Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________________________________________
FORM 10-Q
________________________________________________________________________________________
x
Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2014
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Transition Period From ______ to ______ .
Commission File Number: 001-33093
________________________________________________________________________________________
LIGAND PHARMACEUTICALS INCORPORATED
(Exact name of registrant as specified in its charter)
________________________________________________________________________________________
Delaware
77-0160744
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
11119 North Torrey Pines Road, Suite 200
La Jolla, CA
92037
(Zip Code)
(Address of principal executive offices)
 
(858) 550-7500
(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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x 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)
Large Accelerated Filer
o
 
Accelerated Filer
x
Non-Accelerated Filer
o
(Do not check if a smaller reporting company)
Smaller Reporting Company
o
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 31, 2014, the registrant had 20,023,148 shares of common stock outstanding.


Table of Contents


LIGAND PHARMACEUTICALS INCORPORATED
QUARTERLY REPORT

FORM 10-Q

TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 
 
 





Table of Contents

PART I.
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
LIGAND PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share data)
 
September 30,
 
December 31,
 
2014
 
2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
180,663

 
$
11,639

Short-term investments
5,925

 
4,340

Accounts receivable
5,812

 
2,222

Inventory
1,071

 
1,392

Capitalized expenses, VIE
2,131

 

Other current assets
1,602

 
959

Current debt issuance costs
793

 

Current co-promote termination payments receivable
523

 
4,329

Total current assets
198,520

 
24,881

Restricted cash and investments
1,261

 
1,341

Property and equipment, net
551

 
867

Intangible assets, net
51,317

 
53,099

Goodwill
12,238

 
12,238

Commercial license rights
4,568

 
4,571

Long-term co-promote termination payments receivable

 
7,417

Long-term debt issuance costs
3,598

 

Other assets
230

 
299

Total assets
$
272,283

 
$
104,713

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable (including $2.2 million related to a VIE)
$
4,864

 
$
3,951

Accrued liabilities
4,311

 
5,337

Current contingent liabilities
4,184

 
1,712

Current deferred income taxes
1,574

 
1,574

Current note payable
337

 
9,109

Current co-promote termination liability
523

 
4,329

Current lease exit obligations
2,526

 
2,811

Current deferred revenue
114

 
116

Total current liabilities
18,433

 
28,939

Long-term co-promote termination liability

 
7,417

Long-term deferred revenue, net
2,085

 
2,085

Long-term lease exit obligations
1,133

 
3,071

Deferred income taxes
1,214

 
1,098

Long-term contingent liabilities
12,267

 
11,795

Long-term debt, net
193,631

 

Other long-term liabilities
737

 
695

Total liabilities
229,500

 
55,100

Commitments and Contingencies

 

Stockholders' equity:
 
 
 
Common stock, $0.001 par value; 33,333,333 shares authorized; 20,117,080 and 20,468,521 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
20

 
21

Additional paid-in capital
707,180

 
718,017

Accumulated other comprehensive income
3,543

 
2,914

Accumulated deficit
(666,371
)
 
(671,339
)
Total stockholders' equity attributable to parent
44,372

 
49,613

Noncontrolling interests
(1,589
)
 
$

Total liabilities and stockholders' equity
$
272,283

 
$
104,713

See accompanying notes.

3

Table of Contents

LIGAND PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except share data)

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Royalties
$
7,482

 
$
5,724

 
$
20,573

 
$
16,466

Material sales
6,334

 
6,728

 
15,525

 
12,260

Collaborative research and development and other revenues
1,157

 
553

 
5,441

 
5,511

Total revenues
14,973

 
13,005

 
41,539

 
34,237

Operating costs and expenses:
 
 
 
 
 
 
 
Cost of sales
1,496

 
2,538

 
5,133

 
4,416

Research and development
3,021

 
2,414

 
8,842

 
6,900

General and administrative
6,742

 
4,756

 
17,053

 
13,564

Lease exit and termination costs
182

 
227

 
522

 
359

Write-off of in-process research and development

 

 

 
480

Total operating costs and expenses
11,441

 
9,935

 
31,550

 
25,719

Income from operations
3,532

 
3,070

 
9,989

 
8,518

Other (expense) income:
 
 
 
 
 
 
 
Interest expense, net
(1,516
)
 
(394
)
 
(1,946
)
 
(1,755
)
(Increase) decrease in contingent liabilities
(1,620
)
 
(532
)
 
(4,880
)
 
368

Other, net
505

 
(119
)
 
1,128

 
69

Total other expense, net
(2,631
)
 
(1,045
)
 
(5,698
)
 
(1,318
)
Income before income taxes
901

 
2,025

 
4,291

 
7,200

Income tax expense
(124
)
 
(60
)
 
(131
)
 
(237
)
Income from continuing operations
777

 
1,965

 
4,160

 
6,963

Discontinued operations:
 
 
 
 
 
 
 
Gain on sale of Avinza Product Line before income taxes

 

 

 
2,588

Income from discontinued operations

 

 

 
2,588

Net income including noncontrolling interests:
777

 
1,965

 
4,160

 
9,551

Less: Net loss attributable to noncontrolling interests
(503
)
 

 
(809
)
 

Net income
$
1,280

 
$
1,965

 
$
4,969

 
$
9,551

 
 
 
 
 
 
 
 
Per share amounts attributable to Ligand common shareholders:
 
 
 
 
 
 
 
Basic per share amounts:
 
 
 
 
 
 
 
Income from continuing operations
$
0.06

 
$
0.10

 
$
0.24

 
$
0.34

Income from discontinued operations

 

 

 
0.13

Net income
$
0.06

 
$
0.10

 
$
0.24

 
$
0.47

 
 
 
 
 
 
 
 
Diluted per share amounts:
 
 
 
 
 
 
 
Income from continuing operations
$
0.06

 
$
0.09

 
$
0.23

 
$
0.33

Income from discontinued operations

 

 

 
0.13

Net income
$
0.06

 
$
0.09

 
$
0.23

 
$
0.46

 
 
 
 
 
 
 
 
Weighted-average number of common shares-basic
20,417,187

 
20,357,558

 
20,584,469

 
20,268,261

Weighted-average number of common shares-diluted
21,345,311

 
20,843,742

 
21,632,521

 
20,562,622


See accompanying notes.

4

Table of Contents

LIGAND PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(in thousands)

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
1,280

 
$
1,965

 
$
4,969

 
$
9,551

Unrealized net (loss) gain on available-for-sale securities, net of tax of $0
(1,224
)
 
806

 
1,870

 
2,201

Less: Reclassification of net realized (losses) gains included in net income
(274
)
 

 
1,241

 

Comprehensive (loss) income
$
(218
)
 
$
2,771

 
$
8,080

 
$
11,752


See accompanying notes.


5

Table of Contents

LIGAND PHARMACEUTICAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
Nine months ended
 
September 30,
 
2014
 
2013
Operating activities
 
 
 
Net income including noncontrolling interests
$
4,160

 
$
9,551

Less: gain from discontinued operations

 
2,588

Income from continuing operations
4,160

 
6,963

Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities:
 
 
 
Non-cash change in estimated fair value of contingent liabilities
4,880

 
(368
)
Write-off of in-process research and development

 
480

Realized gain on sale of short-term investment
(1,241
)
 

Gain on write-off of assets
(16
)
 

Depreciation and amortization
1,998

 
2,007

Amortization of debt discount and issuance fees
1,223

 

Stock-based compensation
8,795

 
4,149

Non-cash upfront fee
(1,211
)
 

Deferred income taxes
116

 
237

Accretion of note payable
225

 
321

Other

 
(13
)
Changes in operating assets and liabilities:
 
 
 
     Accounts receivable
(3,590
)
 
(918
)
     Inventory
321

 
86

     Other current assets
(615
)
 
(683
)
     Other long-term assets
(1,245
)
 
173

     Accounts payable and accrued liabilities
(3,478
)
 
(2,702
)
     Deferred revenue
(2
)
 
(434
)
Net cash provided by operating activities of continuing operations
10,320

 
9,298

Net cash used in operating activities of discontinued operations

 
(642
)
Net cash provided by operating activities
10,320

 
8,656

Investing activities
 
 
 
Purchase of commercial license rights

 
(3,571
)
Payments to CVR holders and other contingency payments
(1,936
)
 
(100
)
Purchases of property and equipment

 
(263
)
Proceeds from sale of property and equipment
125

 
3

Proceeds from sale of short-term investments
1,496

 

Other, net
(1
)
 
(40
)
Net cash used in investing activities
(316
)
 
(3,971
)
Financing activities
 
 
 
Repayment of debt
(9,364
)
 
(16,224
)
Gross proceeds from issuance of 2019 Convertible Senior Notes
245,000

 

Payment of debt issuance costs
(5,711
)
 

Proceeds from issuance of warrants
11,637

 

Purchase of convertible bond hedge
(48,143
)
 

Net proceeds from stock option exercises and ESPP
4,124

 
2,429

Share repurchase
(38,523
)
 

Net cash provided by (used in) financing activities
159,020

 
(13,795
)
Net increase (decrease) in cash and cash equivalents
169,024

 
(9,110
)
Cash and cash equivalents at beginning of period
11,639

 
12,381

Cash and cash equivalents at end of period
$
180,663

 
$
3,271



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Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
494

 
$
1,566

Taxes paid
$
3

 
$
5

Supplemental schedule of non-cash activity
 
 
 
Liability for commercial license rights
$

 
$
1,000

Accrued inventory purchases
$

 
$
227

Unrealized gain on AFS investments
$
1,870

 
$
2,201


See accompanying notes

7

Table of Contents

LIGAND PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Basis of Presentation

Ligand Pharmaceuticals Incorporated, a Delaware corporation (the "Company" or "Ligand") is a biopharmaceutical company that develops and acquires royalty and other revenue generating assets and couples them with a lean corporate cost structure. The Company diversifies its portfolio of assets across numerous technology types, therapeutic areas, drug targets, and industry partners. The Company added Captisol® to its technology portfolio in January 2011. Captisol is a formulation technology that has enabled six FDA approved products, including Onyx's Kyprolis® and Baxter International's Nexterone®, and is currently being developed in a number of clinical-stage partner programs. The Company's therapies address the unmet medical needs of patients for a broad spectrum of diseases including hepatitis, multiple myeloma, muscle wasting, Alzheimer’s disease, dyslipidemia, diabetes, anemia, asthma, Focal Segmental Glomerulosclerosis ("FSGS") and osteoporosis. Ligand has established multiple alliances with the world’s leading pharmaceutical companies including GlaxoSmithKline, Onyx Pharmaceuticals (a subsidiary of Amgen, Inc.), Merck, Pfizer, Baxter International, Lundbeck Inc. and Spectrum Pharmaceuticals, Inc. The Company’s principal market is the United States. The Company sold its Oncology Product Line ("Oncology") and Avinza Product Line ("Avinza") on October 25, 2006 and February 26, 2007, respectively. The operating results for Oncology and Avinza have been presented in the accompanying condensed consolidated financial statements as "Discontinued Operations."
 
The Company has incurred significant losses since its inception. As of September 30, 2014, the Company’s accumulated deficit was approximately $666.4 million and the Company had working capital of approximately $180.1 million. Management believes that cash flows from operations will increase due to Captisol® sales, an increase in royalty revenues driven primarily from continued increases in Promacta® and Kyprolis® sales, and also from anticipated new license and milestone revenues. The Company expects to build cash in future months as it continues to generate significant cash flows from operations. The Company’s future operating and capital requirements will depend on many factors, including, but not limited to: the pace of scientific progress in its research and development programs; the potential success of these programs; the scope and results of preclinical testing and clinical trials; the time and costs involved in obtaining regulatory approvals; the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; competing technological and market developments; the amount of royalties on sales of the commercial products of its partners; the efforts of its collaborative partners; obligations under its operating lease agreements; and the capital requirements of any companies the Company may acquire in the future. The ability of the Company to achieve its operational targets is dependent upon the Company’s ability to further implement its business goals and generate sufficient operating cash flow.

Principles of Consolidation
    
The accompanying unaudited condensed consolidated financial statements include Ligand and its wholly owned subsidiaries, Ligand JVR, Allergan Ligand Retinoid Therapeutics, Seragen, Inc., Pharmacopeia, Inc. ("Pharmacopeia"), Neurogen Corporation ("Neurogen"), CyDex Pharmaceuticals, Inc. ("CyDex"), Metabasis Therapeutics, Inc. ("Metabasis") and Nexus VI, Inc. Also included is Viking Therapeutics, Inc. ("Viking"), a variable interest entity ("VIE") for which the Company is deemed under applicable accounting guidance to be the primary beneficiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

Basis of Presentation

The Company’s accompanying unaudited condensed consolidated financial statements as of September 30, 2014 and for the three and nine months ended September 30, 2014 and 2013 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. The Company’s unaudited condensed consolidated balance sheet at December 31, 2013 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position and results of operations of the Company and its subsidiaries, have been included. Operating results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. These financial statements should be read in conjunction with the consolidated financial statements and notes therein included in the Company’s annual report on Form 10-K for the year ended December 31, 2013.

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Use of Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, contingent assets and liabilities, definite and indefinite lived intangible assets, goodwill, co-promote termination payments receivable and co-promote termination liabilities, uncertain tax positions, deferred revenue, lease exit liability and income tax net operating loss carryforwards during the reporting period. The Company’s critical accounting policies are those that are both most important to the Company’s financial condition and results of operations and require the most difficult, subjective or complex judgments on the part of management in their application, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Because of the uncertainty of factors surrounding the estimates or judgments used in the preparation of the condensed consolidated financial statements, actual results may materially vary from these estimates.

Income Per Share

Basic income per share is calculated by dividing net income by the weighted-average number of common shares and vested restricted stock units outstanding. Diluted income per share is computed by dividing net income by the weighted-average number of common shares and vested restricted stock units outstanding and the weighted-average number of dilutive common stock equivalents, including stock options, non-vested restricted stock units, convertible notes and warrants. Common stock equivalents are only included in the diluted income per share calculation when their effect is dilutive. The total number of potential common shares excluded from the computation of diluted income per share because their inclusion would have been anti-dilutive was 5.0 million and 0.9 million, as of September 30, 2014 and 2013, respectively.

The following table sets forth the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share amounts):

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
EPS attributable to common shareholders:
 
 
 
 
 
 
 
Net income from continuing operations
$
1,280

 
$
1,965

 
4,969

 
$
6,963

Net income from discontinued operations

 

 

 
2,588

Net income
$
1,280

 
$
1,965

 
$
4,969

 
$
9,551

 
 
 
 
 
 
 
 
Shares used to compute basic income per share
20,417,187

 
20,357,558

 
20,584,469

 
20,268,261

Dilutive potential common shares:
 
 
 
 
 
 
 
Restricted stock
22,531

 
77,609

 
37,387

 
62,051

     Stock options
905,593

 
408,575

 
1,010,665

 
232,310

Shares used to compute diluted income per share
21,345,311

 
20,843,742

 
21,632,521

 
20,562,622

 
 
 
 
 
 
 
 
Basic per share amounts:
 
 
 
 
 
 
 
Income from continuing operations
$
0.06

 
$
0.10

 
$
0.24

 
$
0.34

Income from discontinued operations

 

 

 
0.13

Net income
$
0.06

 
$
0.10

 
$
0.24

 
$
0.47

 
 
 
 
 
 
 
 
Diluted per share amounts:
 
 
 
 
 
 
 
Income from continuing operations
$
0.06

 
$
0.09

 
$
0.23

 
$
0.33

Income from discontinued operations

 

 

 
0.13

Net income
$
0.06

 
$
0.09

 
$
0.23

 
$
0.46


Cash, Cash Equivalents and Short-term Investments

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Cash and cash equivalents consist of cash and highly liquid securities with maturities at the date of acquisition of three months or less. Securities received by the Company as a result of a milestone payment from licensees are considered short-term investments and have been classified by management as available-for-sale. Such investments are carried at fair value, with unrealized gains and losses included in the statement of comprehensive income (loss). The Company determines the cost of investments based on the specific identification method.
Restricted Cash and Investments
    
Restricted cash and investments consist of certificates of deposit held with a financial institution as collateral under a facility lease and third-party service provider arrangements.

The following table summarizes the various investment categories at September 30, 2014 and December 31, 2013 (in thousands):

 
Cost
 
Gross unrealized
gains
 
Gross unrealized
losses
 
Estimated
fair value
September 30, 2014
 
 
 
 
 
 
 
Short-term investments
$
1,426

 
$
4,499

 
$

 
$
5,925

Certificates of deposit-restricted
1,261

 

 

 
1,261

 
$
2,687

 
$
4,499

 
$

 
$
7,186

December 31, 2013
 
 
 
 
 
 
 
Short-term investments
$
1,426

 
$
2,914

 
$

 
$
4,340

Certificates of deposit-restricted
1,341

 

 

 
1,341

 
$
2,767

 
$
2,914

 
$

 
$
5,681


Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash equivalents, investments and accounts receivable.

The Company invests its excess cash principally in U.S. government debt securities, investment-grade corporate debt securities and certificates of deposit. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The Company did not experience any significant losses on its cash equivalents, short-term investments or restricted investments for the periods ending September 30, 2014 and December 31, 2013.

As of September 30, 2014 and December 31, 2013, cash deposits held at financial institutions in excess of FDIC insured amounts of $250,000 were approximately $92.8 million and $11.1 million, respectively.

Accounts receivable from one customer was 57% of total accounts receivable at September 30, 2014. Accounts receivable from two customers was 75% of total accounts receivable at December 31, 2013

The Company currently obtains Captisol from a single supplier.  If this supplier were not able to supply the requested amounts of Captisol and the Company's existing inventory was depleted, the Company would be unable to continue to derive revenues from the sale of Captisol until it obtained an alternative source, which might take a considerable length of time. The Company maintains inventory of Captisol, which has a five year shelf life, at three geographically spread storage locations in the United States and Europe.  If a disaster were to strike any of these locations, it could lead to supply interruptions.

Inventory

Inventory is stated at the lower of cost or market value. The Company determines cost using the first-in, first-out method. The Company analyzes its inventory levels periodically and writes down inventory to its net realizable value if it has become obsolete, has a cost basis in excess of its expected net realizable value or is in excess of expected requirements. There were no write downs related to obsolete inventory recorded for the three and nine months ended September 30, 2014 and 2013.

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Property and Equipment

Property and equipment is stated at cost and consists of the following (in thousands):

 
September 30,
 
December 31,
 
2014
 
2013
Lab and office equipment
$
2,509

 
$
3,737

Leasehold improvements
273

 
387

Computer equipment and software
631

 
616

 
3,413

 
4,740

Less accumulated depreciation and amortization
(2,862
)
 
(3,873
)
     Total property and equipment, net
$
551

 
$
867


Depreciation of equipment is computed using the straight-line method over the estimated useful lives of the assets, which range from three to ten years. Leasehold improvements are amortized using the straight-line method over their estimated useful lives or their related lease term, whichever is shorter. Depreciation expense recognized for the three months ended September 30, 2014 and 2013 was $0.1 million. Depreciation expense for the nine months ended September 30, 2014 and 2013 was $0.2 million. Depreciation expense is included in operating expenses.

Other Current Assets

Other current assets consist of the following (in thousands):

 
September 30,
 
December 31,
 
2014
 
2013
Prepaid expenses
$
1,178

 
$
786

Other receivables
424

 
173

     Total current assets
$
1,602

 
$
959


Goodwill and Other Identifiable Intangible Assets

Goodwill and other identifiable intangible assets consist of the following (in thousands):

 
September 30,
 
December 31,
 
2014
 
2013
Indefinite lived intangible assets
 
 
 
     Acquired in-process research and development
$
12,556

 
$
12,556

     Goodwill
12,238

 
12,238

Definite lived intangible assets
 
 
 
     Complete technology
15,267

 
15,267

          Less: Accumulated amortization
(2,807
)
 
(2,235
)
     Trade name
2,642

 
2,642

          Less: Accumulated amortization
(487
)
 
(387
)
     Customer relationships
29,600

 
29,600

          Less: Accumulated amortization
(5,454
)
 
(4,344
)
Total goodwill and other identifiable intangible assets, net
$
63,555

 
$
65,337


The Company accounts for goodwill and other intangible assets in accordance with Accounting Standards Codification ("ASC") Topic 350 - Intangibles - Goodwill and Other which, among other things, establishes standards for goodwill acquired in a business combination, eliminates the amortization of goodwill and requires the carrying value of goodwill and certain non-

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amortizing intangibles to be evaluated for impairment on an annual basis. The Company uses the income approach and the market approach, each weighted at 50%, when performing its goodwill impairment analysis. For the income approach, the Company considers the present value of future cash flows and the carrying value of its assets and liabilities, including goodwill. The market approach is based on an analysis of revenue multiples of peer public companies. If the carrying value of the assets and liabilities, including goodwill, were to exceed the Company’s estimation of the fair value, the Company would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. The Company performs an evaluation of goodwill and other intangibles as of December 31 of each year, absent any indicators of earlier impairment, to ensure that impairment charges, if applicable, are reflected in the Company's financial results before December 31 of each year. When it is determined that impairment has occurred, a charge to operations is recorded. Goodwill and other intangible asset balances are included in the identifiable assets of the business segment to which they have been assigned. Any goodwill impairment, as well as the amortization of other purchased intangible assets, is charged against the respective business segments' operating income.

Amortization of definite-lived intangible assets is computed using the straight-line method over the estimated useful life of the asset of 20 years. Amortization expense of $0.6 million and $1.8 million was recognized for each of the three and nine months ended September 30, 2014 and 2013, respectively. Estimated amortization expense for the years ending December 31, 2014 through 2018 is $2.4 million per year.
Acquired In-Process Research and Development
    
Intangible assets related to acquired in-process research and development ("IPR&D") are considered to be indefinite-lived until the completion or abandonment of the associated research and development efforts. During the period the assets are considered to be indefinite-lived, they will not be amortized but will be tested for impairment on an annual basis and between annual tests if the Company becomes aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the IPR&D projects below their respective carrying amounts. If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets would be deemed definite-lived and would then be amortized based on their respective estimated useful lives at that point in time. For the three and nine months ended September 30, 2014 and the three months ended September 30, 2013 there was no impairment of IPR&D. For the nine months ended September 30, 2013, the Company recorded a non-cash impairment charge of $0.5 million for the write-off of IPR&D for Captisol-enabled Clopidogrel (MDCO-157). The asset was impaired upon notification from the Medicines Company that they intended to terminate the license agreement and return the rights of the compound to the Company. MDCO-157 is an intravenous option of the anti-platelet medication designed for situations where the administration of oral platelet inhibitors is not feasible or desirable.

Impairment of Long-Lived Assets
    
Management reviews long-lived assets for impairment annually or whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value for the Company’s long-lived assets is determined using the expected cash flows discounted at a rate commensurate with the risk involved. As of September 30, 2014, management does not believe there have been any events or circumstances indicating that the carrying amount of its long-lived assets may not be recoverable.

Commercial license rights
    
Commercial license rights represent a portfolio of future milestone and royalty payment rights acquired in accordance with the Royalty Stream and Milestone Payments Purchase Agreement entered into with Selexis SA ("Selexis") in April 2013.  The portfolio consists of over 15 Selexis commercial license agreement programs with various pharmaceutical-company counterparties.  The purchase price was $4.6 million, inclusive of acquisition costs. The Company paid $3.6 million upon closing and paid an additional $1.0 million in April 2014. Individual commercial license rights acquired under the agreement are carried at allocated cost and approximate fair value. The carrying value of the license rights will be reduced on a pro-rata basis as revenue is realized over the term of the agreement. Declines in the fair value of individual license rights below their carrying value that are deemed to be other than temporary are reflected in earnings in the period such determination is made. As of September 30, 2014, management does not believe there have been any events or circumstances indicating that the carrying amount of its commercial license rights may not be recoverable.

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Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

 
September 30,
 
December 31,
 
2014
 
2013
Compensation
$
1,388

 
$
1,929

Professional fees
805

 
697

Accrued interest payable
230

 

Other
1,888

 
2,711

     Total accrued liabilities
$
4,311

 
$
5,337


Other Long-Term Liabilities

Other long-term liabilities consist of the following (in thousands):

 
September 30,
 
December 31,
 
2014
 
2013
Deposits
$
402

 
$
345

Deferred rent
335

 
350

     Total other long-term liabilities
$
737

 
$
695

Contingent Liabilities
    
In connection with the Company’s acquisition of CyDex in January 2011, the Company recorded a $17.6 million contingent liability, inclusive of the $4.3 million payment made in January 2012, for amounts potentially due to holders of the CyDex contingent value rights ("CVRs") and former license holders. The liability is periodically assessed based on events and circumstances related to the underlying milestones, royalties and material sales. Any change in fair value is recorded in the Company’s consolidated statements of operations. The carrying amount of the liability may fluctuate significantly and actual amounts paid under the CVR agreements may be materially different than the carrying amount of the liability. The fair value of the liability at September 30, 2014 and December 31, 2013 was $12.9 million and $9.3 million, respectively. The Company recorded a fair-value adjustment to increase the liability for CyDex-related contingent liabilities by $2.8 million and $5.6 million for the three and nine months ended September 30, 2014, respectively, and an adjustment to increase the liability by $1.2 million and to decrease the liability by $2.1 million for the three and nine months ended September 30, 2013, respectively. There was a revenue-sharing payment of $1.6 million made during the nine months ended September 30, 2014, and no revenue sharing payments were made during the three months ended September 30, 2014 and three and nine months ended September 30, 2013. Other contingency payments related to the CyDex acquisition of $0.3 million were made during the three and nine months ended September 30, 2014 and other contingency payments of $0.1 million were made during the three and nine months ended September 30, 2013.
    
In connection with the Company’s acquisition of Metabasis in January 2010, the Company issued to Metabasis stockholders four tradable CVRs, one CVR from each of four respective series of CVR, for each Metabasis share. The CVRs will entitle Metabasis stockholders to cash payments as frequently as every six months as cash is received by the Company from proceeds from the sale or partnering of any of the Metabasis drug development programs, among other triggering events. The fair values of the CVRs are remeasured at each reporting date through the term of the related agreement. Changes in the fair values are reported in the statement of operations as income (decreases) or expense (increases). The carrying amount of the liability may fluctuate significantly based upon quoted market prices and actual amounts paid under the agreements may be materially different than the carrying amount of the liability. The fair value of the liability was estimated to be $3.5 million and $4.2 million as of September 30, 2014 and December 31, 2013, respectively. The Company recorded a decrease in the liability for Metabasis-related CVRs of $1.2 million and an increase in the liability of $0.7 million for the three and nine months ended September 30, 2014, respectively. The Company recorded a decrease in the liability of $0.7 million for the three months ended September 30, 2013 and an increase in the liability of $1.7 million for the nine months ended September 30, 2013.


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Fair Value of Financial Instruments
Fair value is defined as the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. The Company establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels are described in the below with level 1 having the highest priority and level 3 having the lowest:
Level 1 - Quoted prices in active markets;
Level 2 - Inputs other than the quoted prices in active markets that are observable either directly or indirectly; and
Level 3 - Unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions.
The Company’s short-term investments include investments in equity securities which the Company received as a result of event-based and upfront payments from licensees. Additionally, there is a liability related to the investment in equity securities for amounts owed to former license holders. The Metabasis CVR liability is marked-to-market at each reporting period based upon the quoted market prices of the underlying CVR. The fair value of the CyDex contingent liabilities are determined at each reporting period based upon an income valuation model. The co-promote termination payments receivable represents a non-interest-bearing receivable for future payments to be made by Pfizer related to Avinza product sales and is recorded at its fair value. The receivable and liability will remain equal, and are adjusted each quarter for changes in the fair value of the obligation including any changes in the estimate of future net Avinza product sales.
The Company evaluates its financial instruments at each reporting period to determine if any transfers between the various three-level hierarchy have occurred and appropriately reclassifies its financial instruments to the appropriate level within the hierarchy.
Revenue Recognition

Royalties on sales of products commercialized by the Company’s partners are recognized in the quarter reported by the respective partner. Generally, the Company receives royalty reports from its licensees approximately one quarter in arrears due to the fact that its agreements require partners to report product sales between 30 and 60 days after the end of the quarter. The Company recognizes royalty revenues when it can reliably estimate such amounts and collectability is reasonably assured. Under this accounting policy, the royalty revenues reported are not based upon estimates and such royalty revenues are typically reported to the Company by its partners in the same period in which payment is received.
Revenue from material sales of Captisol is recognized upon transfer of title, which normally passes upon shipment to the customer. The Company’s credit and exchange policy includes provisions for the return of product between 30 to 90 days, depending on the specific terms of the individual agreement, when that product (1) does not meet specifications, (2) is damaged in shipment (in limited circumstances where title does not transfer until delivery), or (3) is exchanged for an alternative grade of Captisol.

Revenue from research funding under our collaboration agreements is earned and recognized on a percentage-of completion basis as research hours are incurred in accordance with the provisions of each agreement.
Nonrefundable, upfront license fees are recognized as revenue upon delivery of the license, if the license is determined to have standalone value that is not dependent on any future performance by the Company under the applicable collaboration agreement. Nonrefundable contingent event-based payments are recognized as revenue when the contingent event is met, which is usually the earlier of when payments are received or collections are assured, provided that it does not require future performance by the Company. The Company occasionally has sub-license obligations related to arrangements for which it receives license fees, milestones and royalties. The Company evaluates the determination of gross versus net reporting based on each individual agreement.
Sales-based contingent payments from partners are accounted for similarly to royalties, with revenue recognized upon achievement of the sales targets assuming all other revenue recognition criteria for milestones are met. Revenue from development and regulatory milestones is recognized when earned, as evidenced by written acknowledgement from the collaborator, provided that (1) the milestone event is substantive, its achievability was not reasonably assured at the inception of the agreement, and the Company has no further performance obligations relating to that event, and (2) collectability is reasonably assured. If these criteria are not met, the milestone payment is recognized over the remaining period of the Company’s performance obligations under the arrangement.
The Company analyzes its revenue arrangements and other agreements to determine whether there are multiple elements that should be separated and accounted for individually or as a single unit of accounting. For multiple element

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contracts, arrangement consideration is allocated at the inception of the arrangement to all deliverables on the basis of relative selling price, using a hierarchy to determine selling price. Management first considers vendor-specific objective evidence ("VSOE"), then third-party evidence ("TPE") and if neither VSOE nor TPE exist, the Company uses its best estimate of selling price.
Many of the Company's revenue arrangements involve the bundling of a license with the option to purchase manufactured product. Licenses are granted to pharmaceutical companies for the use of Captisol in the development of pharmaceutical compounds. The licenses may be granted for the use of the Captisol product for all phases of clinical trials and through commercial availability of the host drug or may be limited to certain phases of the clinical trial process. Management believes that the Company's licenses have stand-alone value at the outset of an arrangement because the customer obtains the right to use Captisol in its formulations without any additional input by the Company.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts based on the best estimate of the amount of probable losses in the Company’s existing accounts receivable. Accounts receivable that are outstanding longer than their contractual payment terms, ranging from 30 to 90 days, are considered past due. When determining the allowance for doubtful accounts, several factors are taken into consideration, including historical write-off experience and review of specific customer accounts for collectability. Account balances are charged off against the allowance after collection efforts have been exhausted and the potential for recovery is considered remote. There was no allowance for doubtful accounts included in the balance sheets at September 30, 2014 and December 31, 2013.

Accounting for Stock-Based Compensation

Stock-based compensation expense for awards to employees and non-employee directors is recognized on a straight-line basis over the vesting period until the last tranche vests. Compensation cost for consultant awards is recognized over each separate tranche’s vesting period. The following table summarizes stock-based compensation expense recorded as components of research and development expenses and general and administrative expenses for the periods indicated (in thousands):

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Stock-based compensation expense as a component of:
 
 
 
 
 
 
 
Research and development expenses
$
1,169

 
$
438

 
$
2,814

 
$
1,272

General and administrative expenses
2,533

 
1,095

 
5,981

 
2,877

 
$
3,702

 
$
1,533

 
$
8,795

 
$
4,149


The fair-value for options that were awarded to employees and directors was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Risk-free interest rate
1.9%
 
1.8%
 
1.9%
 
1.4%
Dividend yield
 
 
 
Expected volatility
67%
 
70%
 
68%
 
70%
Expected term
6.4
 
6.3
 
6.4
 
6.3
Forfeiture rate
8.6%
 
8.8%
 
8.6%-9.7%
 
8.4%-9.8%

The risk-free interest rate is based on the U.S. Treasury yield curve at the time of the grant. The expected term of the employee and non-employee director options is the estimated weighted-average period until exercise or cancellation of vested options (forfeited unvested options are not considered) based on historical experience. The expected term for consultant awards is the remaining period to contractual expiration. Volatility is a measure of the expected amount of variability in the stock price over the expected life of an option expressed as a standard deviation. In making this assumption, the Company used the

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historical volatility of the Company’s stock price over a period equal to the expected term. The forfeiture rate is based on historical data at the time of the grant.
Preclinical Study and Clinical Trial Accruals
    
Substantial portions of the Company’s preclinical studies and all of the Company's clinical trials have been performed by third-party laboratories, contract research organizations, or other vendors (collectively "CROs"). Some CROs bill monthly for services performed, while others bill based upon milestone achievement. The Company accrues for each of the agreements it has with CROs on a monthly basis. For preclinical studies, accruals are estimated based upon the percentage of work completed and the contract milestones achieved. For clinical studies, accruals are estimated based upon a percentage of work completed, the number of patients enrolled and the duration of the study. The Company monitors patient enrollment, the progress of clinical studies and related activities to the extent possible through internal reviews of data reported to it by the CROs, correspondence with the CROs and clinical site visits. The Company's estimates are dependent upon the timelines and accuracy of the data provided by its CROs regarding the status of each program and total program spending. The Company periodically evaluates its estimates to determine if adjustments are necessary or appropriate based on information it receives concerning changing circumstances, and conditions or events that may affect such estimates. No material adjustments to preclinical study and clinical trial accrued expenses have been recognized to date.

Sale of Royalty Rights
    
The Company previously sold to third parties the rights to future royalties of certain of its products. As part of the underlying royalty agreements, the partners have the right to offset a portion of any future royalty payments owed to the Company to the extent of previous milestone payments. Accordingly, the Company deferred a portion of the revenue associated with each tranche of royalty right sold, equal to the pro-rata share of the potential royalty offset. Such amounts associated with the offset rights against future royalty payments will be recognized as revenue upon receipt of future royalties from the respective partners. As of September 30, 2014 there was no deferred revenue remaining related to the sale of royalty rights. As of December 31, 2013, the Company had deferred $0.1 million of revenue related to the sale of royalty rights.
Product Returns
    
In connection with the sale of the Avinza and Oncology product lines, the Company retained the obligation for returns of product that were shipped to wholesalers prior to the close of the transactions. The accruals for product returns, which were recorded as part of the accounting for the sales transactions, are based on historical experience. Any subsequent changes to the Company’s estimate of product returns are accounted for as a component of discontinued operations.

Milestone Payments

In May 2014, the Company entered into a licensing agreement and research collaboration with Omthera Pharmaceuticals. The research collaboration will target the development of novel products that utilize the proprietary Ligand-developed LTP TECHNOLOGY™ to improve lipid-lowering activity of certain omega-3 fatty acids. The Company is eligible to receive development, regulatory and event-based payments. The completion of a proof of concept under the development program would trigger a $1.0 million payment which would represent a milestone under the milestone method of accounting as (1) it is an event that can only be achieved in part on the Company's past performance, (2) there was substantive uncertainty at the date the arrangement was entered into that the event would be achieved and (3) it results in additional payment being due to the Company. None of the other event-based payments represents a milestone under the milestone method of accounting. No event based payment or milestone was achieved during the periods presented.

Cost of Goods Sold

The Company determines cost using the first-in, first-out method. Cost of goods sold include all costs of purchase and other costs incurred in bringing the inventories to their present location and condition, including costs to store and distribute.

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Research and Development
    
Collaborative research and development expense consists of labor, material, equipment and allocated facility costs of the Company’s scientific staff who are working pursuant to the Company’s collaborative agreements. From time to time, collaborative research and development expense includes costs related to research efforts in excess of those required under certain collaborative agreements. Management has the discretion to set the scope of such excess efforts and may increase or decrease the level of such efforts depending on the Company’s strategic priorities.
Proprietary research and development expense consists of intellectual property in-licensing costs, labor, materials, contracted services, and allocated facility costs that are incurred in connection with internally funded drug discovery and development programs.

Income Taxes

                Income taxes are accounted for under the liability method.  This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the consolidated financial statements.  A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize their benefit or if future deductibility is uncertain.  As of September 30, 2014, the Company had provided a full valuation allowance against its deferred tax assets as recoverability was uncertain.  Developing the provision for income taxes requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets.  The Company's judgments and tax strategies are subject to audit by various taxing authorities.  While management believes the Company has provided adequately for its income tax liabilities in its consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on the Company's consolidated financial condition and results of operations. 

The Company's ending deferred tax liability represents a future tax obligation for current tax amortization claimed on acquired IPR&D.  As the Company cannot estimate when the IPR&D assets will be amortizable for financial reporting purposes, the deferred tax liability associated with the IPR&D assets cannot be used to support the realization of the Company's deferred tax assets.  As a result, the Company is required to increase its valuation allowance and record a charge to deferred taxes.  

Discontinued Operations-Oncology Product Line
    
In September 2006, the Company and Eisai Inc. and Eisai Co., Ltd. (collectively "Eisai"), entered into a purchase agreement (the "Oncology Purchase Agreement"), pursuant to which Eisai agreed to acquire all of the Company's worldwide rights in and to its oncology products, including, among other things, all related inventory, equipment, records and intellectual property, and to assume certain liabilities as set forth in the Oncology Purchase Agreement. The Oncology product line included the Company's four marketed oncology drugs: Ontak, Targretin capsules, Targretin gel and Panretin gel.
    
Discontinued Operations-Avinza Product Line
    
In September 2006, the Company and King Pharmaceuticals, now a subsidiary of Pfizer, entered into a purchase agreement (the "Avinza Purchase Agreement"), pursuant to which Pfizer acquired all of the rights in and to Avinza in the United States, its territories and Canada, including, among other things, all Avinza inventory, records and related intellectual property, and to assume certain liabilities as set forth in the Avinza Purchase Agreement.

Pursuant to the terms of the Avinza Purchase Agreement, the Company retained the liability for returns of product from wholesalers that had been sold by the Company prior to the close of the transaction. Accordingly, as part of the accounting for the gain on the sale of Avinza, the Company recorded a reserve for Avinza product returns.

During the three and nine months ended September 30, 2014 and the three months ended September 30, 2013 the Company did not recognize any gain or loss on the sale of the Avinza product line. The Company recognized a pre-tax gain of$2.6 million for the nine months ended September 30, 2013, due to subsequent changes in certain estimates and liabilities recorded as of the sale date.

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Segment Reporting
    
Under ASC 280, Segment Reporting ("ASC 280"), operating segments are defined as components of an enterprise about which separate financial information is available that is regularly evaluated by the entity’s chief operating decision maker, in deciding how to allocate resources and in assessing performance. The Company has evaluated this codification and has identified two reportable segments: the development and commercialization of drugs using Captisol technology by CyDex and the biopharmaceutical company with a business model that is based upon the concept of developing or acquiring royalty revenue generating assets and coupling them with a lean corporate cost structure.
Comprehensive Income
    
Comprehensive income represents net income adjusted for the change during the periods presented in unrealized gains and losses on available-for-sale securities less reclassification adjustments for realized gains or losses included in net income. The unrealized gains or losses are reported on the consolidated statements of comprehensive income.

Consolidation of Variable Interest Entities

The Company identifies an entity as a VIE if either: (1) the entity does not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the entity's equity investors lack the essential characteristics of a controlling financial interest. The Company performs ongoing qualitative assessments of its VIEs to determine whether the Company has a controlling financial interest in any VIE and therefore is the primary beneficiary. If the Company is the primary beneficiary of a VIE, it must consolidate the VIE under applicable accounting guidance. The Company determined it holds a variable interest in Viking based on management's assessment that it does not have sufficient resources to carry out its principal activities without the support of the Company. The Company's variable interests in Viking are a loan provided by the Company to Viking and a license agreement executed concurrently. As of September 30, 2014, the Company's total assets include $2.9 million related to Viking and the Company's total liabilities include $4.5 million related to Viking. Viking's consolidated assets are owned by Viking, and Viking's consolidated liabilities are without recourse against Ligand.
New Accounting Pronouncements
    
In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. Under ASU 2013-02, an entity is required to provide information about the amounts reclassified out of Accumulated Other Comprehensive Income ("AOCI") by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. Implementing ASU 2013-02 did not change the current requirements for reporting net income or other comprehensive income in the financial statements. The amendments in this ASU are effective for the Company for fiscal years, and interim periods within those years, beginning after January 1, 2014. The Company's adoption of this standard did not materially affect the consolidated financial statements.

In July 2013, FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 requires the netting of unrecognized tax benefits ("UTBs") against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. UTBs are required to be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the UTBs. ASU 2013-11 is effective for the Company for interim and annual periods beginning after December 15, 2013. The Company's adoption of this standard did not materially affect the consolidated financial statements.

In April 2014, FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 raises the threshold for a disposal to qualify as a discontinued operation and modifies the related disclosure requirements. Under the new guidance, only disposals resulting in a strategic shift that will have a major effect on an entity's operations and financial results will be reported as discontinued operations. ASU 2014-08 also removes the requirement that an entity not have any significant continuing involvement in the operations of the component after disposal to qualify for reporting of the disposal as a discontinued operation. The guidance is effective for annual and interim periods beginning after December 15, 2014, with early adoption permitted for any disposal transaction not previously reported.

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Management does not believe the adoption of this guidance will have a material impact on the Company's consolidated financial statements.

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (1) identify the contract with the customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, (5) recognize revenue when (or as) the entity satisfies a performance obligation. Management is currently evaluating the effect the adoption of this standard will have on the Company's financial statements.

In June 2014, FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments in this update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718, Compensation - Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in this update will be effective for the Company as of January 1, 2016. Earlier adoption is permitted. Entities may apply the amendments in this update either: (1) prospectively to all awards granted or modified after the effective date; or (2) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If a retrospective transition is adopted, the cumulative effect of applying this update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. In addition, if a retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. Management is currently assessing the impact of this update, and believes that its adoption on January 1, 2016 will not have a material impact on the Company's consolidated financial statements.

In August 2014, FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern. The amendments in this update require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period, including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The amendments in this update are effective for the Company as of January 1, 2017. Early application is permitted. Management is currently assessing the impact of this update on its future discussion of its liquidity position in the Management’s Discussion and Analysis.

2. Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including equity securities, co-promote termination payments receivable and the related liability, contingent liabilities, and the Company's convertible senior notes.     

Level 1
The fair value of the Company’s investments which are classified as short-term investments is determined using quoted market prices in active markets. These securities were received by the Company in December 2012 and June 2014 as a result of an event-based payment and an upfront license payment, respectively, under licensees. Additionally, the liability for CVRs for Metabasis are determined using quoted market prices in active markets.

Level 2
The fair value of the Company's convertible senior notes is estimated by using the quoted market rate in an inactive market, which is classified as a Level 2 input.


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Level 3
The co-promote termination payments receivable represents a non-interest bearing receivable for future payments to be made by Pfizer and is recorded at its fair value. The fair value is subjective and is affected by changes in inputs to the valuation model including management’s assumptions regarding future Avinza product sales. The receivable and liability will remain equal, and are adjusted each reporting period for changes in the fair value of the obligation including any changes in the estimate of future net Avinza product sales. The fair value of the liabilities for CyDex contingent liabilities were determined based on the income approach using a Monte Carlo analysis. The fair value is subjective and is affected by changes in inputs to the valuation model including management’s assumptions regarding revenue volatility, probability of commercialization of products, estimates of timing and probability of achievement of certain revenue thresholds and developmental and regulatory milestones which may be achieved and affect amounts owed to former license holders and CVR holders. Changes in these assumptions can materially affect the fair value estimate.

The following table provides a summary of the carrying value of assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2014 (in thousands):

Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Current co-promote termination payments receivable
$
523

 
$

 
$

 
$
523

Available-for-sale securities
5,925

 
5,925

 

 

     Total assets
$
6,448

 
$
5,925

 
$

 
$
523

Liabilities:
 
 
 
 
 
 
 
Current contingent liabilities-CyDex
$
4,184

 
$

 
$

 
$
4,184

Current co-promote termination liability
523

 

 

 
523

Long-term contingent liabilities-Metabasis
3,511

 
3,511

 

 

Long-term contingent liabilities-CyDex
8,755

 

 

 
8,755

Liability for short-term investments owed to former licensees
917

 
917

 

 

     Total liabilities
$
17,890

 
$
4,428

 
$

 
$
13,462


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The following table provides a summary of the assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2013 (in thousands):

Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Current portion of co-promote termination payments receivable
$
4,329

 
$

 
$

 
$
4,329

Available-for-sale securities
4,340

 
4,340

 

 

Long-term portion of co-promote termination payments receivable
7,417

 

 

 
7,417

     Total assets
$
16,086

 
$
4,340

 
$

 
$
11,746

Liabilities:
 
 
 
 
 
 
 
Current portion of contingent liabilities-CyDex
$
1,712

 
$

 
$

 
$
1,712

Current portion of co-promote termination liability
4,329

 

 

 
4,329

Long-term portion of contingent liabilities-Metabasis
4,196

 
4,196

 

 

Long-term portion of contingent liabilities-CyDex
7,599

 

 

 
7,599

Liability for short-term investments owed to licensors
651

 
651

 

 

Long-term portion of co-promote termination liability
7,417

 

 

 
7,417

     Total liabilities
$
25,904

 
$
4,847

 
$

 
$
21,057


Other Fair Value Measurements-2019 Convertible Senior Notes

In August 2014, the Company issued $245.0 million aggregate principal amount of convertible senior unsecured notes due 2019 (the "2019 Convertible Senior Notes"). The Company uses a quoted market rate in an inactive market, which is classified as a Level 2 input, to estimate the current fair value of its 2019 Convertible Senior Notes. The estimated fair value of the 2019 Senior Convertible Notes was $229.8 million as of September 30, 2014. The carrying value of the notes does not reflect the market rate. See Note 7 Financing Arrangements for additional information.

The following table represents significant unobservable inputs used in determining the fair value of contingent liabilities assumed in the acquisition of CyDex:

 
September 30, 2014
 
December 31, 2013
Range of annual revenue subject to revenue sharing (1)
$17.9 million-$20.5 million
 
$4.2 million-$19.8 million
Revenue volatility
25%
 
25%
Average of probability of commercialization
83.8%
 
67.6%
Sales beta
0.60
 
0.60
Credit rating
B
 
BBB
Equity risk premium
6%
 
6%
(1)
Revenue subject to revenue sharing represent management’s estimate of the range of total annual revenue subject to revenue sharing (i.e. annual revenues in excess of $15 million) through December 31, 2016, which is the term of the CVR agreement.


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A reconciliation of the level 3 financial instruments as of September 30, 2014 is as follows (in thousands):

Assets:
 
Fair value of level 3 financial instrument assets as of December 31, 2013
$
11,746

Assumed payments made by Pfizer or assignee
(1,002
)
Fair value adjustments to co-promote termination liability
(10,221
)
Fair value of level 3 financial instrument assets as of September 30, 2014
$
523

 
 
Liabilities:
 
Fair value of level 3 financial instrument liabilities as of December 31, 2013
$
21,057

Assumed payments made by Pfizer or assignee
(1,002
)
Payments to CVR and other former license holders
(1,936
)
Fair value adjustments to contingent liabilities
5,564

Fair value adjustments to co-promote termination liability
(10,221
)
Fair value of level 3 financial instrument liabilities as of September 30, 2014
$
13,462


3. Variable Interest Entities

The Company determined it holds a variable interest in Viking based on management's assessment that Viking does not have sufficient resources to carry out its principal activities without the support of the Company. The Company's variable interests in Viking are a loan provided by the Company to Viking and a license agreement executed concurrently. Additionally, the Company has a shared services and sublease agreement with Viking. The Company examines specific criteria and uses judgment when determining if the Company is the primary beneficiary of a VIE and therefore required to consolidate the investment. Factors considered in determining whether the Company is the primary beneficiary include risk and reward sharing, experience and financial condition of its partner, voting rights, involvement in day-to-day operating decisions, representation on Viking's executive committee, and level of economics between the Company and Viking.

In May 2014, the Company entered into a Master License Agreement to license rights to five programs to Viking, an unrelated clinical-stage biopharmaceutical company focused on the development of novel therapies for metabolic and endocrine disorders. As part of this transaction, the Company extended a $2.5 million convertible loan facility to Viking that can be used to pay Viking’s operating and financing-related expenses. Under the terms of the convertible loan facility, the principal amount outstanding accrues interest at a fixed rate equal to the lesser of 5% and the maximum interest rate permitted by law. The loan is due and payable in May 2016, unless the loans are converted into equity prior to such time. Upon the earlier to occur of an Initial Public Offering ("IPO") or a qualified financing event, the Company may elect to be repaid in cash or equity equal to 200% of the accrued principal and interest. The Company funded $2.0 million towards the convertible loan facility as of September 30, 2014.

The debt conversion feature embedded in the loan is accounted for under ASC Topic 815 Derivatives and Hedging. The valuation of the bifurcated debt conversion feature was performed using Level 3 inputs, requiring Viking to make assumptions about the probability of the occurrence of an IPO or qualified financing and the loan being converted based on the applicable conversion terms.

As partial consideration for the grant of the rights and licenses under the license agreement, in the event Viking consummates an IPO or other qualified financing event, Viking will issue to the Company a certain amount of equity. At the closing of an IPO a number of shares of common stock having an aggregate value of $29.0 million will be issued to the Company, subject to adjustment in certain circumstances. In the event Viking consummates a private financing prior to an IPO, the Company has the option to receive a number of shares of the same class and type of securities issued in the private financing having an aggregate value of $29.0 million, subject to adjustment in certain circumstances. The Company has the right to terminate the license agreement on or after April 30, 2015 if Viking has neither completed an IPO nor received aggregate net proceeds of at least $20.0 million in one or more private financings. The Company also has the right to terminate the license agreement in the event of insolvency or bankruptcy of Viking. On July 1, 2014, Viking filed an initial Form S-1 with the Securities and Exchange Commission for an IPO. As of the date of this report, the filed Form S-1 has not been declared effective. As of September 30, 2014, no amounts have been recorded for the potential receipt of equity related to a financing transaction in accordance with authoritative guidance.

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The following table represents the consolidated assets and liabilities, which are owned by and are obligations of Viking and are with no recourse to the Company, as of September 30, 2014 (in thousands):

 
September 30, 2014
Cash and cash equivalents
$
794

Other current assets
17

Capitalized IPO expenses
2,131

     Total current assets
$
2,942

 
 
Other assets
1

     Total assets
$
2,943

 
 
Accounts payable
$
2,225

Accrued liabilities
77

Current portion of notes payable
337

     Total current liabilities
$
2,639

 
 
Long-term portion of notes payable
1,893

     Total liabilities
$
4,532


The Company has recorded 100% of the losses incurred since May 21, 2014, the effective date of the transaction, as net loss attributable to noncontrolling interest due to the fact that it is considered a primary beneficiary with no equity interest in the VIE. The advances under the loan agreement are included as notes payable by Viking and are eliminated in consolidation.


4. Avinza Co-Promotion

In 2003, the Company and Organon Pharmaceuticals USA Inc. ("Organon") entered into an agreement for the co-promotion of Avinza. Subsequently in 2006, the Company signed an agreement with Organon that terminated the Avinza co-promotion agreement between the two companies and returned Avinza co-promotion rights to the Company. In consideration of the early termination, the Company agreed to make quarterly royalty payments to Organon equal to 6.5% of Avinza net sales through December 31, 2012 and thereafter equal to 6.0% of Avinza net sales through patent expiration, currently anticipated to be November 2017.

In January 2006, the Company and King Pharmaceuticals, now a subsidiary of Pfizer, entered into an agreement pursuant to which Pfizer acquired all of the Company’s rights in and to Avinza. Pfizer also assumed the Company’s co-promote termination obligation to make royalty payments to Organon based on net sales of Avinza. In connection with Pfizer's assumption of this obligation, Organon did not consent to the legal assignment of the co-promote termination obligation to Pfizer. Accordingly, the Company remains liable to Organon in the event of Pfizer's default of the obligation. Therefore, the Company recorded an asset as of February 26, 2007 to recognize Pfizer's assumption of the obligation, while continuing to carry the co-promote termination liability in the Company's consolidated financial statements to recognize the Company’s legal obligation as primary obligor to Organon. This asset represents a non-interest bearing receivable for future payments to be made by Pfizer and is recorded at its fair value. The receivable and liability will remain equal, and are adjusted each reporting period for changes in the fair value of the obligation including for any changes in the estimate of future net Avinza product sales. This receivable will be assessed on a quarterly basis or when a triggering event occurs for impairment (e.g. in the event Pfizer defaults on the assumed obligation to pay Organon).

On a quarterly basis, management reviews the carrying value of the co-promote termination liability. In February 2014, Actavis launched a generic form of Avinza which resulted in a significant decrease in estimates of future net sales used to value the co-promote termination asset and liability. Due to assumptions and judgments inherent in determining the estimates of future net Avinza sales through November 2017, the actual amount of net Avinza sales used to determine the current fair value of the Company’s co-promote termination asset and liability may be materially different from current estimates.

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Table of Contents


A summary of the co-promote termination liability as of September 30, 2014 is as follows (in thousands):

Net present value of payments based on estimated future net Avinza product sales as of December 31, 2013
$
11,746

Assumed payments made by Pfizer or assignee
(1,002
)
Fair value adjustments
(10,221
)
Total co-promote termination liability as of September 30, 2014
$
523


5. Lease Obligations

The Company leases office and laboratory facilities in California, Kansas and New Jersey. These leases expire between 2014 and 2019, some of which are subject to annual rent increases which range from 3.0% to 3.5%. The Company currently subleases office and laboratory space in California and New Jersey. The following table provides a summary of operating lease obligations and payments expected to be received from sublease agreements as of September 30, 2014 (in thousands):

Operating lease obligations:
 
Lease
Termination
Date
 
Less than 1
year
 
1-3 years
 
3-5 years
 
More than
5 years
 
Total
Corporate headquarters-
San Diego, CA
 
July 2019
 
$
677

 
$
1,409

 
$
1,293

 
$

 
$
3,379

Bioscience and Technology Business Center-
Lawrence, KS
 
December 2017
 
55

 
108

 
13

 

 
176

Vacated office and research facility-San Diego, CA
 
July 2015
 
1,912

 

 

 

 
1,912

Vacated office and research facility-
Cranbury, NJ
 
August 2016
 
2,576

 
2,397

 

 

 
4,973

Total operating lease obligations
 
 
 
$
5,220

 
$
3,914

 
$
1,306

 
$

 
$
10,440

 
 
 
 
 
 
 
 
 
 
 
 
 
Sublease payments expected to be received:
 
 
 
Less than 1
year
 
1-3 years
 
3-5 years
 
More than
5 years
 
Total
Office and research facility-
San Diego, CA
 
July 2015
 
$
771

 
$

 
$

 
$

 
$
771

Office and research facility-
Cranbury, NJ
 
August 2014 and 2016
 
492

 
464

 

 

 
956

Net operating lease obligations
 
 
 
$
3,957

 
$
3,450

 
$
1,306

 
$

 
$
8,713


In 2010, the Company ceased use of its facility located in New Jersey. As a result, the Company recorded lease exit costs of $9.7 million for costs related to the difference between the remaining lease obligations of the abandoned operating leases, which run through August 2016, and management's estimate of potential future sublease income, discounted to present value. In addition, the Company wrote-off property and equipment with a net book value of approximately $5.4 million related to the facility closure.

As of September 30, 2014 and December 31, 2013, the Company had lease exit obligations of $3.7 million and $5.9 million, respectively. For the three and nine months ended September 30, 2014, the Company made cash payments, net of sublease payments received of $0.8 million and $2.6 million, respectively. The Company recognized adjustments for accretion and changes in leasing assumptions of $0.2 million and $0.5 million for the three and nine months ended September 30, 2014, respectively. For the three and nine months ended September 30, 2013, the Company made cash payments, net of sublease payments received of $0.9 million and $2.8 million, respectively. The Company recognized adjustments for accretion and changes in leasing assumptions of $0.2 million and $0.4 million for the three and nine months ended September 30, 2013, respectively.

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Table of Contents

Total rent expense under all office leases for each of the three and nine months ended September 30, 2014 and 2013 was $0.2 million and $0.5 million, respectively. The Company recognizes rent expense on a straight-line basis. Deferred rent at September 30, 2014 and December 31, 2013 was $0.3 million and $0.4 million, respectively, and is included in other long-term liabilities.


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Table of Contents

6. Segment Reporting
The Company evaluates performance based on the operating income (loss) of the respective business segments. The segment results may not represent actual results that would be expected if they were independent, stand-alone businesses. Segment information is as follows (in thousands):
Balance Sheet Data:
As of September 30, 2014
 
Ligand
 
CyDex
 
Total
Total assets
$
203,296

 
$
68,987

 
$
272,283

 
 
 
 
 
 
 
As of December 31, 2013
 
Ligand
 
CyDex
 
Total
Total assets
$
38,408

 
$
66,305

 
$
104,713

 
 
 
 
 
 
Operating Data:
For the three months ended September 30, 2014
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
$
6,424

 
$
8,549

 
$
14,973

Depreciation and amortization expense
(61
)
 
(601
)
 
(662
)
Operating (loss) income
(1,683
)
 
5,215

 
3,532

Interest expense, net
(1,516
)
 

 
(1,516
)
Income tax expense from continuing operations
(115
)
 
(9
)
 
(124
)
 
 
 
 
 
 
 
For the three months ended September 30, 2013
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
4,731

 
8,274

 
$
13,005

Depreciation and amortization expense
(62
)
 
(606
)
 
$
(668
)
Operating (loss) income
(1,142
)
 
4,212

 
$
3,070

Interest expense, net
(394
)
 

 
$
(394
)
Income tax (expense) benefit from continuing operations
(70
)
 
10

 
$
(60
)
Gain on sale of Avinza Product Line before income taxes

 

 
$

 
 
 
 
 
 
 
For the nine months ended September 30, 2014
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
18,907

 
22,632

 
$
41,539

Depreciation and amortization expense
(194
)
 
(1,804
)
 
(1,998
)
Operating (loss) income
(2,622
)
 
12,611

 
9,989

Interest expense, net
(1,946
)
 

 
(1,946
)
Income tax expense from continuing operations
(123
)
 
(8
)
 
(131
)
 
 
 
 
 
 
 
For the nine months ended September 30, 2013
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
$
14,789

 
$
19,448

 
$
34,237

Depreciation and amortization expense
(179
)
 
(1,828
)
 
(2,007
)
Write-off of in-process research and development

 
480

 
480

Operating income
(944
)
 
9,462

 
8,518

Interest expense, net
(1,755
)
 

 
(1,755
)
Income tax (expense) benefit from continuing operations
(301
)
 
64

 
(237
)
Gain on sale of Avinza Product Line before income taxes
2,588

 

 
2,588



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Table of Contents

7. Financing Arrangements

Term loan facility

The Company fully repaid its secured term loan credit facility on July 31, 2014. Under the terms of the secured debt, the Company made interest-only payments through February 2013. Subsequent to the interest-only payments, the note amortized with principal and interest payments through the remaining term of the loan. Additionally, the Company made an additional final payment equal to 6% of the total amount borrowed which was due at maturity and was accreted over the life of the loan.

0.75% Convertible Senior Notes Due 2019
    
In August 2014, the Company issued $245.0 million aggregate principal amount of its 2019 Convertible Senior Notes, resulting in net proceeds of $239.3 million. The 2019 Convertible Senior Notes are convertible into common stock at an initial conversion rate of 13.3251 shares per $1,000 principal amount of convertible notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $75.05 per share of common stock. The initial conversion price of the notes represents a premium of approximately 35% to the $55.59 per share close price of the Company's common stock on August 12, 2014. The notes bear interest at a rate of 0.75% per year, payable semi-annually. Holders of the 2019 Convertible Senior Notes may convert the notes at any time prior to the close of business on the business day immediately preceding May 15, 2019, under any of the following circumstances: (1) during any fiscal quarter (and only during such fiscal quarter) commencing after December 31, 2014, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sale price of the Company's common stock on such trading day is greater than 130% of the conversion price on such trading day; (2) during the five business day period immediately following any ten consecutive trading day period, in which the trading price per $1,000 principal amount of notes was less than 98% of the product of the last reported sale price of the Company's common stock on such trading day and the conversion rate on each such trading day; or (3) upon the occurrence of certain specified corporate events as specified in the indenture governing the notes. On or after May 15, 2019 until the close of business on the second scheduled trading day immediately preceding August 15, 2019, holders of the notes may convert all or a portion of their notes at any time, regardless of the foregoing circumstances. Upon conversion, Ligand must deliver cash to settle the principal and may deliver cash or shares of common stock, at the option of the Company, to settle any premium due upon conversion.

In accordance with accounting guidance for debt related to conversion and other options, the Company separately accounted for the debt and equity components of the 2019 Convertible Senior Notes by allocating the $245.0 million total proceeds between the debt component and the embedded conversion option, or equity component, due to Ligand's ability to settle the 2019 Convertible Senior Notes in cash for the principal portion and to settle any premium in cash or common stock, at the Company's election. The debt allocation was performed in a manner that reflected the Company's non-convertible borrowing rate for similar debt of 5.83% derived from independent valuation analysis. The initial debt value of $192.5 million accretes at 5.83% to reach $245.0 million at the maturity date. The equity component of the 2019 Convertible Senior Notes was recognized as a debt discount and represents the difference between the $245.0 million proceeds at issuance of the 2019 Convertible Senior Notes and the fair value of the debt allocation on their respective issuance dates. The debt discount is amortized to interest expense using the effective interest method over the expected life of a similar liability without an equity component. The notes will have a dilutive effect to the extent the average market price per share of common stock for a given reporting period exceeds the conversion price of $75.05. As of September 30, 2014, the “if-converted value” did not exceed the principal amount of the 2019 Convertible Senior Notes.    

In connection with the issuance of the 2019 Convertible Senior Notes, the Company incurred $5.7 million of issuance costs, which primarily consisted of underwriting, legal and other professional fees. The portions of these costs allocated to the equity components totaling $1.2 million were recorded as a reduction to additional paid-in capital. The portions of these costs allocated to the liability components totaling $4.5 million were recorded as assets on the balance sheet.  The portions allocated to the liability components are amortized to interest expense using the effective interest method over the expected life of the 2019 Convertible Senior Notes.
 
The Company determined the expected life of the debt discount for the 2019 Convertible Senior Notes to be equal to the original five-year term of the notes. The carrying value of the equity component related to the 2019 Convertible Senior Notes as of September 30, 2014, net of issuance costs, was $51.3 million.


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Table of Contents

Convertible Bond Hedge and Warrant Transactions

In August 2014, in connection with the issuance of the 2019 Convertible Senior Notes, to minimize the impact of potential dilution to the Company's common stock upon conversion of such notes, the Company entered into convertible bond hedges and sold warrants covering approximately 3,264,643 shares of its common stock. The convertible bond hedges have an exercise price of $75.05 per share and are exercisable when and if the 2019 Convertible Senior Notes are converted. If upon conversion of the 2019 Convertible Senior Notes, the price of the Company's common stock is above the exercise price of the convertible bond hedges, the counterparties will deliver shares of common stock and/or cash with an aggregate value approximately equal to the difference between the price of common stock at the conversion date and the exercise price, multiplied by the number of shares of common stock related to the convertible bond hedge transaction being exercised. The convertible bond hedges and warrants described below are separate transactions entered into by the Company and are not part of the terms of the 2019 Convertible Senior Notes. Holders of the 2019 Convertible Senior Notes and warrants will not have any rights with respect to the convertible bond hedges. The Company paid $48.1 million for these convertible bond hedges and recorded the amount as a reduction to additional paid-in capital.

Concurrently with the convertible bond hedge transactions, the Company entered into warrant transactions whereby it sold warrants to acquire, approximately 3,264,643 shares of common stock with an exercise price of approximately $125.08 per share, subject to certain adjustments. The warrants have various expiration dates ranging from November 13, 2019 to April 22, 2020. The warrants will have a dilutive effect to the extent the market price per share of common stock exceeds the applicable exercise price of the warrants, as measured under the terms of the warrant transactions. The Company received $11.6 million for these warrants and recorded this amount to additional paid-in capital. The common stock issuable upon exercise of the warrants will be in unregistered shares, and the Company does not have the obligation and does not intend to file any registration statement with the Securities and Exchange Commission registering the issuance of the shares under the warrants.

The carrying values and the fixed contractual coupon rates of the Company's financing arrangements as of September 30, 2014 and December 31, 2013 were as follows (in thousands):

 
September 30, 2014
 
December 31, 2013
2019 Convertible Senior Notes
 
 
 
     Principal amount outstanding
$
245,000

 
$

     Unamortized discount
(51,369
)
 

          Net carrying amount
193,631

 

Convertible notes payable, Viking Therapeutics, Inc.
337

 

Current portion notes payable, 8.64%, due August 1, 2014

 
6,642

Current portion notes payable, 8.9012%, due August 1, 2014

 
2,467

Total notes payable
$
193,968

 
$
9,109


8. Stockholders’ Equity

The Company grants options and awards to employees, non-employee consultants, and non-employee directors. Only new shares of common stock are issued upon the exercise of stock options. Non-employee directors are accounted for as employees. Options and restricted stock granted to certain directors vest in equal monthly installments over the one-year period following the date of grant. Options granted to employees vest 1/8 on the six month anniversary of the date of grant, and 1/48 each month thereafter for 42 months. Option awards generally expire ten years from the date of grant.

Stock Option Activity

The following is a summary of the Company’s stock option plan activity and related information:


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Table of Contents

 
Shares
 
Weighted-
Average
Exercise
Price
 
Weighted-Average
Remaining
Contractual Term in
Years
 
Aggregate
Intrinsic Value
(In thousands)
Balance as of December 31, 2013
1,746,709

 
$
16.79

 
7.6
 
$
62,705

Granted
366,184

 
73.81

 
 
 
 
Exercised
(262,820
)
 
15.43

 
 
 
 
Forfeited
(49,967
)
 
16.69

 
 
 
 
Cancelled
(4,414
)
 
80.81

 
 
 
 
Balance as of September 30, 2014
1,795,692

 
28.46

 
7.5
 
$
43,200

Exercisable as of September 30, 2014
1,052,706

 
20.00

 
7.5
 
$
30,339

Options vested and expected to vest as of September 30, 2014
1,795,692

 
28.46

 
6.8
 
$
43,200


The weighted-average grant date fair value of all stock options granted during the nine months ended September 30, 2014 was $47.44 per share. The total intrinsic value of all options exercised during the nine months ended September 30, 2014 and 2013 was approximately $14.7 million and $3.6 million, respectively. As of September 30, 2014, there was $14.6 million of total unrecognized compensation cost related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 2.3 years.

Net cash received from options exercised during the nine months ended September 30, 2014 and 2013 was approximately $4.1 million and $2.3 million, respectively. There is no current tax benefit related to options exercised because of net operating losses for which a full valuation allowance has been established.

As of September 30, 2014, 1.1 million shares were available for future option grants or direct issuance under the Company's 2002 Stock Incentive Plan, as amended.

Restricted Stock Activity

Restricted stock activity for the nine months ended September 30, 2014 was as follows:

 
Shares
 
Weighted-
Average Grant
Date Fair Value
Nonvested at December 31, 2013
115,386

 
$
21.93

Granted
41,671

 
72.50

Vested
(74,312
)
 
25.21

Cancelled
(3,972
)
 
18.42

Nonvested at September 30, 2014
78,773

 
$
45.77


Restricted stock awards generally vest over three years. As of September 30, 2014, there was $2.3 million of total unrecognized compensation cost related to nonvested restricted stock. That cost is expected to be recognized over a weighted-average period of 1.5 years.

Employee Stock Purchase Plan

The Company's Employee Stock Purchase Plan, as amended and restated (the "Amended ESPP") allows participants to purchase up to 1,250 shares of Ligand common stock during each offering period, but in no event may a participant purchase more than 1,250 shares of common stock during any calendar year. The length of each offering period is six months, and employees are eligible to participate in the first offering period beginning after their hire date.

The Amended ESPP allows employees to purchase Ligand common stock at the end of each six month period at a price equal to 85% of the lesser of fair market value on either the start date of the period or the last trading day of the period (the "Lookback Provision"). The 15% discount and the Lookback Provision make the Amended ESPP compensatory.  There were 2,230 and 5,016 shares of common stock issued under the amended ESPP during the nine months ended September 30,

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Table of Contents

2014 and 2013, respectively. The Company recorded compensation expense related to the ESPP of $43,515 and $37,000 for the nine months ended September 30, 2014 and 2013, respectively. As of September 30, 2014, 77,285 shares were available for future purchases under the Amended ESPP.

Public Offerings

During the three and nine months ended September 30, 2014 and 2013, the Company did not issue any common shares pursuant to its at-the-market equity issuance plan.
Corporate Share Repurchases
In August 2014, the Company's Board of Directors authorized the Company to repurchase up to $200.0 million of its common stock for a period of up to one year. During the three and nine months ended September 30, 2014 the Company repurchased 692,800 common shares pursuant to the repurchase program for an aggregate purchase price of approximately $38.5 million. Subsequent to the end of the quarter through October 30, 2014, the Company repurchased an additional 110,000 common shares for an aggregate purchase price of approximately $5.0 million.

9. Litigation

The Company records an estimate of a loss when the loss is considered probable and estimable. Where a liability is probable and there is a range of estimated loss and no amount in the range is more likely than any other number in the range, the Company records the minimum estimated liability related to the claim in accordance with ASC Topic 450-Contingencies. As additional information becomes available, the Company assesses the potential liability related to its pending litigation and revises its estimates. Revisions in the Company's estimates of potential liability could materially impact its results of operations.

Securities Litigation

             On June 8, 2012, a federal securities class action and shareholder derivative lawsuit was filed in the Eastern District of Pennsylvania against Genaera Corporation and its officers, directors, major shareholders and trustee ("Genaera Defendants") for allegedly breaching their fiduciary duties to Genaera shareholders.  The lawsuit also names the Company and its CEO as additional defendants for allegedly aiding and abetting the Genaera Defendants' various breaches of fiduciary duties based on the Company's purchase of a licensing interest in a development-stage pharmaceutical drug program from the Genaera Liquidating Trust in May 2010 and the Company's subsequent sale of half of its interest in the transaction to Biotechnology Value Fund, Inc. 

Following an amendment to the complaint and a round of motions to dismiss, the court dismissed the amended complaint with prejudice on August 12, 2013.  Plaintiff appealed that dismissal on September 10, 2013, and the Third Circuit reversed on October 17, 2014.  The Company intends to continue to vigorously defend against the claims against the Company and its CEO.  Due to the complex nature of the legal and factual issues involved, however, the outcome of this matter is not presently determinable.

Other Litigation

                On June 19, 2014, a complaint was filed in California Superior Court seeking attorneys’ fees in connection with claims related to executive compensation matters described in the Company’s June 6, 2013 supplemental proxy materials.  On August 1, 2014 the Company filed an answer denying all allegations in the complaint and asserting several affirmative defenses.  Management believes the fees demanded by plaintiffs’ counsel are excessive and the Company intends to defend itself vigorously in the litigation.  Due to the complex nature of the legal and factual issues involved, however, the outcome of this matter is not presently determinable.


ITEM 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

Caution: This discussion and analysis may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed in Part II, Item 1A:"Risk Factors." This outlook represents our current judgment on the future direction of our business. These statements include those related to our Captisol-related revenues, our Promacta, Kyprolis, and other product royalty revenues, product returns, and product development.

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Actual events or results may differ materially from our expectations. For example, there can be no assurance that our revenues or expenses will meet any expectations or follow any trend(s), that we will be able to retain our key employees or that we will be able to enter into any strategic partnerships or other transactions. We cannot assure you that we will receive expected Promacta, Kyprolis, Captisol and other product revenues to support our ongoing business or that our internal or partnered pipeline products will progress in their development, gain marketing approval or achieve success in the market. In addition, ongoing or future arbitration, or litigation or disputes with third parties may have a material adverse effect on us. Such risks and uncertainties, and others, could cause actual results to differ materially from any future performance suggested. We undertake no obligation to make any revisions to these forward-looking statements to reflect events or circumstances arising after the date of this quarterly report. This caution is made under the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act.

Our trademarks, trade names and service marks referenced herein include Ligand. Each other trademark, trade name or service mark appearing in this quarterly report belongs to its owner.

References to “Ligand Pharmaceuticals Incorporated,” “Ligand,” the “Company,” “we” or ”our” include our wholly owned subsidiaries: Ligand JVR, Allergan Ligand Retinoid Therapeutics, Seragen, Inc., Pharmacopeia, Inc., or Pharmacopeia, Neurogen Corporation, or Nuerogen, CyDex Pharmaceuticals, Inc., or CyDex, Metabasis Therapeutics, Inc., or Metabasis, and Nexus VI, Inc.

Overview
    
We are a biotechnology company that develops and acquires revenue generating assets and coupling them with a lean corporate cost structure. Our goal is to create a sustainably profitable business and generate meaningful value for our stockholders. Since a portion of our business model is based on the goal of partnering with other pharmaceutical companies to commercialize and market our assets, a significant amount of our revenue is based largely on payments made to us by partners for royalties, milestones, event-based payments, and license fees. We recognized the important role of the drug reformulation segment in the pharmaceutical industry and in 2011 added Captisol® to our technology portfolio. Captisol is a formulation technology that has enabled seven FDA approved products, including Onyx's Kyprolis® and Baxter International's Nexterone® and is currently being developed in a number of clinical-stage partner programs. In comparison to our peers, we believe we have assembled one of the largest and most diversified asset portfolios in the industry with the potential to generate significant revenue in the future. The therapies in our development portfolio address the unmet medical needs of patients for a broad spectrum of diseases including hepatitis, multiple myeloma, muscle wasting, Alzheimer’s disease, dyslipidemia, diabetes, anemia, epilepsy, FSGS and osteoporosis. We have established multiple alliances with the world’s leading pharmaceutical companies including GlaxoSmithKline, Onyx Pharmaceuticals (a subsidiary of Amgen, Inc.), Merck, Pfizer, Baxter International, Lundbeck Inc., Eli Lilly and Co., and Spectrum Pharmaceuticals, Inc.

Highlights from the first nine months of 2014 include:

We received a $1.0 million commercial sales-based contingent payment from Onyx. The payment was triggered by the achievement of over $250.0 million of annual product sales of Kyprolis in 2013.
We received a $1.0 million event-based payment as a result of the recent FDA approval of Merck’s NOXAFIL® which is a new Captisol-enabled formulation of NOXAFIL for intravenous (IV) use. Additionally, we earned a $0.6 million event-based payment upon approval for Captisol-enabled NOXAFIL® (posaconazole) from the European Medicines Agency ("EMA"). We will also generate revenue from Captisol material sales to Merck for this product under a commercial supply agreement.
Our partner Lundbeck LLC announced that the FDA accepted for review a New Drug Application ("NDA") for its investigational therapy intravenous carbamazepine, an intravenous formulation of the anti-epileptic drug carbamazepine. With acceptance of the NDA filing, we earned a $0.2 million event-based payment.
We completed the dosing of the last patient in its Glucagon Receptor Agonist Phase 1 Single Ascending Dose (SAD) clinical trial and also presented positive data from that trial at the American Diabetes Association Scientific Sessions meeting.
We received an event-based payment of $0.2 million in connection with an amendment to our license agreement with Sage Therapeutics, Inc. for the additional of a new subfield.

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We received a $0.1 million project development fee as a result of entering into a licensing agreement and research collaboration with Omthera Pharmaceuticals. The research collaboration will target the development of novel products that utilize the proprietary Ligand-developed LTP TECHNOLOGY™ to improve lipid-lowering activity of certain omega-3 fatty acids. Under the terms of the agreement, we will be eligible to receive payments of up to $44.5 million upon the achievement of specific events, as well as tiered royalties ranging from mid to high single digit percentages of net sales.
We entered into a master license agreement with Viking covering the following five programs: FBPase inhibitor program for type 2 diabetes, a Selective Androgen Receptor Modulator (SARM) program for muscle wasting, a Thyroid Hormone Receptor-ß (TRß) Agonist program for dyslipidemia, an Erythropoietin Receptor (EPOR) Agonist program for anemia, and an Enterocyte-Directed Diacylglycerol Acyltransferase-1 (DGAT-1) Inhibitor program for dyslipidemia. The FBPase Inhibitor program was the subject of an option originally granted to Viking in 2012. As part of the transaction, we agreed to extend a $2.5 million convertible loan facility to Viking that will be used to pay Viking's operating and financing-related expenses.
We received 125,000 upfront shares of common stock in our partner TG Therapeutics, Inc., as a result of entering into a license agreement for the IRAK-4 Inhibitor Program. The shares were initially valued at $1.2 million. Additionally, we entered into a research agreement with TG Therapeutics and we are currently receiving R&D service payments associated with that agreement.
We licensed our Captisol-enabled Lamotrigine program to CURx Pharmaceuticals. Under the terms of the agreement, we are eligible to receive up to $22 million in potential milestone payments, revenue from sales of Captisol and tiered royalties on future net sales in the range of 4% to 7%.
In the third quarter we entered into new Captisol clinical-stage agreements with Avion Pharmaceuticals, Inc., Marinus Pharmaceuticals Inc, Boston Strategics Group and Amgen Inc., for Captisol-enabled programs.
We completed an offering of $245.0 million aggregate principal amount of 0.75% convertible senior notes due 2019 in a private offering to qualified institutional buyers. The conversion rate for the notes is initially equivalent to a conversion price of approximately $75 per share of common stock, and is subject to adjustment under the terms of the notes. Additionally, we entered into a convertible bond hedge and warrant transaction which increases the effective conversion price of the notes to approximately $125 per share. Concurrent with the close of the transaction, we repurchased $37.8 million of our common stock, or 680,800 shares.


Results of Operations

Three and nine months ended September 30, 2014 and 2013
Total revenues for the three and nine months ended September 30, 2014 were $15.0 million and $41.5 million, respectively, compared to $13.0 million and $34.2 million, respectively, for the same periods in 2013. We reported income from continuing operations of $0.8 million and $4.2 million for the three and nine months ended September 30, 2014, respectively, compared to $2.0 million and $7.0 million, respectively, for the same periods in 2013.

Royalty Revenue
Royalty revenues were $7.5 million and $20.6 million for the three and nine months ended September 30, 2014, respectively, compared to $5.7 million and $16.5 million, respectively, for the same periods in 2013. The increase in royalty revenue is primarily due to an increase in Promacta and Kyprolis royalties, partially offset by a decline in Avinza royalties as a result of generic competition entering the market in February 2014.

Material Sales
We recorded material sales of $6.3 million and $15.5 million for the three and nine months ended September 30, 2014, respectively, compared to $6.7 million and $12.3 million, respectively, for the same periods in 2013. The decrease in material sales of $0.4 million for the three months ended September 30, 2014 and the increase in material sales of $3.2 million for the nine months ended September 30, 2014 is due to timing of customer purchases.

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Collaborative Research and Development and Other Revenues
We recorded collaborative research and development and other revenues of $1.2 million and $5.4 million for the three and nine months ended September 30, 2014, respectively, compared to $0.6 million and $5.5 million, respectively, for the same periods in 2013. The increase of $0.6 million for the three months ended September 30, 2014 is primarily due to an event based payment received in the third quarter of 2014 for EMA approval of Noxafil®. The decrease of $0.1 million for the nine months ended September 30, 2014 is due to timing of event-based payments and upfront license fees earned.

Cost of Sales
Cost of sales were $1.5 million and $5.1 million for the three and nine months ended September 30, 2014, respectively, compared to $2.5 million and $4.4 million, respectively, for the same periods in 2013. The decrease of $1.0 million for the three months ended September 30, 2014 is primarily due to the product mix of material sales. The increase of $0.7 million for the nine months ended September 30, 2014 is primarily due to an increase in material sales.

Research and Development Expenses
Research and development expenses were $3.0 million and $8.8 million for the three and nine months ended September 30, 2014, respectively, compared to $2.4 million and $6.9 million, respectively, for the same periods in 2013. The increase of $0.6 million and $1.9 million for the three and nine months ended September 30, 2014, respectively, is primarily due to an increase in stock-based compensation expense and Viking related expenses.

As summarized in the table below, we are developing several proprietary products for a variety of indications. Our programs are not limited to the following, but are representative of a range of future licensing opportunities to expand our partnered asset portfolio.

Program
 
Disease/Indication
 
Development
Phase
 
 
 
 
 
Glucagon Receptor Antagonist
 
Diabetes
 
Phase I
HepDirect™
 
Liver Diseases
 
Preclinical
Oral Human Granulocyte Colony Stimulating Factor
 
Neutropenia
 
Preclinical
LTP Technology Platform
 
Metabolic and Cardiovascular Disease
 
Preclinical

We do not provide forward-looking estimates of costs and time to complete our ongoing research and development projects as such estimates would involve a high degree of uncertainty. Uncertainties include our inability to predict the outcome of complex research, our inability to predict the results of clinical studies, regulatory requirements placed upon us by regulatory authorities such as the FDA and EMA, our inability to predict the decisions of our collaborative partners, our ability to fund research and development programs, competition from other entities of which we may become aware in future periods, predictions of market potential from products that may be derived from our research and development efforts, and our ability to recruit and retain personnel or third-party research organizations with the necessary knowledge and skills to perform certain research. Refer to “Item 1A. Risk Factors” for additional discussion of the uncertainties surrounding our research and development initiatives.

General and Administrative Expenses
General and administrative expenses were $6.7 million and $17.1 million for the three and nine months ended September 30, 2014, respectively, compared to $4.8 million and $13.6 million, respectively, for the same periods in 2013. The increase of $1.9 million and $3.5 million for three and nine months ended September 30, 2014, respectively, is primarily due to an increase in stock-based compensation expense and costs associated with business development activities.


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Lease Exit and Termination Costs
In September 2010, we ceased use of our facility located in Cranbury, New Jersey. As a result, during the three months ended September 30, 2010, we recorded lease exit costs of $9.7 million for costs related to the difference between the remaining lease obligations of the abandoned operating leases, which run through August 2016, and management’s estimate of potential future sublease income, discounted to present value. Actual future sublease income may differ materially from our estimate, which would result in us recording additional expense or reductions in expense. In addition, we wrote-off approximately $5.4 million of property and equipment related to the facility closure and recorded approximately $1.8 million of severance related costs. Lease exit and termination costs were $0.2 million and $0.5 million for the three and nine months ended September 30, 2014, respectively, compared to $0.2 million and $0.4 million, respectively for the same periods in 2013. The increase for the nine months ended September 30, 2014 is primarily due to changes in sublease assumptions.

Interest Expense, net
Interest expense, net was $1.5 million and $1.9 million for the three and nine months ended September 30, 2014, respectively, compared to $0.4 million and $1.8 million, respectively, for the same periods in 2013. The increase in interest expense of $1.1 million and $0.1 million for the three and nine months ended September 30, 2014, respectively, is due to cash interest expense and non-cash debt related costs related to the 2019 Convertible Senior Notes partially offset by interest expense related to the term loan facility which was paid off in July 2014.

(Increase) decrease in Contingent Liabilities
We recorded an increase in contingent liabilities of $1.6 million and $4.9 million for the three and nine months ended September 30, 2014, respectively, compared to an increase of $0.5 million and a decrease of $0.4 million for the same periods in 2013. The increase for the three months ended September 30, 2014 primarily relates to an increase in the liability for amounts potentially due to holders of CVRs related to our CyDex acquisition of $2.8 million and is partially offset by a decrease of $1.2 million in the liability for amounts potentially due to holders of CVRs associated with our Metabasis acquisition. The increase for the nine months ended September 30, 2014 primarily relates to an increase of $5.6 million in the liability for amounts potentially due to holders of CVRs related to our CyDex acquisition and a decrease of $0.7 million in the liability for amounts potentially due to holders of CVRs associated with our Metabasis acquisition. The increase for the three months ended September 30, 2013 relates to an increase in the liability for amounts potentially due to holders of CVRs and former license holders associated with our CyDex acquisition of $1.2 million and is partially offset by a decrease in amounts potentially due to holders of CVRs associated with our Metabasis acquisition of $0.7 million. The decrease for the nine months ended September 30, 2013 is primarily due to a decrease in amounts potentially due to CyDex CVR holders and former license holders of $2.1 million related to Captisol-enabled Clopidogrel, and is partially offset by an increase in Metabasis CVRs of $1.7 million.

Income Tax Expense
We recorded income tax expense from continuing operations of $0.1 million for each of the three and nine months ended September 30, 2014, compared to income tax expense from continuing operations of $0.1 million and $0.2 million, for the three and nine months ended September 30, 2013, respectively. Our estimated annual effective rate of 3.4% is primarily attributable to deferred taxes associated with the amortization of acquired IPR&D assets for tax purposes. 

Discontinued Operations

Avinza Product Line
In September 2006, we and King Pharmaceuticals, now a subsidiary of Pfizer, entered into a purchase agreement, or the Avinza Purchase Agreement, pursuant to which Pfizer acquired all of our rights in and to Avinza in the United States, its territories and Canada, including, among other things, all Avinza inventory, records and related intellectual property, and assume certain liabilities as set forth in the Avinza Purchase Agreement.

Pursuant to the terms of the Avinza Purchase Agreement, we retained the liability for returns of product from wholesalers that had been sold by us prior to the close of this transaction. Accordingly, as part of the accounting for the gain on the sale of Avinza, we recorded a reserve for Avinza product returns.

During the three and nine months ended September 30, 2014, there were no pre-tax gains or losses recognized on the sale of the Avinza product line due to subsequent changes in certain estimates and liabilities recorded as of the sale date. During the three months ended September 30, 2013 we did not recognize a gain or loss on the sale of the Avinza product line.

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During the nine months ended September 30, 2013 we recognized a pre-tax gain of $2.6 million, as a result of subsequent changes in certain estimates and liabilities recorded as of the sale date.

Liquidity and Capital Resources

We have financed our operations through offerings of our equity securities, borrowings from long-term debt, issuance of convertible notes, product sales and the subsequent sales of our commercial assets, royalties, collaborative research and development and other revenues, and capital and operating lease transactions.

We have incurred significant losses since inception. At September 30, 2014, our accumulated deficit was $666.4 million and we had working capital of $180.1 million. We believe that our currently available cash, cash equivalents and short-term investments, as well as our current and future royalty, license and milestone revenues and Captisol material sales will be sufficient to fund our anticipated operating and capital requirements, at a minimum, for the next twelve months.  However, our projected revenue may decrease or our expenses may increase, which could lead to our resources being consumed earlier than expected.  Although we do not believe that we will need to raise additional funds to finance our current operations through the next twelve months, if we are required to seek additional financing, there can be no assurance that such financing will be available on terms acceptable to management, or at all. We believe that cash flows from operations will increase due to Captisol sales, an increase in royalty revenues driven primarily from continued increases in Promacta and Kyprolis sales, recent product approvals and regulatory developments, as well as revenues from new licenses and event-based payments. We expect to build cash in future months as we continue to generate significant cash flows from operations. Our future operating and capital requirements will depend on many factors, including, but not limited to: the pace of scientific progress in our research and development programs; the potential success of these programs; the scope and results of preclinical testing and clinical trials; the time and costs involved in obtaining regulatory approvals; the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; competing technological and market developments; the amount of royalties on sales of the commercial products of our partners; the efforts of our collaborative partners; obligations under our operating lease agreements; and the capital requirements of any companies we acquire. While we believe in the viability of our strategy to generate sufficient operating cash flow and in our ability to raise additional funds, there can be no assurances to that effect. Our ability to achieve our operational targets is dependent upon our ability to further implement our business plan and generate sufficient operating cash flow.

Investments

We invest our excess cash principally in U.S. government debt securities, investment-grade corporate debt securities and certificates of deposit. We have established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. Additionally, we own certain securities which are classified as short-term investments which we received in December 2012 and June 2014 as a result of an event-based payment and an upfront license payment, respectively, under licensees.     

Borrowings and Other Liabilities

Term Loan Facility
    
In January 2011, we entered into a $20.0 million secured term loan credit facility with Oxford Financial Group. The loan was amended in January 2012 to increase the secured credit facility to $27.5 million. The original $20.0 million borrowed under the facility bore interest at a fixed rate of 8.6%. The additional $7.5 million bore interest at a fixed rate of 8.9%. Under the terms of the secured debt, we made interest-only payments through February 2013. Subsequent to the interest-only payments, the note amortized with principal and interest payments through the remaining term of the loan. We were required to make an additional final payment equal to 6% of the total amount borrowed at maturity, which was accreted over the life of the loan. The maturity date of the term loan was August 1, 2014, and we fully repaid the loan as of July 31, 2014.

In March 2013, we prepaid $7.0 million of the secured term loan credit facility. Additionally, we paid a prepayment fee of 1% of the prepayment amount, or $0.1 million, and a prorated final-payment fee of 6% of the final payment, or $0.4 million.

0.75% Convertible Senior Notes Due 2019

We have convertible debt outstanding as of September 30, 2014 related to our 2019 Convertible Senior Notes. In August 2014, we issued $245.0 million aggregate principal amount of convertible senior unsecured notes. The Notes are

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convertible into common stock upon satisfaction of certain conditions. Interest of 0.75% per year is payable semi-annually on August 15th and February 15th through the maturity of the notes in August 2019.

Repurchases of Common Stock
In August 2014, our Board of Directors authorized us to repurchase up to $200.0 million of our common stock for a period of up to one year. During the three and nine months ended September 30, 2014 we repurchased 692,800 common shares pursuant to the repurchase program for an aggregate purchase price of approximately $38.5 million. Subsequent to the end of the quarter through October 30, 2014, the Company repurchased an additional 110,000 common shares for an aggregate purchase price of approximately $5.0 million.

Public Offerings

In October 2013, we filed a universal shelf registration statement with the Securities and Exchange Commission, or the SEC, that was automatically declared effective due to our status as a well-known seasoned issuer. This registration statement provides additional financial flexibility for us to sell shares of common stock or other equity or debt securities as needed at any time, including through our at-the-market equity issuance program. During the three and nine months ended September 30, 2014, we did not issue any common shares through this at-the-market equity issuance program.

Cash Flows

Operating Activities

Operating activities generated cash of $10.3 million for the nine months ended September 30, 2014, compared to $8.7 million for the same period in 2013.

The cash generated for the nine months ended September 30, 2014 reflects net income of $4.2 million, adjusted by $14.8 million of non-cash items to reconcile net income to net cash generated from operations. These reconciling items primarily reflect an increase in the estimated fair value of contingent liabilities of $4.9 million, depreciation and amortization of $2.0 million, stock-based compensation of $8.8 million, amortization of debt discount and issuance fees of $1.2 million, deferred income taxes of $0.1 million and accretion of notes payable of $0.2 million, partially offset by a non-cash upfront fee received of $1.2 million and a realized gain on investments of $1.2 million. The cash generated during the nine months ended September 30, 2014 is further impacted by changes in operating assets and liabilities due primarily to an increase in accounts receivable of $3.6 million, an increase in other current assets of $0.6 million, an increase in other long-term assets of $1.2 million and an increase in accounts payable and accrued liabilities of $3.5 million, partially offset by a decrease in inventory of $0.3 million.

The cash generated for the nine months ended September 30, 2013 reflects net income of $9.6 million, adjusted by $2.6 million of gain from discontinued operations and $6.8 million of non-cash items to reconcile the net income to net cash generated in operations. These reconciling items primarily reflect depreciation and amortization of $2.0 million, share-based compensation of $4.1 million, the change in deferred income taxes of $0.2 million, write-off of IPR&D of $0.5 million, and accretion of note payable of $0.3 million, partially offset by the decrease in the estimated fair value of contingent liabilities of $0.4 million. The cash generated during the nine months ended September 30, 2013 is further impacted by changes in operating assets and liabilities due primarily to an increase in accounts receivable of $0.9 million, increase in other current assets of $0.7 million, decrease in accounts payable and accrued liabilities of $2.3 million, decrease in other liabilities of $0.4 million, and a decrease in deferred revenue of $0.4 million, partially offset by a decrease in cash paid for inventory of $0.1 million and a decrease in other long term assets of $0.2 million. Cash used in operating activities of discontinued operations was $0.6 million for the nine months ended September 30, 2013.

Investing Activities

Investing activities used cash of $0.3 million for the nine months ended September 30, 2014, compared to $4.0 million for the same period in 2013.

Cash used by investing activities during the nine months ended September 30, 2014 primarily reflects payments to CVR holders and other contingency payments of $1.9 million, partially offset by proceeds from short-term investments of $1.5 million and proceeds from the sale of equipment of $0.1 million.


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Cash used by investing activities during the nine months ended September 30, 2013 primarily reflects the purchase of commercial license rights of $3.6 million.

Financing Activities

Financing activities provided cash of $159.0 million for the nine months ended September 30, 2014, compared to use of cash of $13.8 million for the same period in 2013.

Cash used by financing activities for the nine months ended September 30, 2014 primarily reflects gross proceeds received from the issuance of the 2019 Convertible Senior Notes of $245.0 million, proceeds from issuance of warrants of $11.6 million, and $4.1 million of proceeds received from stock option exercises and our employee stock purchase plan, partially offset by repayment of debt of $9.4 million, purchase of convertible bond hedge of $48.1 million, payment for share repurchases of $38.5 million and payment of debt issuance costs of $5.7 million.
    
Cash used by financing activities for the nine months ended September 30, 2013 primarily reflects $16.2 million of repayment of debt, partially offset by proceeds from stock option exercises and our employee stock purchase plan of $2.4 million.

Other

In connection with the acquisition of Metabasis in January 2010, Metabasis security holders received CVRs under four CVR agreements. The CVRs entitle the holders to cash payments upon the sale or licensing of certain assets and upon the achievement of specified milestones. The fair value of the liability at September 30, 2014 was $3.5 million, and as of December 31, 2013 was $4.2 million.