceeds the principal amount, the principal amount is due in cash and the difference between the conversion value and the principal amount is due in shares of the Company’s common stock. As of March 31, 2012, the remaining discount amortization period was 3.1 years.

The principal amount, carrying value and unamortized discount of our May 2015 Notes were:

 

Interest expense for our May 2015 Notes on the Condensed Consolidated Statements of Income was:

 

 

As of March 31, 2012, the market price condition for convertibility of our May 2015 Notes was not met and there were no related purchased call options or warrants exercised.

  

Purchased Call Options

The purchased call options cover, subject to anti-dilution and certain other customary adjustments substantially similar to those in our May 2015 Notes, approximately 21.6 million shares of our common stock at a strike price of approximately $7.18, which corresponds to the conversion price of our May 2015 Notes. We may exercise the purchased call options upon conversion of our May 2015 Notes and require the hedge counterparty to deliver shares to the Company in an amount equal to the shares required to be delivered by the Company to the note holder for the excess conversion value.

Warrants

At March 31, 2012, the outstanding warrants of up to 27.5 million shares of common stock underlying our May 2015 Notes, have a current strike price of approximately $8.45 per share, subject to additional anti-dilution and certain other customary adjustments.  

 

 

February 2015 Notes

 

As of March 31, 2012, our February 2015 Notes aggregate principal amount outstanding was $1.0 million after the completion of our exchange transactions for new Series 2012 Notes. As of March 31, 2012, the remaining unamortized issuance costs of $16,000 and the unamortized discount of $12,000 are being amortized to interest expense over the term of our February 2015 Notes, with a remaining amortization period of approximately 2.9 years. As of March 31, 2012, our February 2015 Notes were convertible into 159.098 shares of common stock per $1,000 principal amount or approximately $6.29 per common share.

 

Non-recourse Notes

 

As of March 31, 2012, the remaining principal balance was $69.5 million and the remaining unamortized issuance costs of $0.6 million, were included as a component of Prepaid and other current assets on the Condensed Consolidated Balance Sheets. These issuance costs are being amortized to interest expense using the effective interest method with approximately 0.5 years remaining.

 

10. Stock-Based Compensation

 

Stock-based compensation expense for directors and employees for the three months ended March 31, 2012 and 2011, was $150,500 and $49,900, respectively. For the three months ended March 31, 2011, there was only stock-based compensation for directors. Additionally, we recorded stock-based award expense for outside consultants of $53,900 for the three months ended March 31, 2012.

 

11. Cash Dividends

 

On January 18, 2012, our board of directors declared that the regular quarterly dividends to be paid to our stockholders in 2012 will be $0.15 per share of common stock, payable on March 14, June 14, September 14 and December 14 of 2012 to stockholders of record on March 7, June 7, September 7 and December 7 of 2012, the record dates for each of the dividend payments, respectively.

 

In connection with the March 14, 2012, dividend payment, the conversion rates for our convertible notes increased as follows:

 

 

12. Income Taxes

 

Income tax expense was $21.6 million and $24.0 million for the three months ended March 31, 2012 and 2011, respectively, and was primarily derived by applying the federal statutory rate of 35% to operating income before income taxes.

13. Accumulated Other Comprehensive Loss

 

Comprehensive income is comprised of net income and other comprehensive loss. We include unrealized net gains on investments held in our available-for-sale securities and unrealized losses on our cash flow hedges in other comprehensive loss, and present the amounts net of tax. Our other comprehensive loss is included in our Condensed Consolidated Statements of Comprehensive Income.

 

 

The balance of accumulated other comprehensive loss, net of tax, was as follows:

 

 

ITEM  2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Quarterly Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, including any statements concerning new licensing, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue” or “opportunity,” or the negative thereof or other comparable terminology. Although we believe that the expectations presented in the forward-looking statements contained herein are reasonable at the time they were made, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth below or incorporated by reference herein, and for the reasons described elsewhere in this Quarterly Report. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

 

OVERVIEW

 

PDL pioneered the humanization of monoclonal antibodies and, by doing so, enabled the discovery of a new generation of targeted treatments for cancer and immunologic diseases. Today, PDL is focused on intellectual property asset management, investing in new royalty bearing assets and maximizing the value of its patent portfolio and related assets. We receive royalties based on sales of humanized antibody products marketed today and may also receive royalty payments on additional humanized antibody products launched before final patent expiry in December 2014. Under most of our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies.

 

We continuously evaluate alternatives to increase return for our stockholders, for example, purchasing new royalty generating assets, buying back or redeeming our convertible notes, repurchasing our common stock, selling the company and paying dividends. At the beginning of each fiscal year, our board of directors reviews the Company’s total annual dividend payment for the prior year and determines whether to increase, maintain or decrease the quarterly dividend payments for that year. The board of directors evaluates the financial condition of the Company and considers the economic outlook, corporate cash flow, the Company’s liquidity needs and the health and stability of credit markets when determining whether to maintain or change the dividend.

 

Recent Developments

Declaration of 2012 Regular Quarterly Dividends and March 14, 2012, Dividend Payment

 

On January 18, 2012, our board of directors declared that the regular quarterly dividends to be paid to our stockholders in 2012 will be $0.15 per share of common stock, payable on March 14, June 14, September 14 and December 14 of 2012 to stockholders of record on March 7, June 7, September 7 and December 7 of 2012, the record dates for each of the dividend payments, respectively. On March 14, 2012, we paid the first quarterly dividend to our stockholders totaling $21.0 million using earnings generated in the first quarter of 2012 and cash on hand.

 

Convertible Notes

 

In our continued efforts to restructure the Company’s capital and reduce the potential dilution associated with our convertible notes, in January 2012, we exchanged $169.0 million aggregate principal amount, of our 2.875% Convertible Senior Notes due February 15, 2015 (February 2015 Notes), for an identical principal amount of new 2.875% Series 2012 Convertible Senior Notes due February 15, 2015 (Series 2012 Notes), plus a cash payment of $5.00 for each $1,000 principal amount tendered for a total cash incentive payment of approximately $0.8 million. In February 2012, we entered into separate privately negotiated exchange agreements under which we exchanged an additional $10.0 million aggregate principal amount of our February 2015 Notes for an identical principal amount of our Series 2012 Notes. As of March 31, 2012, $1.0 million of our February 2015 Notes and $179.0 million of our Series 2012 Notes were outstanding. Our Series 2012 Notes net share settle, meaning upon a conversion, the principal amount would be paid in cash, and the excess, if any, would be settled in shares of the Company’s common stock. The effect of issuing $179.0 million aggregate principal of our Series 2012 Notes with the net share settle feature in exchange for our February 2015 Notes was the reduction of 27.8 million shares of potential dilution to our stockholders.

 

 

 

In connection with a cash dividend, the conversion rates increase based on multiplying the previous conversion rate by a fraction, calculated as follows:

 

·

for the May 2015 Notes, the numerator equals the average closing price of PDL's common stock for the ten consecutive trading days immediately preceding the ex-dividend date, and the denominator of which is such ten day average closing price less the per share dividend amount; and

 

·

for the Series 2012 Notes and February 2015 Notes, the numerator equals the average closing price of PDL's common stock for the five consecutive trading days immediately preceding the ex-dividend date, and the denominator of which is such five day average closing price less the per share dividend amount.

Intellectual Property

 

Patents

 

We have been issued patents in the United States and elsewhere, covering the humanization of antibodies, which we refer to as our Queen et al. patents. Our Queen et al. patents, for which final patent expiry is in December 2014, cover, among other things, humanized antibodies, methods for humanizing antibodies, polynucleotide encoding in humanized antibodies and methods of producing humanized antibodies.

 

The following is a list of our U.S. patents within our Queen et al. patent portfolio:

 

Application Number	Filing Date		Patent Number		Issue Date		Expiration Date
08/477,728	06/07/95		5,585,089		12/17/96		06/25/13
08/474,040	06/07/95		5,693,761		12/02/97		12/02/14
08/487,200	06/07/95		5,693,762		12/02/97		06/25/13
08/484,537	06/07/95		6,180,370		01/30/01		06/25/13

 

Our U.S. Patent No. 5,693,761 patent (‘761 patent), which is the last to expire of our U.S. patents, covers methods and materials used in the manufacture of humanized antibodies. In addition to covering methods and materials used in the manufacture of humanized antibodies, coverage under our ‘761 patent will typically extend to the use or sale of compositions made with those methods and/or materials.

 

 

The European Patent No. 0 451 216B (‘216B Patent) expired in Europe in December 2009. We have been granted Supplementary Protection Certificates (SPCs) for the Avastin ® , Herceptin ® , Lucentis ® , Xolair ® and Tysabri ® products in many of the jurisdictions in the European Union in connection with the ‘216B Patent. These SPCs effectively extend our patent protection with respect to these products generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014. Because SPCs are granted on a jurisdiction-by-jurisdiction basis, the duration of the extension varies slightly in certain jurisdictions. We may still be eligible for royalties notwithstanding the unavailability of SPC protection if the relevant royalty-bearing humanized antibody product is also made, used, sold or offered for sale in or imported from a jurisdiction in which we have an unexpired Queen et al. patent such as the United States.

 

Licensing Agreements

 

We have entered into licensing agreements with numerous entities that are independently developing or have developed humanized antibodies under which we have licensed certain rights under our Queen et al. patents to make, use, sell, offer for sale and import humanized antibodies. We receive royalties on net sales of products that are made, used or sold prior to patent expiry. In general, these agreements cover antibodies targeting antigens specified in the license agreements. Under our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees’ net sales of covered antibodies. Additionally, we receive minimal annual maintenance fees, as well as periodic milestone payments, from licensees of our Queen et al. patents prior to patent expiry. Total annual milestone payments in each of the last several years have been less than 1% of total revenue and we expect this trend will continue through the expiration of the Queen et al. patents.

 

 

For the three months ended March 31, 2012 and 2011, we received royalty revenues under license agreements of $77.3 million and $73.3 million, respectively.

 

In June 2010, after results from a clinical trial raised concerns about the efficacy and safety of Mylotarg ® , Pfizer Inc. (Pfizer), the parent company of Wyeth, announced that it will be discontinuing commercial availability of Mylotarg. For the three months ended March 31, 2012 and 2011, our royalties for sales of Mylotarg were insignificant.

 

 

Genentech

 

We entered into a master patent license agreement, effective September 25, 1998, under which we granted Genentech a license under our Queen et al. patents to make, use and sell certain antibody products. Our master patent license agreement with Genentech provides for a tiered royalty structure under which the royalty rate Genentech must pay on royalty-bearing products sold in the United States or manufactured in the United States and used or sold anywhere in the world (U.S.-based Sales) in a given calendar year decreases on incremental U.S.-based Sales above certain sales thresholds based on 95% of the underlying gross U.S.-based Sales. The net sales thresholds and the applicable royalty rates are outlined below:

 

 

As a result of the tiered royalty structure, Genentech’s average annual royalty rate for a given year will decline as Genentech’s U.S.-based Sales increase during that year. Because we receive royalties one quarter in arrears, the average royalty rates for the payments we receive from Genentech for U.S.-based Sales in the second calendar quarter for Genentech’s sales from the first calendar quarter have been and are expected to continue to be higher than the average royalty rates for following quarters. The average royalty rates for payments we receive from Genentech are generally lowest in the fourth and first calendar quarters for Genentech’s sales from the third and fourth calendar quarters when more of Genentech’s U.S.-based Sales bear royalties at the 1% royalty rate.