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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2009

OR

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 0-19756

Facet Biotech Corporation

(Exact name of registrant as specified in its charter)

1500 Seaport Boulevard

Redwood City, CA 94063

(Address of principal executive offices and Zip Code)

(650) 454-1000

(Registrant’s telephone number, including area code)

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  x No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the  preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o No  x

As of October 27, 2009, there were 25,067,740 shares of the Registrant’s Common Stock outstanding.

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FACET BIOTECH CORPORATION

INDEX

We own or have rights to numerous trademarks, trade names, copyrights and other intellectual property used in our business, including Facet Biotech and the Facet Biotech logo, each of which is considered a trademark. All other company names, tradenames and trademarks included in this Quarterly Report are trademarks, registered trademarks or trade names of their respective owners.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FACET BIOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)

See accompanying notes.

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FACET BIOTECH CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

See accompanying notes.

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FACET BIOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

See accompanying notes.

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FACET BIOTECH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2009

(unaudited)

1. Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

Facet Biotech Corporation (we, us, our, Facet Biotech, the Company) was organized as a Delaware corporation in July 2008 by PDL BioPharma, Inc. (PDL) as a wholly owned subsidiary of PDL. PDL organized the Company in preparation for the spin-off of the Company, which was effected on December 18, 2008 (the Spin-off). In connection with the Spin-off, PDL contributed to us PDL’s Biotechnology Business and PDL distributed to its stockholders all of the outstanding shares of our common stock. Following the Spin-off, we became an independent, publicly traded company owning and operating what previously had been PDL’s Biotechnology Business.

Prior to the Spin-off, PDL’s Biotechnology Business, now operated by the Company, was not operated by a legal entity separate from PDL and a direct ownership relationship did not exist among all the components comprising the Biotechnology Business. We describe the Biotechnology Business transferred to us by PDL in connection with the Spin-off as though the Biotechnology Business were our business for all historical periods described. However, Facet Biotech had not operated the Biotechnology Business prior to the Spin-off. References in these Condensed Consolidated Financial Statements to the historical assets, liabilities, products, business or activities of our business are intended to refer to the historical assets, liabilities, products, business or activities of the Biotechnology Business as those were conducted as part of PDL prior to the Spin-off.

For the purposes of preparing the financial statements of the Biotechnology Business for the three and nine months ended September 30, 2008, which were derived from PDL’s historical consolidated financial statements, allocations of revenues, research and development (R&D) expenses, asset impairment charges, restructuring charges, gains on sales of assets and non-operating income and expenses to Facet Biotech were made on a specific identification basis. Facet Biotech’s operating expenses also included allocations related to information technology and facilities costs. Management believes that the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 include a reasonable allocation of costs incurred by PDL, which benefited Facet Biotech. However, such expenses may not be indicative of the actual level of expense that we would have incurred if we had operated as an independent, publicly traded company.

The accompanying condensed consolidated financial statements are unaudited, but include all adjustments (consisting only of normal, recurring adjustments) that we consider necessary for a fair presentation of our financial position at such dates and the operating results and cash flows for those periods. Certain information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) has been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for quarterly reporting.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC. The Condensed Consolidated Balance Sheet as of December 31, 2008 is derived from our audited consolidated financial statements as of that date.

Our revenues, expenses, assets and liabilities vary during each quarter of the year. Therefore, the results and trends in these interim condensed consolidated financial statements may not be indicative of results for any other interim period or for the entire year. For example, revenue recognized in connection with the reimbursement of our R&D expenses under the terms of our collaboration agreements may vary period-to-period, and milestone payments received from our out-licensing agreements are often times recognized immediately when earned and could significantly affect the revenue reported in each period. In addition, our operating expenses may fluctuate significantly during periods in which we enter into in-licensing agreements or recognize restructuring or asset impairment charges.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of inter-company accounts and transactions.

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Management Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the use of management’s estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Revenue Recognition

Collaboration Agreements

Under our collaboration agreements with Biogen Idec Inc. (Biogen Idec), Bristol-Myers Squibb Company (BMS) and Trubion Pharmaceuticals, Inc. (Trubion), we share development costs related to the products covered by the applicable collaboration. The purpose of the collaboration agreements is to create synergies while bringing a product candidate to market by sharing technologies, know-how and costs. Once a product is brought to market, we would share in commercialization costs as well as in profits related to the product, or generate a royalty based on net sales. Our collaboration agreements with Biogen and BMS included the receipt of upfront fees.  For these arrangements, we are not able to establish fair value of the undelivered elements, which consist primarily of research and development services. As such, we recognize these upfront fees over the period of time that the research and development services are expected to be performed. For all of our collaborations, each quarter, we and our collaborator reconcile what each party has incurred in terms of development costs, and we record either a net receivable or a net payable on our consolidated balance sheet. For each quarterly period, if we have a net receivable from a collaborator, we recognize revenues by such amount, and if we have a net payable to our collaborator, we recognize additional R&D expenses by such amount. Therefore, our revenues and R&D expenses may fluctuate depending on which party in the collaboration is conducting the majority of the development activities in the reporting period.

Out-License Agreements

We have entered into license agreements under which companies have obtained from us licenses to certain of our intellectual property rights, including patent rights, related to certain development product candidates, which we outlicensed. In these arrangements, the licensee is customarily responsible for all of the development work on the licensed development product and we have no significant future performance obligations under these agreements. Upfront consideration that we receive for license agreements is recognized as revenue upon execution and delivery of the license agreement and when payment is reasonably assured. If the agreements require continuing involvement in the form of development, manufacturing or other commercialization efforts by us, we recognize revenues in the same manner as the final deliverable in the arrangement. Under our out-license agreements, we may also receive annual license maintenance fees, payable at the election of the licensee to maintain the license in effect. We have no performance obligations with respect to such fees, and they are recognized as they become due and when payment is reasonably assured.

Humanization Agreements

Under our humanization agreements, the licensee typically pays us an upfront fee to humanize an antibody. We recognize revenue related to these fees as the humanization work is performed or upon acceptance of the humanized antibody by the licensee if such acceptance clause exists in the agreement. Under our humanization agreements, we may also receive annual maintenance fees, payable at the election of the licensee to maintain the humanization and know-how licenses in effect. We have no performance obligations with respect to such fees, and therefore, we recognize these fees as revenues when they become due and when payment is reasonably assured.

Milestones

Our licensing and humanization arrangements may contain milestones related to reaching particular stages in product development. We recognize “at risk” milestone payments upon achievement of the underlying milestone event and when they are due and payable under the arrangement. Milestones are deemed to be “at risk” when, at the onset of an arrangement, management believes that they will require a reasonable amount of effort to be achieved and are not simply reached by the lapse of time or through a perfunctory effort. Milestones which are not deemed to be “at risk” are recognized as revenue in the same manner as up-front payments. We also receive milestone payments under patent license agreements, under which we have no further obligations, when our licensees reach certain stages of development with respect to the licensed product. We recognize these milestones as revenue once they have been reached and payment is reasonably assured.

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Significant Customers and Revenues by Geographic Area

The following table summarizes revenues as a percentage of total revenues from our licensees and collaborators, which individually accounted for 10% or more of our revenues for the three and nine months ended September 30, 2009 and 2008:

*Less than 10%

Cash Equivalents, Marketable Securities and Concentration of Credit Risk

We consider all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. We place our cash equivalents and marketable securities with high-credit-quality financial institutions and, by policy, limit the amount of credit exposure in any one financial instrument.

Net Loss per Share

We calculate basic net loss per share by dividing net loss by the weighted-average number of common shares outstanding during the reported period. Diluted net loss per share is calculated using the sum of the weighted-average number of common shares outstanding and dilutive common equivalent shares outstanding. Common equivalent shares result from the assumed exercise of stock options, the assumed release of restrictions of issued restricted stock and the assumed issuance of common shares under our Employee Stock Purchase Plan (ESPP) using the treasury stock method. Since we were in a net loss position for the three and nine months ended September 30, 2009, we excluded the effect of 0.7 million and 0.3 million, respectively, of weighted-average common equivalent shares in the diluted net loss per share calculations as their effect would have been anti-dilutive.

For the three and nine months ended September 30, 2008, the computation of net loss per basic and diluted share and the weighted-average shares outstanding are presented based on the 23.9 million shares that were issued in connection with the Spin-off on December 18, 2008.

Income Taxes

Prior to July 2008, the operations of Facet Biotech were included in PDL’s consolidated U.S. federal and state income tax returns and in tax returns of certain PDL foreign subsidiaries. Prior to the Spin-off on December 18, 2008, our provision for income taxes was determined as if Facet Biotech had filed tax returns separate and apart from PDL.  The income tax expense for the three and nine months ended September 30, 2008 related solely to foreign taxes on income earned by our foreign operations.

The unrealized gain on the Trubion equity investment is reflected in other accumulated comprehensive income (loss) within stockholders’ equity net of the related $1.1 million deferred tax liability.  Such deferred tax liability was calculated using the 40% statutory tax rate.  In establishing the valuation allowance for our deferred tax assets, we need to consider sources of future taxable income.  The existence of the unrealized gain on the Trubion equity investment is considered to be a future source of taxable income and accordingly, we have reduced our valuation allowance on our deferred tax assets.  For the three months ended September 30, 2009, we recognized a tax benefit of approximately $1.1 million for the reduction in our valuation allowance on our deferred tax assets.  See Notes 4 and 9 for further details on our Trubion collaboration agreement and equity investment.

Subsequent Events

We have evaluated our subsequent events through November 3, 2009, when our financial statements were issued.

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2. Stock-Based Compensation

Prior to January 2009, our employees had received stock-based compensation awards only under PDL’s equity compensation plans and, therefore, stock-based compensation expense pertaining to the three and nine months ended September 30, 2008 relate to stock-based compensation expense arising from PDL equity awards that was allocated to Facet Biotech’s operations.  All non-vested PDL equity instruments held by Facet Biotech employees were cancelled on December 18, 2008 when those employees ceased being employed by a wholly owned subsidiary of PDL as a result of the Spin-off.  In January 2009, we began granting equity awards under our 2008 Equity Incentive Plan and, in March 2009, we commenced employee participation in our 2008 Employee Stock Purchase Plan.

Stock-based compensation expense for employees and directors was as follows:

Valuation Assumptions

The stock-based compensation expense was determined using the Black-Scholes option valuation model.  Option valuation models require the input of subjective assumptions and these assumptions can vary over time.  The weighted-average assumptions underlying stock-based compensation related to awards granted under our equity plans were as follows:

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Stock Option Activity

A summary of our stock option activity for the period is presented below:

In April 2009, we granted approximately 699,000 fully-vested, at-the-money stock options to our employees (Value Transfer Grants). Consistent with the intent of these grants as disclosed in prior filings with the SEC, the Value Transfer Grants were provided to our employees to compensate them for the estimated value of vested PDL stock options that were forfeited in connection with the Spin-off. The total fair value of the Value Transfer Grants on the date of grant was $4.0 million, as calculated using the Black-Scholes valuation model. As these stock options were fully vested as of the grant date, we recognized 100% of the fair value of the Value Transfer Grants as stock-based compensation expense in the second quarter of 2009.

Total unrecognized compensation expense related to unvested stock options outstanding as of September 30, 2009, excluding potential forfeitures, was $7.9 million, which we expect to recognize over a weighted-average period of 3.4 years.

Restricted Stock Award Activity

A summary of our restricted stock award activity for the period is presented below:

Total unrecognized compensation expense related to unvested restricted stock awards outstanding as of September 30, 2009, excluding potential forfeitures, was $5.3 million, which we expect to recognize over a weighted-average period of 2.5 years.

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Employee Stock Purchase Plan

The stock-based compensation expense recognized in connection with our ESPP for the three and nine months ended September 30, 2009 was $0.1 million and $0.3 million, respectively.  Prior to the Spin-off, employees of PDL’s Biotechnology Business were eligible to participate in PDL’s 1993 Employee Stock Purchase Plan (PDL ESPP). The stock-based compensation expense allocated to the Biotechnology Business and recognized in connection with the PDL ESPP for the three and nine months ended September 30, 2008 was $0.2 million and $0.5 million, respectively.

3. Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive income.  Specifically, we include in other comprehensive income the changes in unrealized gains and losses on our holdings of available-for-sale securities, which are excluded from our net loss. In addition, other comprehensive income includes the liability that has not yet been recognized as net periodic benefit cost for our postretirement benefit plan. The following table presents the calculation of our comprehensive loss:

4. Collaborative and Licensing Agreements

In August 2009, we and Trubion entered into a collaboration agreement for the global development and commercialization of TRU-016, a product candidate in phase 1 clinical trials for chronic lymphocytic leukemia.  Under the terms of the collaboration agreement, we paid Trubion an upfront license fee of $20.0 million and we may be obligated to pay Trubion up to $176.5 million in additional contingent payments if certain development, regulatory and sales milestones are achieved for each product under the collaboration agreement, the significant majority of which are for achievement of later-stage development, regulatory and sales-based milestones. We and Trubion will share equally the costs of all development, commercialization and promotional activities and all global operating profits.

In addition, we purchased 2,243,649 shares of newly issued shares of Trubion common stock for $10.0 million. Our $10.0 million equity investment in Trubion reflected an approximate 16% premium over the closing price of Trubion’s common stock on the date the stock purchase agreement was executed, resulting in a total premium of $1.4 million. Since the stock purchase agreement and the collaboration agreement were entered into concurrently, we recognized the $1.4 million premium as additional R&D expense in the third quarter of 2009. We recorded the $8.6 million fair value of the equity investment as marketable securities.  As Trubion’s early-stage technology to which we have licensed rights has not reached technological feasibility and has no alternative future uses, we recognized the $21.4 million upfront license fee as R&D expense in the third quarter of 2009. (See Note 9 for further details on the accounting treatment for our equity investment in Trubion.)

Both we and Trubion have the right to opt out of all rights and obligations to co-develop and co-commercialize any collaboration product at certain specified milestone points or upon the occurrence of certain events.  In addition, we have the right to terminate the collaboration agreement for any reason upon written notice to Trubion, provided that if we give notice on or before February 27, 2011, we are required to pay a termination fee of $10.0 million.

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For the three months ended September 30, 2009, we recorded a $0.5 million payable to Trubion which represents the net amount due to Trubion for R&D expense reimbursement under the cost sharing provisions of our agreement.  This $0.5 million was reflected as R&D expense in the period.

5. Sale of Manufacturing Assets and Clinical Supply Agreement

In March 2008, we sold our Minnesota manufacturing facility and related operations to an affiliate of Genmab A/S (Genmab) for total cash proceeds of $240.0 million. Under the terms of the purchase agreement, Genmab acquired our manufacturing and related administrative facilities in Brooklyn Park, Minnesota, and related assets therein, and assumed certain lease obligations related to our former facilities in Plymouth, Minnesota (together, the Manufacturing Assets). We recognized a pre-tax gain of $49.7 million upon the close of the sale in March 2008. Such gain represents the $240.0 million in gross proceeds, less the net book value of the underlying assets transferred of $185.4 million and $4.9 million in transaction costs and other charges.

In addition, to fulfill our then-anticipated clinical manufacturing needs through 2010, we entered into a clinical supply agreement with Genmab that became effective upon the close of the transaction in March 2008.  Under the terms of the clinical supply agreement, we committed to order and Genmab agreed to manufacture clinical drug substance for certain of our pipeline products through 2010.

In September 2009, we entered into an amendment to this clinical supply agreement which provides us the right to extend the manufacturing of any remaining committed batches beyond 2010 and up through 2012 in exchange for payment of additional fees.  In addition, we agreed to provide an additional deposit of $1.1 million with respect to the remaining committed manufacturing batches not yet scheduled for manufacturing. The total deposit in place under the Genmab supply agreement was $4.9 million as of September 30, 2009, which was classified as an other asset.

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6. Restructuring Charges

The following table summarizes the restructuring activity and restructuring accrual balances for the nine months ended September 30, 2009:

* Represents a change in estimate to previously recognized restructuring expenses

2008 Restructuring Plan

In an effort to reduce our operating costs, in March 2008 we commenced a restructuring plan pursuant to which we immediately eliminated approximately 120 employment positions and would eliminate approximately 130 additional employment positions over the subsequent 12 months (the 2008 Restructuring Plan). All impacted employees were notified in March 2008. Employees terminated in connection with the restructuring efforts were eligible for a specified severance package. We recognized severance charges for employees whose positions were terminated over the subsequent 12 months over their respective estimated service periods. Under the 2008 Restructuring Plan, we recognized restructuring charges of $1.0 million and $0.0 million during the three months ended September 30, 2008 and 2009, respectively. Such charges for the nine months ended September 30, 2008 and 2009 were $9.4 million and $0.0 million, respectively.  These charges primarily consisted of post-termination severance costs as well as salary accruals relating to the portion of the 60-day notice period over which the terminated employees would not be providing services to the Company. We have substantially paid all of our obligations under the 2008 Restructuring Plan.

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France Restructuring Plan

During the fourth quarter of 2008, we decided to close our offices in France, which at the time employed seven individuals. During the three and nine months ended September 30, 2009 we recognized $0.0 million and $0.5 million, respectively in restructuring charges under this restructuring plan. We have paid all obligations related to the closure of our French office as of September 30, 2009.

2009 Restructuring Plan

As a result of a strategic review process to enhance our focus and significantly reduce our operating expenses, we undertook a reduction in force in early 2009, pursuant to which we eliminated approximately 80 positions (the 2009 Restructuring Plan). As a result of the 2009 restructuring activities, we recognized charges related to severance benefits totaling $3.5 million for the nine months ended September 30, 2009. During the three months ended September 30, 2009, we recognized a credit of $0.1 million, representing a change in estimate from prior periods.  We have substantially paid all obligations related to the severance benefits under the 2009 Restructuring Plan.

In connection with the 2009 Restructuring Plan, we vacated approximately 85%, or approximately 240,000 square feet, of one of our two leased buildings in Redwood City (the Administration Building) and consolidated our operations into the other building (the Lab Building) during the second quarter of 2009. We consolidated our operations into the Lab Building to both reduce our future operating expenses and expedite potential future subleases for the vacated space. In connection with vacating this space in the Administration Building, we recognized lease-related restructuring charges of $17.0 million in the second quarter of 2009. The lease-related restructuring charges were comprised of a $23.0 million lease-related restructuring liability, which was calculated as the present value of the estimated future facility costs for which we will obtain no future economic benefit over the term of our lease, net of estimated future sublease income and a $6.0 million credit for an existing deferred rent liability associated with the vacated area of the Administration Building.

During the third quarter of 2009, based on updated assumptions resulting from our ongoing discussions with potential subtenants, we recognized a credit to our lease-related restructuring charges of $1.6 million, comprised of a favorable change in estimate of $2.4 million partially offset by $0.8 million of accretion expenses, which, in addition to payments and adjustments, reduced the lease-related restructuring liability to $18.1 million as of September 30, 2009.  The adjustments to the lease-related restructuring liability related to prepaid rent and property taxes as of September 2009.  This change in estimate reduced net loss per share for each of the three- and nine-months periods ended September 30, 2009 by $0.10.

The estimates underlying the fair value of the lease-related restructuring liability of $18.1 million involve significant assumptions regarding the time required to contract with subtenants, the amount of space we may be able to sublease, the range of potential future sublease rates and the level of leasehold improvements expenditures that we may incur to sublease the property. We have continued to evaluate a number of potential sublease scenarios with differing assumptions and have probability weighted these scenarios and calculated the present value of cash flows based on management’s best judgment.  We will continue to monitor and update the liability balance when future events impact our cash flow estimates related to the vacated area of the Administration Building.

In addition, in connection with our sublease efforts for the Administration Building, we are also pursuing sublease arrangements under which we could potentially contract with subtenants for both the Administration Building and the Lab Building, which we currently occupy. If we sublease these facilities for rates that are not significantly in excess of our costs, we would not likely recover the carrying value of certain assets associated with these facilities, which was approximately $60.0 million as of September 30, 2009. As such, we could potentially incur a substantial asset impairment charge, as much as the carrying value of such assets, if we were to sublease both of these buildings.

7. Asset Impairment Charges

Total asset impairment charges recognized during the three and nine months ended September 30, 2009 were $0.2 million and $1.0 million, respectively.  These impairment charges related to certain information technology projects that we terminated as well as to equipment that we no longer intend to utilize in our ongoing operations, primarily resulting from the consolidation of our operations almost entirely into one of our two leased buildings in Redwood City, as discussed in Note 6.

We recognized asset impairment charges of $0.0 million and $3.8 million during the three and nine months ended September 30, 2008, respectively, which primarily represented the costs of certain research equipment that we expect to have no future useful life and certain information technology projects that we terminated, in each case, as a result of our restructuring activities.

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8. Other Accrued Liabilities

Other accrued liabilities consisted of the following:

9. Cash Equivalents, Marketable Securities and Restricted Cash

At September 30, 2009, we had invested in money market funds, as well as marketable debt and equity securities. Our securities are classified as available-for-sale. Available-for-sale securities are carried at estimated fair value, which is based upon quoted market prices for these or similar instruments, with unrealized gains and losses reported in accumulated other comprehensive income (loss) in stockholders’ equity. The amortized cost of debt securities is adjusted for amortization of premiums and discounts from the purchase date to maturity. Such amortization is included in interest income. 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. In addition, we do not require collateral for our investment activities. We did not have any cash equivalents or marketable securities as of December 31, 2008.

We have classified all of our available-for-sale securities as current assets since they are available for use in our daily operations.  The following table summarizes, by type of security, the amortized cost and estimated fair value of our available-for-sale securities as of September 30, 2009:

The following table presents the classification of available-for-sale securities on our Consolidated Balance Sheet.

As of September 30, 2009 and December 31, 2008 we had a total of $6.4 million and $5.8 million of restricted cash, respectively, held in certificate of deposits to support letters of credit serving as security deposits for our Redwood City, California building and other operating leases.

We have excluded from the tables above $5.0 million of cash, which is included in the cash and cash equivalents caption in the Consolidated Balance Sheet as of September 30, 2009. As of December 31, 2008, all of our excess capital was held in cash accounts and was reflected as cash and cash equivalents in the Consolidated Balance Sheet.

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10. Fair Value Measurements

We are required under U.S. GAAP to establish fair value using a three-tier hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

·                  Level 1—quoted prices in active markets for identical assets and liabilities

·                  Level 2—observable inputs other than quoted prices in active markets for identical assets and liabilities

·                  Level 3—unobservable inputs

Marketable Securities

At September 30, 2009, we determined the fair values of our available-for-sale securities using Level 1 and Level 2 inputs, as reflected in the table below:

(1)  All corporate securities held at September 30, 2009 were secured by the U.S. Government under the terms of the Treasury Loan Guarantee Program.

Lease Financing Liability

In July 2006, we entered into agreements to lease two buildings in Redwood City, California, to serve as our corporate headquarters. The underlying lease term for these buildings was 15 years. Significant leasehold improvements were performed for one of the buildings (the Lab Building), which previously had never been occupied or improved for occupancy. Due to our involvement in and assumed risk during the construction period, as well as the nature of the leasehold improvements for the Lab Building, we were required to reflect the lease of the Lab Building in our financial statements as if we had purchased the building by recording the fair value of the building and a corresponding lease financing liability.  The carrying amount of this lease financing liability as of September 30, 2009 was $25.5 million, which approximated its fair value at that date.

11. Contingencies

As permitted under Delaware law, pursuant to the terms of our bylaws, we have agreed to indemnify our officers and directors and, pursuant to the terms of indemnification agreements, we have agreed to indemnify our executive officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving as an officer or director of the Company. While the maximum amount of potential future indemnification is unlimited, we have a director and officer insurance policy in place that limits our exposure and may enable us to recover a portion of any future amounts paid. We believe the fair value of these indemnification agreements and bylaw provisions is immaterial and, accordingly, we have not recorded the fair value liability associated with these agreements as of September 30, 2009 or as of December 31, 2008.

Under the terms of the Separation and Distribution Agreement, we and PDL each agreed to indemnify the other from and after the Spin-off with respect to the indebtedness, liabilities and obligations retained by our respective companies. These indemnification obligations could be significant. The ability to satisfy these indemnities if called upon to do so will depend upon the future financial strength of each of our companies. We cannot determine whether we will have to indemnify PDL for any substantial obligations in the future, nor can we be sure that, if PDL has to indemnify us for any substantial obligations, PDL will have the ability to satisfy those obligations.

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In April 2009, we became aware of assertions from one of PDL’s former commercial product distributors that it believes it should be reimbursed for certain amounts relating to sales rebates on the sale of the Busulfex® commercial product in Italy during the 2006 and 2007 fiscal periods. We believe these assertions are invalid and without merit. Under the terms of the indemnification provisions contained in the Separation and Distribution Agreement, we could be responsible for any amounts ultimately deemed due and payable to this distributor by PDL should these assertions be deemed valid. As any potential liability related to these assertions is not probable at this time, we have not recorded any liability relating to this matter on our balance sheet as of September 30, 2009.

In September 2009, purported stockholder John Dugdale filed a complaint in San Diego Superior Court on behalf of himself and all others similarly situated and derivatively on behalf of the Company, in the Superior Court of the State of California, County of San Diego (the Complaint). The Complaint purports to be both a stockholder class action and derivative action and alleges claims for breach of fiduciary duties, abuse of control, gross mismanagement and corporate waste against the Company’s directors Faheem Hasnain, Brad Goodwin, Gary Lyons, David R. Parkinson, Kurt Von Emster, Hoyoung Huh and Does 1-25 (the Defendants), in connection with certain offers made by Biogen Idec to acquire the Company, including the tender offer. The Complaint seeks declaratory and injunctive relief, including an order compelling Defendants to comply with their fiduciary duties, prohibiting Defendants “from entering into any contractual provisions which harm Facet or its shareholders” or that “prohibit [D]efendants from maximizing shareholder value,” and either invalidating or directing the rescission or redemption of the rights to purchase shares of Series A Preferred Stock issued pursuant to the Rights Agreement between the Company and Mellon Investor Services LLC, dated as of September 7, 2009 and any other “defensive measure that has or is intended to have the effect of making the consummation of an offer to purchase the Company more difficult or costly for a potential acquirer.” The Complaint further seeks fees and costs, including attorneys’ and experts’ fees. As we currently believe that the Complaint is without merit, we have not accrued any amounts related to this matter in the financial statements as of September 30, 2009

12. Release of Escrow Funds

In the second quarter of 2009, we received $1.0 million from an escrow account that was initially set up by PDL and EKR Therapeutics, Inc. (EKR) under the terms of EKR’s purchase of PDL’s former cardiovascular assets in March 2008.  In connection with EKR’s purchase of the cardiovascular assets, $6.0 million of the purchase price was placed in an escrow account for a period of one year to cover certain product-return and sales-rebate related costs. Through the term of the escrow agreement, EKR had submitted claims totaling approximately $5 million against the escrow account, which funds were released to EKR by the escrow agent. The rights and obligations under this escrow agreement were transferred to us upon the Spin-off and, in April 2009, the remaining escrow funds of $1.0 million were transferred to us. We recognized such amount in interest and other income, net in the second quarter of 2009.

13. Biogen Idec Inc.’s Tender Offer for Facet Biotech’s Common Stock

On September 21, 2009, Biogen Idec, through a wholly owned subsidiary, commenced an unsolicited tender offer to acquire the outstanding shares of common stock of the Company, subject to a number of terms and conditions contained in the tender offer documents that Biogen Idec filed with the SEC, for $14.50 per share in cash. On October 1, 2009, we filed a Schedule 14D-9 with the SEC in which our Board of Directors unanimously recommended that our stockholders reject the Biogen Idec offer and not tender their shares pursuant to Biogen Idec’s tender offer. On October 2, 2009, we filed a first amendment to our Schedule 14D-9 to disclose that our Board of Directors had approved certain programs intended to promote employee retention in light of the uncertainty created by the tender offer. Our Board of Directors approved certain amendments to the agreements governing the equity awards that the Company has granted to employees who are not participants in the Retention and Severance Plan (Non-RSP Employees) and the adoption of a severance plan for Non-RSP Employees that would provide benefits upon certain terminations of employment following a change in control of the Company.  On October 16, 2009 Biogen Idec extended its $14.50 per share tender offer to December 16, 2009. On October 19, 2009, we filed a second amendment to our Schedule 14D-9 to reiterate the recommendation of our Board of Directors that Facet Biotech stockholders reject Biogen Idec’s unsolicited tender offer. For information as to the reasons of our Board of Directors for their recommendation and further information related to the tender offer and these benefit programs, see our Schedule 14D-9 and amendments to the Schedule 14D-9 filed with the SEC.

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This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and 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, any statements concerning proposed new products or licensing or collaborative arrangements, 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 “believes,” “may,” “will,” “expects,” “plans,” “anticipates,” “estimates,” “potential,” or “continue” or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this report are reasonable, 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 the risk factors set forth below, and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this 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

The information included in this management’s discussion and analysis of financial conditions should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission (SEC) and our unaudited Consolidated Financial Statements for the three and nine months ended September 30, 2009, as well as other disclosures, including the disclosures under “Risk Factors,” that have been included in this Quarterly Report on Form 10-Q.

Facet Biotech Corporation (we, us, our, the Company) is a biotechnology company dedicated to advancing our pipeline of five clinical-stage products, leveraging our research and development capabilities to identify and develop new oncology drugs and applying our proprietary next-generation protein engineering technologies to potentially improve the clinical performance of protein therapeutics.

Basis of Presentation

Facet Biotech was organized as a Delaware corporation in July 2008 by PDL BioPharma, Inc. (PDL) as a wholly owned subsidiary of PDL. PDL organized the Company in preparation for the spin-off of the Company, which was effected on December 18, 2008 (the Spin-off). Prior to the Spin-off, PDL’s Biotechnology Business was not operated by a legal entity separate from PDL and a direct ownership relationship did not exist among all the components comprising the Biotechnology Business. We describe the Biotechnology Business transferred to us by PDL in connection with the Spin-off as though the Biotechnology Business were our business for all historical periods described. However, Facet Biotech had not conducted any operations prior to the Spin-off. References in this quarterly report to the historical assets, liabilities, products, business or activities of our business are intended to refer to the historical assets, liabilities, products, business or activities of the Biotechnology Business as those were conducted as part of PDL prior to the Spin-off.

We have prepared the condensed consolidated financial statements for the three and nine months ended September 30, 2008 using PDL’s historical cost basis of the various activities that comprised the Biotechnology Business as a component of PDL, and such financial statements reflect the results of operations and cash flows of the Biotechnology Business as a component of PDL. The statements of operations for the three and nine months ended September 30, 2008 include expense allocations for general corporate overhead functions historically shared with PDL, including finance, legal, human resources, investor relations and other administrative functions, which include the costs of salaries, benefits, stock-based compensation and other related costs, as well as consulting and other professional services. Where appropriate, these allocations were made on a specific identification basis. Otherwise, the expenses related to services provided to the Biotechnology Business by PDL were allocated to Facet Biotech based on the relative percentages, as compared to PDL’s other businesses, of headcount or another appropriate methodology depending on the nature of each item of cost to be allocated.

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Recent Developments

The following represents the significant events or developments that have occurred in the nine months ended September 30, 2009 and up to the date of the filing of this quarterly report:

·                  In January 2009, we undertook a restructuring effort pursuant to which we eliminated approximately 80 positions, and our workforce is now comprised of approximately 200 employment positions. We recognized costs related to severance and post-termination benefits totaling $3.5 million in the nine months ended September 30, 2009.

·                  In the first quarter for 2009, we and Biogen Idec Inc. (Biogen Idec) announced that the United States Food and Drug Administration (FDA) and European regulatory agencies agreed to consider an expanded SELECT study, which is an ongoing study of daclizumab in patients with relapsing-remitting multiple sclerosis (MS), as a registration-enabling study, thus requiring us to conduct only one additional registration-enabling study. As a result, we have amended the SELECT study protocol to increase the sample size from 300 to 600 patients and change the primary endpoint to annualized relapse rate, and have submitted the amended protocol to the appropriate regulatory authorities.

·                  During the second quarter of 2009, we consolidated nearly all of our operations into one of our two leased buildings in Redwood City, resulting in our ceasing use of the significant majority of one of our leased buildings.  As a result, we recognized total lease-related restructuring charges of $15.4 million in the second and third quarters of 2009 in connection with these consolidation efforts (including a $1.6 million reduction to the charges recognized in the third quarter of 2009).

·                  In August 2009, we announced our decision, along with Biogen Idec, to continue planning for the phase 3 trial of daclizumab in MS. On July 31, 2009, a futility analysis was performed with respect to the SELECT trial to ensure safety of the subjects and to evaluate whether the trial should continue. As described in an unblinding plan submitted to the FDA, an independent statistician analyzed clinical data from approximately 150 trial subjects that had completed at least six months of treatment. An independent safety monitoring committee reviewed the interim data and recommended to Biogen Idec and the Company the continuation of the SELECT study with both daclizumab dose arms (150mg and 300mg). In addition, to determine whether the collaboration should trigger the DECIDE phase 3 trial and to inform the design of this phase 3 trial, certain prearranged employees of each of the Company and Biogen Idec (which employees are no longer directly involved in the management of the SELECT study) reviewed summary data tables prepared by the independent statistician from the interim analysis. Based on this review and data from prior studies, these prearranged personnel recommended on behalf of the Company and Biogen Idec that the collaboration should initiate the DECIDE phase 3 study, which is the second and final required registration-enabling study. SELECT remains an ongoing blinded study. In August 2009, we submitted a Special Protocol Assessment to the FDA and we, together with Biogen Idec, are working with the FDA to finalize the protocol for the DECIDE study. We expect to initiate the phase 3 trial during the first half of 2010.

·                 In August 2009, we and Trubion Pharmaceuticals, Inc (Trubion) entered in to a collaboration agreement for the global development and commercialization of TRU-016, a CD37-directed small modular immunopharmaceutical in phase 1 clinical trials for chronic lymphocytic leukemia. The collaboration agreement covers TRU-016 in all indications and all other CD37-directed protein therapeutics. Under the terms of the collaboration agreement, we paid Trubion an upfront license fee of $20.0 million and we may be obligated to pay Trubion up to $176.5 million in additional contingent payments if certain development, regulatory and sales milestones are achieved for each product under the collaboration agreement, the significant majority of which are for achievement of later-stage development, regulatory and sales-based milestones. In addition, we purchased 2,243,649 shares of newly issued Trubion common stock for an aggregate purchase price of $10.0 million. (See Note 4 to the Condensed Consolidated Financial Statement for more details on the collaboration agreement.)

·                  In September 2009, FBC Acquisition Corp, a wholly owned subsidiary of Biogen Idec, announced that it had commenced a tender offer (Biogen Idec’s tender offer) to acquire all of our outstanding shares for $14.50 per share in cash.  After careful consideration, our Board of Directors determined that the Biogen Idec offer was not in the best interests of our stockholders and unanimously recommended that our stockholders reject the offer and not tender their shares to Biogen Idec for purchase. We publicly announced our Board’s recommendation on October 1, 2009, which was reiterated on October 19, 2009 after Biogen Idec extended its $14.50 per share tender offer to December 16, 2009.

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Summary Financial Results for the Third Quarter of 2009

In the third quarter of 2009, we recognized total revenues of $10.8 million, generally consistent with the amounts recognized in each of the first two quarters of 2009.  Our revenues continue to be comprised primarily of revenues related to our collaborations with BMS and Biogen Idec.  Our total costs and expenses in the third quarter of 2009 were $53.1 million, consisting primarily of $45.1 million in research and development (R&D) expenses and $9.5 million in general and administrative (G&A) expenses. Although our restructuring activities conducted in the first half of 2009 reduced the run-rate of employee-related expenses in our R&D and G&A functions, both R&D and G&A expenses for the third quarter of 2009 increased as compared to prior 2009 periods.  R&D expenses, which were $45.1 million the third quarter of 2009, increased significantly compared to each of the first two quarters of 2009 due primarily to a $20.0 million upfront payment recognized in the current period upon the execution of our collaboration with Trubion.  G&A expenses of $9.5 million incurred in the third quarter of 2009 increased from the second quarter of 2009 due largely to $2.5 million in expenses incurred during the period related to responding to Biogen Idec’s tender offer. Our net loss for the third quarter of 2009 was $40.9 million. (See “Results of Operations” for further details on our financial results for the period.)

At September 30, 2009, we had cash, cash equivalents, marketable securities and restricted cash of $331.9 million, compared to $403.4 million at December 31, 2008, representing a change of $71.5 million for the first nine months of 2009.  The $20.0 million upfront payment made to Trubion upon execution of the collaboration agreement in the third quarter of 2009 was a significant contributor to the change in these balances.

Research and Development Programs

We currently have several investigational compounds in various stages of development for the treatment of cancer and immunologic diseases, four of which we are developing with our collaboration partners; two with Biogen Idec, one with Bristol-Myers Squibb Company (BMS) and one with Trubion. The table below lists the compounds for which we are pursuing development activities either on our own or in collaboration with other companies. None of our product candidates have been approved by the FDA or commercialized in the indication in which our trials are focused. Not all clinical trials for each product candidate are listed below. The development and commercialization of our product candidates are subject to numerous risks and uncertainties, as noted in our “Risk Factors” of this Quarterly Report. For additional details on each product in the table below, please refer to Item 1 in our Annual Report on Form 10-K for the year ended December 31, 2008 as well as the Recent Developments section of this report above.

(a)             In August 2009, we entered into a collaboration agreement with Trubion for the development of TRU-016, a CD37-directed small modular immunopharmaceutical in phase 1 clinical trials for chronic lymphocytic leukemia. The collaboration agreement covers TRU-016 in all indications and all other CD37-directed protein therapeutics. See Note 4 to the Condensed Consolidated Financial Statements for more details on the collaboration agreement with Trubion.

(b)            BMS has an option to expand our collaboration to include the PDL241 antibody after completion of certain pre-agreed preclinical studies, which we completed and submitted to BMS in the fourth quarter of 2009.

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CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES

There have been no material changes in our critical accounting policies, estimates and judgments during the quarter ended September 30, 2009 compared to the disclosures in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2008, except for the following addition:

Restructuring

In connection with our 2009 restructuring activities, we vacated and ceased use of approximately 85% of one of our two leased buildings in Redwood City (the Administration Building) and consolidated our operations into the other building (the Lab Building) during the second quarter of 2009. In connection with vacating this space within the Administration Building, we recognized lease-related restructuring charges of $17.0 million in the second quarter of 2009. These charges are comprised of our initial estimate of $23.0 million for the Lease Restructuring Liability, which represented the present value of the estimated facility costs for which we will obtain no future economic benefit offset by estimated future sublease income, partially offset by a $6.0 million credit for a then- existing deferred rent liability associated with the vacated area of the Administration Building.

During the third quarter of 2009, based on updated assumptions resulting from continued discussions with potential subtenants, we recognized a credit to our lease-related restructuring charges of $1.6 million, driven by a change in estimate of $2.4 million, which, in addition to payments and adjustments, reduced the lease-related restructuring liability to $18.1 million as of September 30, 2009. The total estimated obligations under the lease for the Administration Building, as of September 30, 2009, are summarized below (these amounts exclude obligations related to the Lab Building):

(1)          Lease payments represent actual and estimated contractual rental payments under our lease for the Administration Building. These lease obligations reflect our estimates of future lease payments, which are subject to potential escalations based on market conditions after the year 2014 and, therefore, could be lower or higher than amounts included in the table.

(2)          Other lease-related obligations reflect estimated amounts that we are contractually required to pay over the term of the Administration Building lease, including insurance, property taxes and common area maintenance fees. Such amounts are estimated based on historical costs that we have incurred since the inception of the lease.

We derived our estimates for the $18.1 million Lease Restructuring Liability, which involved significant assumptions regarding the time required to contract with subtenants, the amount of idle space we would be able to sublease and potential future sublease rates, based on discussions with our brokers and discussions currently in process with potential subtenants. The present value factor, which also affects the level of accretion expense that we will recognize as additional restructuring charges over the term of the lease, is based on our estimate of Facet Biotech’s current credit-risk adjusted borrowing rate.

We have established a number of potential scenarios with differing assumptions and have calculated the present value of and applied probability weighting to each scenario based on management’s best judgment.  Changes in the assumptions underlying these scenarios, as well as the relative likelihood applied to each scenario, could have a material impact on our restructuring charge and Lease Restructuring Liability.  For example, using a set of assumptions of contracting the entire property with a single subtenant within one year for 100% of our lease costs would result in a favorable adjustment of approximately $6.5 million to our Lease Restructuring Liability.  However, a scenario in which we would contract with several subtenants over a period of five years at lease rates approximating 75% of our costs, and assuming an average vacancy rate of 40% over the remaining term of our lease, would result in an unfavorable adjustment of $11.3 million to our Lease Restructuring Liability.

We are required to continue to update our estimate of the Lease Restructuring Liability in future periods as conditions warrant, and we expect to further revise our estimate in future periods as we continue our discussions with potential subtenants.

In addition, in connection with our sublease efforts for the Administration Building, we are also pursuing sublease arrangements under which we could potentially contract with subtenants for both the Administration Building and the Lab Building (which we currently occupy). If we sublease these facilities for rates that are not significantly in excess of our costs, we would not likely recover the carrying value of certain assets associated with these facilities, which was approximately $60.0 million as of September 30, 2009. As such, we could potentially recognize a substantial asset impairment charge, as much as the carrying value of such assets, if we were to sublease both of these buildings.

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RESULTS OF OPERATIONS

Revenues

Revenues consist of (1) license and milestone revenues from collaborations, (2) reimbursement of R&D expenses under collaborations and (3) other revenues. Other revenues include license, maintenance and milestone revenues from the out-licensing of our technologies, humanization revenues and royalties.