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, 2016
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.)
 
 
3911 Sorrento Valley Boulevard, Suite 110 San Diego, CA
92121
(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
x
 
Accelerated Filer
o
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 November 1, 2016, the registrant had 20,900,189 shares of common stock outstanding.


Table of Contents


LIGAND PHARMACEUTICALS INCORPORATED
QUARTERLY REPORT

FORM 10-Q

TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015 (restated)
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015 (restated)(Unaudited)
 
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016 and 2015 (restated)(Unaudited)
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015 (restated)(Unaudited)
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
ITEM 2. Unregistered Sales of Equity Securities
 
 
 





























Table of Contents

GLOSSARY OF TERMS AND ABBREVIATIONS
Abbreviation
Definition
2019 Convertible Senior Notes
$245.0 million aggregate principal amount of convertible senior unsecured notes due 2019
Amgen
Amgen, Inc.
AOCI
Accumulated Other Comprehensive Income
ASC
Accounting Standards Codification
ASU
Accounting Standards Update
Company
Ligand Pharmaceuticals Incorporated, including subsidiaries
CorMatrix
CorMatrix Cardiovascular, Inc.
CVR
Contingent value right
CyDex
CyDex Pharmaceuticals, Inc.
DTA
Deferred Tax Asset
Amended ESPP
Employee Stock Purchase Plan, as amended and restated
Eisai
Eisai Incorporated
EMA
European Medicines Agency
FASB
Financial Accounting Standards Board
FDA
Food and Drug Administration
FSGS
Focal segmental glomerulosclerosis
GAAP
Generally accepted accounting principles in the United States
IPO
Initial public offering
IPR&D
In-Process Research and Development
Ligand
Ligand Pharmaceuticals Incorporated, including subsidiaries
LSA
Loan and Security Agreement
Metabasis
Metabasis Therapeutics, Inc.
MLA
Master License Agreement
NOLs
Net Operating Losses
OMT
OMT, Inc. or Open Monoclonal Technology, Inc.
Par
Par Pharmaceuticals, Inc.
Pfizer
Pfizer Inc.
Retrophin
Retrophin Inc.
SEC
Securities and Exchange Commission
Selexis
Selexis, SA
TPE
Third-party evidence
VIE
Variable interest entity
Viking
Viking Therapeutics
Viking IPO
Viking's initial public offering
VSOE
Vendor-specific objective evidence


2

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PART I.
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
LIGAND PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except share data)
 
September 30, 2016
 
December 31, 2015 restated
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
86,580

 
$
97,428

Short-term investments
37,535

 
102,791

Accounts receivable
6,586

 
6,170

Note receivable from Viking Therapeutics
3,207

 
4,782

Inventory
4,027

 
1,633

Other current assets
2,756

 
1,908

Total current assets
140,691

 
214,712

Deferred income taxes
133,486

 
189,083

Investment in Viking Therapeutics
17,339

 
29,728

Intangible assets, net
207,435

 
48,347

Goodwill
72,359

 
12,238

Commercial license rights, net
25,985

 
8,554

Property and equipment, net

1,826

 
372

Other assets
1,744

 
27

Total assets
$
600,865

 
$
503,061

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,757

 
$
4,083

Accrued liabilities
6,675

 
5,397

Current contingent liabilities
5,079

 
10,414

Current lease exit obligations

 
934

2019 convertible senior notes, net
210,115

 
201,985

Other current liabilities
1,505

 
8

Total current liabilities
226,131

 
222,821

2019 convertible senior notes, net

 

Long-term contingent liabilities
3,933

 
3,033

Other long-term liabilities
408

 
297

Total liabilities
230,472

 
226,151

Commitments and Contingencies

 

Equity component of currently redeemable convertible notes (Note 5)

32,138

 
39,628

Stockholders' equity:
 
 
 
Common stock, $0.001 par value; 33,333,333 shares authorized; 20,898,889 and 19,949,012 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
28

 
20

Additional paid-in capital
762,576

 
661,850

Accumulated other comprehensive income
3,652

 
4,903

Accumulated deficit
(428,001
)
 
(429,491
)
Total stockholders' equity attributable to Ligand Pharmaceuticals
338,255

 
237,282

Total liabilities and stockholders' equity
$
600,865

 
$
503,061


See accompanying notes.

3

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LIGAND PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2016
 
2015 restated
 
2016
 
2015 restated
Revenues:
 
 
 
 
 
 
 
Royalties
$
15,698

 
$
9,755

 
$
39,842

 
$
26,648

Material sales
4,219

 
6,046

 
13,445

 
20,456

License fees, milestones and other revenues
1,702

 
1,900

 
17,500

 
3,618

Total revenues
21,619

 
17,701

 
70,787

 
50,722

Operating costs and expenses:
 
 
 
 
 
 
 
Cost of sales (1)
999

 
1,250

 
2,674

 
4,923

Amortization of intangibles
2,706

 
593

 
7,912

 
1,780

Research and development
5,898

 
1,945

 
14,813

 
8,730

General and administrative
6,305

 
4,971

 
19,995

 
18,190

Lease exit and termination costs
245

 
345

 
863

 
786

Total operating costs and expenses
16,153

 
9,104

 
46,257

 
34,409

Income from operations
5,466

 
8,597

 
24,530

 
16,313

Other (expense) income:
 
 
 
 
 
 
 
Interest expense, net
(3,116
)
 
(2,930
)
 
(9,172
)
 
(8,875
)
Increase (decrease) in contingent liabilities
(958
)
 
2,301

 
(2,595
)
 
(4,976
)
Gain on deconsolidation of Viking Therapeutics

 

 

 
28,190

Loss from Viking Therapeutics
(1,396
)
 
(2,169
)
 
(14,139
)
 
(3,040
)
Other income, net
1,215

 
1,485

 
2,107

 
1,889

Total other (expense) income, net
(4,255
)
 
(1,313
)
 
(23,799
)
 
13,188

Income before income taxes
1,211

 
7,284

 
731

 
29,501

Income tax benefit (expense)
(160
)
 
191,881

 
28

 
191,602

Income from operations
1,051

 
199,165

 
759

 
221,103

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

 

 
1,139

 

Income tax expense on discontinued operations

 

 
(408
)
 

Income from discontinued operations

 

 
731

 

Net income including noncontrolling interests:
1,051

 
199,165

 
1,490

 
221,103

Less: Net loss attributable to noncontrolling interests

 

 

 
(2,380
)
Net income
$
1,051

 
$
199,165

 
$
1,490

 
$
223,483

Per share amounts attributable to Ligand common shareholders:
 
 
 
 
 
 
 
Basic earnings per share data(2)
 
 
 
 
 
 
 
     Income from continuing operations
$
0.05

 
$
10.01

 
$
0.04

 
$
11.32

     Income from discontinued operations

 

 
0.04

 

Net income
$
0.05

 
$
10.01

 
$
0.07

 
$
11.32

 
 
 
 
 
 
 
 
Diluted earnings per share data (2)


 


 


 


     Income from continuing operations
$
0.05

 
$
9.28

 
$
0.03

 
$
10.58

     Income from discontinued operations

 

 
0.03

 

Net (loss) income
$
0.05

 
$
9.28

 
$
0.07

 
$
10.58

 
 
 
 
 
 
 
 
Shares used for computation (in thousands)
 
 
 
 
 
 
 
     Basic
20,887

 
19,887

 
20,806

 
19,741

     Diluted
22,997

 
21,460

 
22,742

 
21,122

(1) Excludes amortization of intangibles.

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(2) The sum of net income per share amounts may not equal the totals due to rounding

See accompanying notes.

5

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

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2016
 
2015 restated
 
2016
 
2015 restated
Net income:
$
1,051

 
$
199,165

 
$
1,490

 
$
223,483

Unrealized net gain on available-for-sale securities, net of tax
978

 
(3,059
)
 
367

 
1,978

Less: Reclassification of net realized gains included in net income, net of tax
(1,071
)
 
(606
)
 
(1,670
)
 
(1,591
)
Comprehensive income
$
958

 
$
195,500

 
$
187

 
$
223,870

(a) See restatement discussion in footnote 1
See accompanying notes.


6

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LIGAND PHARMACEUTICAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Nine months ended
 
September 30,
 
2016
 
2015 Restated
Operating activities
 
 
 
Net income including noncontrolling interests
$
1,490

 
$
221,103

Less: income from discontinued operations
731

 

Income from continuing operations

759

 
221,103

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
2,595

 
4,976

Realized gain on sale of short-term investment
(1,776
)
 
(1,988
)
Gain on disposal of assets
183

 

Depreciation and amortization
8,322

 
1,940

Amortization of discount on investments, net
510

 
73

Amortization of debt discount and issuance fees
8,130

 
7,646

Stock-based compensation
13,690

 
9,511

Deferred income taxes
347

 
(191,615
)
Accretion of note payable

 
16

Gain on deconsolidation of Viking Therapeutics

 
(28,190
)
Change in fair value of the Viking convertible debt receivable and warrants

(464
)
 

Loss from Viking Therapeutics

14,139

 
3,040

Changes in operating assets and liabilities:
 
 
 
     Accounts receivable
(411
)
 
7,142

     Inventory
(2,394
)
 
(158
)
     Other current assets
(9
)
 
(438
)
     Other long-term assets
(31
)
 
(546
)
     Accounts payable and accrued liabilities
(3,079
)
 
(4,993
)
     Restricted investments

 
661

     Deferred revenue
1,497

 
(118
)
Net cash provided by operating activities
42,008

 
28,062

Investing activities
 
 
 
Purchase of commercial license rights
(17,695
)
 
(4,030
)
Payments to CVR holders and other contingency payments
(7,055
)
 
(4,941
)
Purchases of property and equipment
(1,783
)
 
(27
)
Cash paid for acquisition, net of cash acquired

(92,504
)
 

Purchase of short-term investments
(73,109
)
 
(111,788
)
Purchase of common stock in equity method investment
(1,000
)
 

Purchase of Viking common stock and warrants
(700
)
 
(9,000
)
Proceeds from sale of property and equipment

 
1

Proceeds received from repayment of Viking note receivable
300

 

Reduction of cash due to deconsolidation of Viking

 
(247
)
Proceeds from sale of short-term investments
23,387

 
5,680

Proceeds from maturity of short-term investments

113,694

 
22,967

Net cash used in investing activities
(56,465
)
 
(101,385
)
Financing activities
 
 
 
Net proceeds from stock option exercises and ESPP
4,608

 
7,379

Taxes paid related to net share settlement of equity awards

(999
)
 

Share repurchase


 
(489
)
Net cash provided by financing activities
3,609

 
6,890

Net decrease in cash and cash equivalents
(10,848
)
 
(66,433
)
Cash and cash equivalents at beginning of period
97,428

 
160,203

Cash and cash equivalents at end of period
$
86,580

 
$
93,770


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Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
1,838

 
$
1,822

Taxes paid
36

 
19

Supplemental schedule of non-cash activity
 
 
 
Stock issued for acquisition, net of issuance cost

(77,330
)
 

Unsettled repurchase of common stock
(1,554
)
 

Stock and warrant received for repayment of Viking notes receiveable
1,200

 

Accrued inventory purchases

 

Unrealized gain (loss) on AFS investments
(271
)
 
3,082

(a) See restatement discussion in footnote 1
See accompanying notes

8

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

1. Basis of Presentation and Summary of Significant Accounting Policies

Business    
    
Ligand is a biopharmaceutical company with a business model based on developing or acquiring assets which generate royalty, milestone or other passive revenue for the Company and using a lean corporate cost structure. We operate in one business segment: development and licensing of biopharmaceutical assets.
 
Principles of Consolidation
    
The accompanying condensed consolidated financial statements include Ligand and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Basis of Presentation

The Company’s accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information. 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. Interim financial results are not necessarily indicative of the results that may be expected for the full year. 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, 2015 filed on November 14, 2016.

Upon the occurrence of certain circumstances, holders of the 2019 Convertible Senior Notes may require us to purchase all or a portion of their notes for cash, which may require the use of a substantial amount of cash. If such cash is not available, we may be required to sell other assets or enter into alternate financing arrangements at terms that may or may not be desirable. The existence of the 2019 Convertible Senior Notes and the obligations that we incurred by issuing them may restrict our ability to take advantage of certain future opportunities, such as engaging in future debt or equity financing activities.

Restatement

The Company is restating its previously issued consolidated financial statements as of and for the year ended December 31, 2015 and the condensed consolidated financial statements as of and for the three and nine months ended September 30, 2015 to correct errors relating to the Company's net operating loss (NOL) carryforward benefits in the United States which resulted in an overstatement of deferred tax assets (DTA).  In connection with three acquisitions that were completed prior to February 2010, the Company recognized DTAs for a portion of the NOLs, which included capitalized research and development expenses, obtained from the acquired businesses. From the time of the acquisitions until September 2015, there was a full valuation allowance against all of the Company’s NOLs, including those obtained from the entities acquired. In September 2015, the Company concluded that it was more likely than not that a substantial portion of it deferred tax assets would be realized through future taxable income. As a result, the Company released the majority of its DTA valuation allowance, including $27.5 million related to NOLs recognized as part of the businesses acquired prior to February of 2010.

During the quarter ended September 30, 2016, the Company concluded that for accounting purposes the approximately $27.5 million of DTAs that were obtained upon acquiring the businesses prior to February of 2010 did not meet the more likely-than-not criterion for recognition in 2015 and that the related valuation allowance should not have been reversed.
As a result, the Company's income tax benefit and net income for the year ended December 31, 2015 and the three and nine month periods ended September 30, 2015 were overstated by $27.5 million each.

The Company also recorded adjustments to the consolidated financial statements as part of this restatement relating to the classification of our 2019 Convertible Senior Notes. As of December 31, 2015, the Company's last reported sale price exceeded the 130% threshold described in Note 5 - "Financing Arrangements" and accordingly the 2019 Convertible Senior Notes have been reclassified as a current liability as of December 31, 2015. As a result, the related unamortized discount of

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$39.6 million previously classified within stockholders' equity was reclassified as temporary equity component of currently redeemable convertible notes on our Consolidated Balance Sheet.

The account balances labeled As Reported in the following tables as of December 31, 2015 and as of and for the three and nine months ended September 30, 2015 represent the previously reported amounts as presented in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 and the Quarterly Report on Form 10-Q for the three months ended September 30, 2015, respectively.

The effects of these prior period corrections on the statement of operations and comprehensive income are as follows (in thousands except for per share data):

 
Nine months ended September 30, 2015
 
As Reported
 
Adjustments
 
As Restated
Income tax benefit
$
219,083

 
$
(27,481
)
 
$
191,602

Net income
250,964

 
(27,481
)
 
223,483

Comprehensive income
251,351

 
(27,481
)
 
223,870

Basic earnings per share
12.71

 
(1.39
)
 
11.32

Diluted earnings per share data
11.88

 
(1.30
)
 
10.58

     Basic
19,741

 

 
19,741

     Diluted
21,122

 

 
21,122


 
Three months ended September 30, 2015
 
As Reported
 
Adjustments
 
As Restated
Income tax benefit (expense)
$
219,362

 
$
(27,481
)
 
$
191,881

Net income
226,646

 
(27,481
)
 
199,165

Comprehensive income
222,981

 
(27,481
)
 
195,500

Basic earnings per share
11.40

 
(1.39
)
 
10.01

Diluted earnings per share data
10.56

 
(1.28
)
 
9.28


The effects of these prior period corrections on the consolidated balance sheet is as follows:

 
As of December 31, 2015
 
As Reported
 
Adjustments
 
As Restated
Deferred income taxes
$
216,564

 
$
(27,481
)
 
$
189,083

Total assets(1)
530,542

 
(27,481
)
 
503,061

2019 convertible senior notes, net - current

 
201,985

 
201,985

Total current liabilities
20,836

 
201,985

 
222,821

2019 convertible senior notes, net - long term(1)
201,985

 
(201,985
)
 

Equity component of currently redeemable convertible notes (Note 5)


 
39,628

 
39,628

Additional paid-in capital
701,478

 
(39,628
)
 
661,850

Accumulated deficit
(402,010
)
 
(27,481
)
 
(429,491
)
Total stockholders' equity
304,391

 
(67,109
)
 
237,282

Total liabilities and stockholders' equity(1)
530,542

 
(27,481
)
 
503,061

(1) $3.4 million of unamortized issuance cost was reclassified to debt discount in the concurrently filed 2015 10-K/A form that it is filed after the Company's retrospective adoption of ASU 2015-03, Interest-Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs in Q1 2016.

The effects of these prior period corrections on the condensed consolidated balance sheet is as follows:


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As of September 30, 2015
 
As Reported
 
Adjustments
 
As Restated
Deferred income taxes
$
208,530

 
$
(27,481
)
 
$
181,049

Total assets
523,807

 
(27,481
)
 
496,326

Accumulated deficit
(408,351
)
 
(27,481
)
 
(435,832
)
Total stockholders' equity
294,288

 
(27,481
)
 
266,807

Total liabilities and stockholders' equity
523,807

 
(27,481
)
 
496,326


The corrections did not have any impact on the company's cash flow statements for any period.

Significant Accounting Policies

We describe our significant accounting policies in Note 1 to the financial statements in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2015. There have been no changes to our significant accounting policies during the first nine months of fiscal 2016.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and the accompanying notes. Actual results may differ from those estimates.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.
Recent Accounting Pronouncements

During the first quarter of 2016, we adopted a new accounting standard, ASU 2015-03, Interest-Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs that amends the presentation for debt issuance costs. see Note 5 for details.
    
In May 2014, the Financial Accounting Standards Board (FASB) issued a new accounting standard that amends the guidance for the recognition of revenue from contracts with customers to transfer goods and services. The FASB has subsequently issued additional clarifying standards to address issues arising from implementation of the new revenue recognition standard. The new revenue recognition standard and clarifying standards are effective for interim and annual periods beginning January 1, 2018, and may be adopted earlier, but not before January 1, 2017. The revenue standards are required to be adopted by taking either a full retrospective or a modified retrospective approach. We are currently evaluating the impact that the revenue standards will have on our consolidated financial statements and determining the transition method that we will apply.

In February 2016, the FASB issued a new accounting standard that amends the guidance for the accounting and disclosure of leases. This new standard requires that lessees recognize the assets and liabilities that arise from leases on the balance sheet and disclose qualitative and quantitative information about their leasing arrangements. The new standard is effective for interim and annual periods beginning on January 1, 2019. We are currently evaluating the impact that this new standard will have on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation, which identifies areas for simplification involving several aspects of accounting for stock-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU No. 2016-09 is effective for reporting periods beginning after December 31, 2016.  Early adoption is permitted. We are currently assessing the potential impact that the adoption of ASU No. 2016-09 will have in our condensed consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments which requires that expected credit losses relating to financial assets measured on an amortized cost basis and available-for-sale debt securities be recorded through an allowance for credit losses. ASU 2016-13

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limits the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and also requires the reversal of previously recognized credit losses if fair value increases. The new standard will be effective for us on January 1, 2020. Early adoption will be available on January 1, 2019. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements.

In August 2016 the FASB issued ASU No. 2016-15 Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. The guidance addresses the classification of cash flows related to (1) debt prepayment or extinguishment costs, (2) settlement of zero-coupon debt instruments or other debt instruments with coupon rates that are insignificant in relation to the effective interest rate of the borrowing, (3) contingent consideration payments made after a business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance, including bank-owned life insurance, (6) distributions received from equity method investees and (7) beneficial interests in securitization transactions. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The new guidance will be effective for fiscal years beginning after 15 December 2017, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements.

Income (Loss) Per Share

Basic income (loss) per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted income (loss) per share is computed based on the sum of the weighted average number of common shares and potentially dilutive common shares outstanding during the period.

Potentially dilutive common shares consist of shares issuable under 2019 convertible senior notes, stock options and restricted stock. 2019 convertible senior notes have a dilutive impact when the average market price of the Company’s common stock exceeds the applicable conversion price of the respective notes. Potentially dilutive common shares from stock options and restricted stock are determined using the average share price for each period under the treasury stock method. In addition, the following amounts are assumed to be used to repurchase shares: proceeds from exercise of stock options; the average amount of unrecognized compensation expense for restricted stock; and estimated tax benefits that will be recorded in additional paid-in capital when expenses related to equity awards become deductible. In loss periods, basic net loss per share and diluted net loss per share are identical because the otherwise dilutive potential common shares become anti-dilutive and are therefore excluded.



The following table presents the calculation of weighted average shares used to calculate basic and diluted earnings per share (in thousands):

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Weighted average shares outstanding:
20,886,705

 
19,886,877

 
20,805,604

 
19,741,081

Dilutive potential common shares:
 
 
 
 
 
 
 
Restricted stock
134,008

 
63,324

 
102,282

 
55,899

     Stock options
792,474

 
763,856

 
788,106

 
922,051

     2019 convertible senior notes
1,184,092

 
745,591

 
1,046,257

 
402,941

Shares used to compute diluted income per share
22,997,279

 
21,459,648

 
22,742,249

 
21,121,972

Potentially dilutive shares excluded from calculation due to anti-dilutive effect
3,540,806

 
3,343,719

 
3,522,063

 
3,803,007

 
 
 
 
 
 
 
 

Subsequent to September 30, 2016, the Company repurchased 20,000 shares of its common stock for $1.9 million in the aggregate.

Cash Equivalents

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Cash equivalents consist of all investments with maturities of three months or less from the date of acquisition.
Short-term Investments
Short-term investments primarily consist of investments in debt securities that have effective maturities greater than three months and less than twelve months from the date of acquisition. The Company classifies its short-term investments 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.
The following table summarizes the various investment categories at September 30, 2016 and December 31, 2015 (in thousands):

 
Amortized cost
 
Gross unrealized
gains
 
Gross unrealized
losses
 
Estimated
fair value
September 30, 2016
 
 
 
 
 
 
 
Short-term investments
 
 
 
 
 
 


     Bank deposits
$
11,999

 
$
9

 
$
(2
)
 
$
12,006

     Corporate bonds
6,014

 
31

 

 
6,045

     Commercial paper
13,096

 
4

 
(9
)
 
13,091

     Asset backed securities
63

 

 

 
63

     Municipal Bonds
1,778

 
13

 

 
1,791

     Corporate equity securities
1,578

 
2,961

 

 
4,539

 
$
34,528

 
$
3,018

 
$
(11
)
 
$
37,535

December 31, 2015
 
 
 
 
 
 
 
Short-term investments
 
 
 
 
 
 
 
     Bank deposits
$
43,043

 
$

 
$
(4
)
 
$
43,039

     Corporate bonds
41,238

 

 
(35
)
 
41,203

     Commercial paper
1,747

 

 

 
1,747

     Asset backed securities
10,020

 

 
(5
)
 
10,015

     Corporate equity securities
1,843

 
4,944

 

 
6,787

 
$
97,891

 
$
4,944

 
$
(44
)
 
$
102,791


Inventory

Inventory, which consists of finished goods, is stated at the lower of cost or market value. The Company determines cost using the first-in, first-out method. Inventory levels are analyzed periodically and written down to 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, 2016 and 2015.

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Goodwill and Other Identifiable Intangible Assets

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

 
September 30,
 
December 31,
 
2016
 
2015
Indefinite lived intangible assets
 
 
 
     Acquired IPR&D
$
12,246

 
$
12,556

     Goodwill
72,359

 
12,238

Definite lived intangible assets
 
 
 
     Complete technology
182,577

 
15,267

          Less: Accumulated amortization
(10,465
)
 
(3,762
)
     Trade name
2,642

 
2,642

          Less: Accumulated amortization
(751
)
 
(652
)
     Customer relationships
29,600

 
29,600

          Less: Accumulated amortization
(8,414
)
 
(7,304
)
Total goodwill and other identifiable intangible assets, net
$
279,794

 
$
60,585


The Company tests the carrying value of goodwill in accordance with accounting rules on impairment of goodwill, which require that the Company estimate the fair value of the reporting unit annually, or when impairment indicators exist, and compare such amounts to their respective carrying values to determine if an impairment is required. The Company performed its annual assessment for goodwill impairment for the year ended December 31, 2015, noting no impairment.

Commercial License Rights

Commercial License Rights consist of the following (in thousands):

 
September 30,
 
December 31,
 
2016
 
2015
CorMatrix
$
17,696

 
$

Selexis
8,601

 
8,602

 
26,297

 
8,602

Less: accumulated amortization
(312
)
 
(48
)
     Total commercial rights, net
$
25,985

 
$
8,554


Commercial license rights represent a portfolio of future milestone and royalty payment rights acquired from Selexis in April 2013 and April 2015 and CorMatrix in May 2016. Individual commercial license rights acquired 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, 2016, 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.

Relationships between the CorMatrix Parties
 
As previously disclosed in Ligand’s filings, Jason Aryeh is a director of both Ligand and CorMatrix. Mr. Aryeh beneficially owns equity of CorMatrix representing less than 1% of CorMatrix’s outstanding equity. Mr. Aryeh recused himself from all of the board’s consideration of the purchase agreement between the Company and CorMatrix, including any financial analysis, the terms of the purchase agreement and the vote to approve the Purchase Agreement and the related transactions.


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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,
 
2016
 
2015
Lab and office equipment
$
1,068

 
$
2,248

Leasehold improvements
1,686

 
273

Computer equipment and software
568

 
632

 
3,322

 
3,153

Less accumulated depreciation and amortization
(1,496
)
 
(2,781
)
     Total property and equipment, net
$
1,826

 
$
372


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 the shorter of the estimated useful lives or the related lease term. Depreciation expense of $0.1 million was recognized for each of the nine months ended September 30, 2016 and 2015, which is included in operating expenses.
    
Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

 
September 30,
 
December 31,
 
2016
 
2015
Compensation
$
2,150

 
$
1,711

Professional fees
640

 
726

Amounts owed to former licensees
980

 
915

Royalties owed to third parties
1,028

 
823

Other
1,877

 
1,222

     Total accrued liabilities
$
6,675

 
$
5,397

Contingent Liabilities
    
In connection with the Company’s acquisition of CyDex in January 2011, the Company recorded a contingent liability, for amounts potentially due to holders of the CyDex 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 statement 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, 2016 and December 31, 2015 was $6.7 million and $9.5 million, respectively. The Company recorded a fair-value adjustment to increase the liability by $1.2 million and $1.6 million for the three and nine months ended September 30, 2016, respectively. The Company paid CyDex CVR holders $1.4 million and $4.4 million for the three and nine months ended September 30, 2016. The Company recorded a fair-value adjustment to increase the liability by $0.9 million and $3.1 million for the three and nine months ended September 30, 2015, respectively. The Company paid CyDex CVR holders $0.8 million and $3.9 million during the three and nine months ended September 30, 2015, respectively.

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 potential 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. Any change in fair value is recorded in the Company’s consolidated statement of operations. The carrying amount of the liability may fluctuate significantly based upon quoted market prices and actual amounts paid under the agreements may be

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materially different than the carrying amount of the liability. The fair value of the liability was estimated to be $2.3 million and $4.0 million as of September 30, 2016 and December 31, 2015, respectively. The Company recorded a decrease in the liability for Metabasis-related CVRs of $0.2 million and an increase of $1 million for the three and nine months ended September 30, 2016. The Company paid Metabasis CVR holders $2.6 million for the nine months ended September 30, 2016. No payments were made to Metabasis CVR holders for the three months ended September 30, 2016. The Company recorded a decrease in the liability of Metabasis-related CVRs of $3.2 million and an increase of $1.9 million for the three and nine months ended September 30, 2015, respectively. The Company paid Metabasis CVR holders $0.5 million and $0.8 million during the three and nine months ended September 30, 2015.



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. 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,
 
2016
 
2015
 
2016
 
2015
Stock-based compensation expense as a component of:
 
 
 
 
 
 
 
Research and development expenses
$
2,845

 
$
957

 
$
6,112

 
$
3,131

General and administrative expenses
2,486

 
1,879

 
7,578

 
6,380

 
$
5,331

 
$
2,836

 
$
13,690

 
$
9,511


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,
 
2016
 
2015
 
2016
 
2015
Risk-free interest rate
1.3%
 
2%
 
1.5%
 
1.7%-2.0%
Dividend yield
 
 
 
Expected volatility
49%
 
50%
 
50%
 
50%-58%
Expected term
6.7
 
6.5
 
6.6
 
6.6
Forfeiture rate
5.0%
 
8.5%
 
5.0%
 
8.5%

Lease Obligations

We describe our operating lease obligations in Note 4 to the financial statements in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2015. As of December 31, 2015, the Company had lease exit obligations of $0.9 million. As of September 30, 2016, the Company no longer records a lease obligation with respect to it's vacated space expiring in June of 2019 as the sublease proceeds offset the estimated lease exist obligation. There were no other significant changes in our operating lease commitments during the first nine months of 2016.


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Table of Contents

Convertible Debt

In August 2014, the Company completed a $245.0 million offering of 2019 Convertible Senior Notes, which bear interest at 0.75%. The Company accounted for the 2019 Convertible Senior Notes by separating the liability and equity components of the instrument in a manner that reflects the Company's nonconvertible debt borrowing rate. As a result, the Company assigned a value to the debt component of the 2019 Convertible Senior Notes equal to the estimated fair value of similar debt instruments without the conversion feature, which resulted in the Company recording the debt instrument at a discount. The Company is amortizing the debt discount over the life of the 2019 Convertible Senior Notes as additional non-cash interest expense utilizing the effective interest method.




2. Business Combination

On January 8, 2016, the Company acquired substantially all of the assets and liabilities of OMT. OMT is a biotechnology company engaged in the genetic engineering of animals for the generation of human therapeutic antibodies through its OmniAb® technology, which currently offers three transgenic animal platforms for license, including OmniRat®, OmniMouse® and OmniFlic®. The transaction, which was accounted for as a business combination, initially added 16 partnerships to the Company's portfolio and provides the Company with opportunities for further licensing and collaborations in the area.

The aggregate acquisition consideration was $173.4 million, consisting of (in thousands, except per share amounts):

Cash consideration
$
96,006

Total share consideration:
 
     Actual number of shares issued
790

     Multiplied by: Ligand closing share price on January 8, 2016
$
97.92

Total share consideration
77,373

Total consideration
$
173,379


The acquisition consideration is subject to certain customary post-closing adjustments up to 15 months from January 8, 2016, in accordance with the terms and subject to the conditions contained in the merger agreement between the Company and OMT.
    The acquisition consideration was preliminarily allocated to the acquisition date fair values of acquired assets and assumed liabilities as follows (in thousands):

     Cash and cash equivalents
$
3,504

     Accounts receivable
5

     Income tax receivable
140

     Prepaid expenses and other current assets
2

     Deferred tax liabilities, net
(56,114
)
     Intangible asset with finite life - core technology
167,000

     Liabilities assumed
(1,279
)
     Goodwill
60,121

Total consideration
$
173,379


The fair value of the core technology, or OMT's OmniAb technology, was based on the discounted cash flow method that estimated the present value of a hypothetical royalty stream derived from the licensing of the OmniAb technology. These projected cash flows were discounted to present value using a discount rate of 15.5%. The fair value of the core technology is being amortized on a straight-line basis over the estimated useful life of 20 years.


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Table of Contents

The excess of the acquisition date consideration over the fair values assigned to the assets acquired and the liabilities assumed was $60.1 million and was recorded as goodwill, which is not deductible for tax purposes and is primarily attributable to OMT’s potential revenue growth from combining the OMT and Ligand businesses and workforce, as well as the benefits of access to different markets and customers.

The purchase price allocations were prepared on a preliminary basis and are subject to change as additional information becomes available concerning the fair value and tax basis of the assets acquired and liabilities assumed. Any measurement period adjustments to the OMT purchase price allocation will be made as soon as practicable but no later than one year from the date of acquisition.

The following table presents supplemental pro forma information for the three and nine months ended September 30, 2016 and September 30, 2015, as if the acquisition of OMT had occurred on January 1, 2015 (in thousands except for income per share):

 
Three months ended
Nine months ended
 
September 30,
September 30,
 
2016
 
2015
2016
 
2015
Revenue
$
21,619

 
$
18,824

$
73,263

 
$
55,795

Net (loss) income
$
1,051

 
196,354

$
3,759

 
$
216,900

 
 
 
 
 
 
 
Basic (loss) income per share:
$
0.05

 
$
9.87

$
0.18

 
$
10.99

Diluted (loss) income per share:
$
0.05

 
$
9.15

$
0.17

 
$
10.27


The unaudited pro forma consolidated results include pro forma adjustments that assume the acquisition occurred on January 1, 2015. The primary adjustments include: (i) the $0.3 million and $0.9 million for the three and nine months ended September 30, 2015, respectively, for share based compensation expenses related to the stock awards issued to the retained OMT employees after the acquisition, (ii) additional intangible amortization expense of  $2.1 million and $6.3 million was included in the three and nine months ended September 30, 2015, respectively and (iii) a platform license fee of $3.0 million paid by OMT during the nine months ended September 30, 2015. The license agreement was terminated upon acquisition by Ligand. The adjustments also include $2.5 million license revenue recognized by OMT from January 1, 2016 to the acquisition date. The unaudited pro forma consolidated results are not necessarily indicative of what our consolidated results of operations actually would have been had we completed the acquisition on January 1, 2015. In addition, the unaudited pro forma consolidated results do not purport to project the future results of operations of the combined company nor do they reflect the expected realization of any cost savings associated with the acquisition.


3. Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value on a recurring basis. 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 below with level 1 having the highest level input that is significant to the measurement and level 3 having the lowest:
Level 1 - Quoted prices in active markets;
Level 2 - Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or 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.    

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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, 2016 (in thousands). There were no transfers between Level 1 and Level 2 securities during the nine months ended September 30, 2016:

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:
 
 
 
 
 
 
 
Short-term investments (2)
$
37,535

 
$
4,539

 
$
32,996

 
$

Note receivable Viking (3)
3,207

 

 

 
3,207

Investment in warrants (4)
684

 
684

 

 

     Total assets
$
41,426

 
$
5,223

 
$
32,996

 
$
3,207

Liabilities:
 
 
 
 
 
 
 
Current contingent liabilities-CyDex (5)
$
5,079

 
$

 
$

 
$
5,079

Long-term contingent liabilities-CyDex (5)
1,634

 

 

 
1,634

Long-term contingent liabilities-Metabasis (6)
2,299

 

 
2,299

 

Liability for amounts owed to former licensees(7)
536

 
536

 

 

     Total liabilities
$
9,548

 
$
536

 
$
2,299

 
$
6,713


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, 2015 (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:
 
 
 
 
 
 
 
Cash equivalents (1)
$
3,015

 
$

 
$
3,015

 
$

Short-term investments (2)
92,775

 
6,786

 
85,989

 

Viking note receivable (3)
4,782

 

 

 
4,782

     Total assets
$
100,572

 
$
6,786

 
$
89,004

 
$
4,782

Liabilities:
 
 
 
 
 
 
 
Current contingent liabilities-CyDex (5)
$
7,812

 
$

 
$

 
$
7,812

Current contingent liabilities-Metabasis (6)
2,602

 

 
2,602

 

Long-term contingent liabilities-Metabasis (6)
1,355

 

 
1,355

 

Long-term contingent liabilities-CyDex (5)
1,678

 

 

 
1,678

Liability for amounts owed to former licensees (7)
794

 
794

 

 

     Total liabilities
$
14,241

 
$
794

 
$
3,957

 
$
9,490


(1)
Highly liquid investments with maturities less than 90 days from the purchase date are recorded as cash equivalents that are classified as Level 2 of the fair value hierarchy, as these investment securities are valued based upon quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. 
(2)
Investments in equity securities, which the Company received as a result of event-based and upfront payments from licensees, are classified as level 1 as the fair value is determined using quoted market prices in active markets for the same securities. Short-term investments in marketable securities with maturities greater than 90 days are classified as level 2 of the fair value hierarchy, as these investment securities are valued based upon quoted prices for identical or

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similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. 
(3)
The fair value of the convertible note receivable from Viking was determined using a probability weighted option pricing model using a lattice methodology. The fair value is subjective and is affected by certain significant input to the valuation model such as the estimated volatility of the common stock, which was estimated to be 75% at September 30, 2016. Changes in these assumptions may materially affect the fair value estimate.
(4)
Investment in warrants, which the Company received as a result of Viking’s partial repayment of the Viking note receivable and the Company’s purchase of Viking common stock and warrants in April 2016, are classified as level 1 as the fair value is determined using quoted market prices in active markets for the same securities.
(5)
The fair value of the liabilities for CyDex contingent liabilities were determined based on the income approach. To the extent the estimated future income may vary significantly given the long-term nature of the estimate, the Company utilizes a Monte Carlo model. The fair value is subjective and is affected by changes in inputs to the valuation model including management’s 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.
(6)
The liability for CVRs for Metabasis are determined using quoted prices in an market that is not active for the underlying CVR.
(7)
The liability for amounts owed to former licensees are determined using quoted market prices in active markets for the underlying investment received from a partner, a portion of which is owed to former licensees.

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

 
September 30, 2016
 
December 31, 2015
Annual revenue subject to revenue sharing (1)
$28.0 million
 
$22.5 million
Revenue volatility
25%
 
25%
Average probability
92%
 
73%
Sales beta
0.30
 
0.40
Credit rating
BB
 
BB
Equity risk premium
6%
 
6%
(1)
Revenue subject to revenue sharing represent management’s estimate of the 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.

A reconciliation of the level 3 financial instruments as of September 30, 2016 is as follows (in thousands):

Assets:
 
Fair value of level 3 financial instrument assets as of December 31, 2015
$
4,782

Viking note receivable fair market value adjustment
(215
)
Cash payment received as partial repayment of note receivable
(300
)
Fair market value of stock received as partial repayment of note receivable
(1,060
)
Fair value of level 3 financial instrument assets as of September 30, 2016
$
3,207

 
 
Liabilities:
 
Fair value of level 3 financial instrument liabilities as of December 31, 2015
$
9,490

Payments to CVR and other former license holders
(4,413
)
Fair value adjustments to contingent liabilities
1,636

Fair value of level 3 financial instrument liabilities as of September 30, 2016
$
6,713


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Table of Contents



Other Fair Value Measurements

2019 Convertible Senior Notes

In August 2014, the Company issued $245.0 million aggregate principal amount of its 2019 Convertible Senior Notes. The Company uses a quoted rate in a market that is not active, 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 $357.6 million as of September 30, 2016. The carrying value of the notes does not reflect the market rate. See Note 5 Financing Arrangements for additional information.

Viking Therapeutics

The Company records its investment in Viking under the equity method of accounting. The investment is subsequently adjusted for the Company’s share of Viking's operating results, and if applicable, cash contributions and distributions. See Note 4 Investment in Viking Therapeutics for additional information. The market value of the Company's investment in Viking was $8.8 million as of September 30, 2016. The carrying value of the investment in Viking does not reflect the market value.

4. Investment in Viking Therapeutics

In 2014, the Company entered into a MLA with Viking to license the rights to five of the Company's programs to Viking. Under the terms of the MLA, no consideration was exchanged upon execution, but rather Viking agreed to issue shares of Viking common stock with an aggregate value of approximately $29.2 million upon consummation of Viking's IPO. As part of this transaction, the Company also extended a $2.5 million convertible loan to Viking under a LSA. As a result of these transactions, the Company determined it held a variable interest in Viking. The Company considered certain criteria in the accounting guidance for VIEs, and determined that Viking was a VIE and Ligand was the primary beneficiary of Viking. As a result, the Company consolidated Viking on its financial statements from May 2014 through May 2015, the effective date of Viking's IPO. The Company recorded 100% of the losses incurred as net loss attributable to noncontrolling interest because it was the primary beneficiary with no equity interest in the VIE.

In May 2015, Viking completed the Viking IPO and issued the Company approximately 3.7 million shares of Viking common stock with an aggregate value of $29.2 million based on the IPO price of $8.00 per share. In connection with the Viking IPO, the Company purchased 1.1 million shares of Viking common stock for an aggregate price of $9.0 million at the initial public offering price. Upon completion of Viking’s IPO, the Company determined that Viking was no longer a VIE and the Company did not have any other element of control that would require consolidation of Viking. In May 2015, the Company deconsolidated Viking and began to account for its equity investment in Viking under the equity method and records its proportional share of Viking gains and losses in Loss from Viking Therapeutics in the Company's consolidated statement of operations. The Company owned an aggregate of 31.4% of the outstanding common stock of Viking at September 30, 2016.

In January 2016, the Company entered into an amendment to the LSA with Viking to extend the maturity of the convertible loan to May 2017, reduce the interest rate from 5.0% to 2.5%, and extend the lock up period by one year such that the Company may not sell, transfer, or dispose of any Viking securities prior to January 23, 2017. Additionally, upon the consummation of a subsequent capital financing transaction, Viking will be required to repay $1.5 million of the Viking Note obligation to the Company, with at least $0.3 million to be paid in cash and the remaining amount to be paid in the form and at the price of the Viking equity securities sold in the financing transaction. Upon maturity or further payments, the Company may elect to receive equity of Viking common stock or cash equal to 200% of the principal amount plus accrued and unpaid interest. The Company has opted to account for the Viking convertible note receivable at fair value.

In April 2016, Viking closed its underwritten public offering of 7.5 million shares of common stock and warrants to purchase up to 7.5 million shares of its common stock at a price of $1.25 per share of its common stock and related warrants. The warrant has an exercise price of $1.50 per share, immediately exercisable and will expire on April 13, 2021. As part of this public offering, the Company purchased 560,000 shares of common stock and warrants to purchase 560,000 shares of Viking's common stock for a total purchase price of $0.7 million. The purchased shares of common stock and warrants are subject to the same terms as the shares issued in this offering. In addition, on April 13, 2016, pursuant to the terms of the amendment to the LSA that was entered in January 2016 between Ligand and Viking, Viking repaid $0.3 million of the convertible notes in cash, and issued the Company 960,000 shares of its common stock and warrants to purchase 960,000 shares of its common stock as

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repayment of $1.2 million of the convertible notes. The shares received as part of the repayment, like all Viking securities held by the Company, are subject to a lock-up period that ends on January 23, 2017 in accordance with the amended LSA. A gain of $0.2 million representing the fair market value of the warrants is included within other income for the quarter ended September 30, 2016. As of September 30, 2016, the aggregate fair value of the note receivable was $3.2 million. The Company recorded a $0.2 million decrease in the fair value of the Viking convertible note in "Other Income" on its Condensed and Consolidated Statement of Operations for the nine months ended September 30, 2016. See Note 3, Fair Value Measurements for additional details.

The Company's ownership in Viking decreased to 32.7% after the public offering and the repayment of the convertible notes. Accordingly, the book value of the Company's equity method investment in Viking decreased by $10.0 million. The resulting net loss was recognized in Loss from Viking Therapeutics in the Company's consolidated statement of operations for the nine months ended September 30, 2016. The Company's ownership in Viking decreased to 31.4% during the third quarter of 2016 resulting in a loss of $0.3 million which was recognized in Loss from Viking Therapeutics in the Company's consolidated statement of operations for the three months ended September 30, 2016.

The Company reviews its investment in Viking on a regular basis and assesses whether events, changes in circumstances or the passage of time, in management's judgment, indicate that a loss in the market value of the investment may be other than temporary. This might include, but would not necessarily be limited to, the period of time during which the carrying value of our investment is significantly above the observed market value, a deterioration in Viking's financial condition, or an adverse event relating to its lead clinical programs. The Company has the ability to hold its investment in Viking at the current market value, and we do not believe there was an other-than-temporary impairment for the periods ended September 30, 2016 or December 31, 2015.


5. Financing Arrangements
    
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 notes bear cash 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.

As of September 30, 2016, the Company's last reported sale price has exceeded the 130% threshold described above and accordingly the Convertible Notes have been classified as a current liability as of September 30, 2016. As a result, the related unamortized discount of $32.1 million was classified as temporary equity component of currently redeemable convertible notes on our Condensed Consolidated Balance Sheet. The determination of whether or not the Convertible Notes are convertible as described above is made each quarter until maturity, conversion or repurchase. It is possible that the Convertible Notes may not be convertible in future periods, in which case the Convertible Notes would be classified as long-term debt, unless one of the other conversion events described above were to occur.


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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 per share. As of September 30, 2016, the “if-converted value” exceeded the principal amount of the 2019 Convertible Senior Notes by $88.2 million.    

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 are recorded net of the liability component on the balance sheet beginning in 2016 in accordance with ASU 2015-03, Interest-Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs.  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, 2016 and December 31, 2015, net of issuance costs, was $51.3 million.


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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 SEC 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, 2016 and December 31, 2015 were as follows (in thousands):

 
September 30, 2016
 
December 31, 2015
2019 Convertible Senior Notes
 
 
 
     Principal amount outstanding
$
245,000

 
$
245,000

     Unamortized discount
(34,885
)
 
(43,015
)
Total notes payable
$
210,115

 
$
201,985


6. Income Tax

As of September 30, 2015, the Company concluded that it was more likely than not that a substantial portion of its deferred tax assets would be realized through future taxable income. The Company's income tax provision of $191.9 million and $191.6 million for the three and nine months ended September 30, 2015, respectively, included income tax expense and a discrete income tax benefit related to the release of a majority of the Company’s valuation allowance and various adjustments to its deferred tax assets, including studies validating the Company’s tax attributes and adjustments resulting from the tax return filings during the quarter.

The Company's income tax expense from continuing operations for the three months ended September 30, 2016 was $0.2 million, or $0.01 per diluted share. The Company recorded an income tax benefit of $28.0 thousand for the nine months ended September 30, 2016. The Company's income tax expense from discontinued operations for the nine months ended September 30, 2016 was $0.4 million.

The Company estimates its annual effective income tax rate for continuing operations to be approximately 42% for 2016, compared to the 509.5% effective income tax rate for 2015. The estimated effective tax rate for 2016 is different from the federal statutory rate primarily as a result of significant permanent book-to-tax differences and state taxes. The permanent differences include non-taxable contingent consideration income (expense) recorded related to the change in market value of contingent liabilities. Any significant contingent consideration expense or income will result in a significantly higher or lower effective tax rate because contingent consideration expense is largely not deductible for tax purposes and contingent consideration income is not taxable. Other permanent differences between financial statement income and taxable income relate to items such as stock compensation, meals and entertainment charges, and compensation of officers. The primary

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difference in the estimated effective tax rate in 2016 compared to 2015 relates to the release of the Company’s valuation allowance in 2015.
    
The Company maintains a valuation allowance in the amount of $8.9 million against certain U.S. state NOLs, federal NOLs arising from Pre-ASC 718 excess stock compensation benefits and federal research and development tax credits. Each reporting period, the Company evaluates the need for a valuation allowance on our deferred tax assets by jurisdiction and adjusts our estimates as more information becomes available. The Company will reassess the ability to realize the deferred tax assets on a quarterly basis. If it is more likely than not that it will not realize the recognized deferred tax assets, then all or a portion of the valuation allowance may need to be re-established, which would result in a charge to tax expense. Conversely if new events indicate that it is more likely than not that we will realize additional deferred tax assets, then all or a portion of the remaining valuation allowance may be released, which would result in a tax benefit.

As of September 30, 2016, the Company had unrecognized tax benefits of approximately $33.5 million related to uncertain tax positions that, if recognized, would result in adjustments to the related deferred tax assets and reduce our annual effective tax rate, subject to the remaining valuation allowance.

The Company files income tax returns in the U.S. and in various state jurisdictions with varying statutes of limitations. The Company is no longer subject to income tax examination by tax authorities for years prior to 2011; however, its net operating loss and research credit carry-forwards arising prior to that year are subject to adjustment. It is the Company's policy to recognize interest expense and penalties related to income tax matters as a component of income tax expense.  As of September 30, 2016, there was no material accrued interest related to uncertain tax positions.

7. Stockholders’ Equity

The Company grants options and awards to employees and non-employee directors pursuant to a stockholder approved stock incentive plan, which is described in further detail in Note 8, Stockholders' Equity, of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

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

 
Stock Options
 
Restricted Stock Award
 
Shares
 
Weighted-
Average
Exercise
Price
 
Shares
 
Weighted-
Average Grant
Date Fair Value
Balance as of December 31, 2015
1,683,341

 
$
34.23

 
130,749

 
$
60.36

Granted
263,489

 
92.09

 
234,855

 
95.31

Exercised
(130,185
)
 
34.65

 
(53,121
)
 
93.49

Forfeited
(30,115
)
 
60.17

 
(2,183
)
 
71.03

Balance as of September 30, 2016
1,786,530

 
$
42.29

 
310,300

 
$
76.02


Net cash received from options exercised during the nine months ended September 30, 2016 and 2015 was approximately $4.5 million and $7.3 million, respectively. Tax deductions for stock options and restricted stock which have exceeded stock based compensation expense in previous years have not been recognized by the Company. The Company will monitor the utilization of the net operating losses and recognize the excess tax deduction when that deduction reduces taxes payable.

As of September 30, 2016, 951,526 shares were available for future option grants or direct issuance under the Company's 2002 Stock Incentive Plan, as amended.

Employee Stock Purchase Plan

The Company's Amended ESPP allows participating employees 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

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offering period beginning after their hire date. This plan is described in further detail in Note 8, Stockholders' Equity, of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

There were 1,241 shares of common stock issued under the amended ESPP during the nine months ended September 30, 2016. There were no shares of common stock issued under the amended ESPP plan during the nine months ended September 30, 2015. As of September 30, 2016, 71,126 shares were available for future purchases under the Amended ESPP.

Issuance of common stock

In conjunction with the acquisition of OMT, the Company issued 790,163 shares of its common stock.

8. 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 FASB 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

In 2012, a federal securities class action and shareholder derivative lawsuit was filed in Pennsylvania alleging that the Company and its CEO assisted various breaches of fiduciary duties based on the Company’s purchase of a licensing interest in a development-stage pharmaceutical program from the Genaera Liquidating Trust in 2010 and the Company’s subsequent sale of half of its interest in the transaction to Biotechnology Value Fund, Inc.  Plaintiff filed a second amended complaint in February 2015, which the Company moved to dismiss in March 2015.  The district court granted the motion to dismiss on November 11, 2015.  The plaintiff has appealed that ruling to the Third Circuit.  The Company intends to continue to vigorously defend against the claims against the Company and its CEO.  The outcome of the matter is not presently determinable.

Paragraph IV Certification by Par Pharmaceuticals

On January 7, 2016, the Company received a paragraph IV certification from Par Sterile Products, LLC, a subsidiary of Par Pharmaceuticals, Inc., or Par, advising us that it had filed an ANDA with the FDA seeking approval to market a generic version of Merck’s NOXAFIL-IV product.  On October 31, 2016, the parties entered into a consent judgment dismissing all claims, counterclaims, affirmative defenses and demands. The parties have reported to the court that they entered into a confidential settlement agreement, and that they submitted the agreement to the Federal Trade Commission and the United States Department of Justice pursuant to Section 112(a) of the Medicare Prescription Drug, Improvement and Modernization Act of 2003.





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. 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

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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 Ligand Pharmaceuticals Incorporated and our wholly owned subsidiaries.

Overview
    
We are a biotechnology company with a business model based on developing or acquiring assets which generate royalty, milestone or other passive revenue for Ligand and using a lean corporate cost structure. By diversifying our portfolio of assets across numerous technology types, therapeutic areas, drug targets, and industry partners, we offer investors an opportunity for broad exposure to multiple pharmaceutical and biotechnology assets without the risk associated with developing only one or a limited number of drugs.  These therapies address the unmet medical needs of patients for a broad spectrum of diseases including thrombocytopenia, multiple myeloma, hepatitis, ventricular fibrilation, muscle wasting, Alzheimer’s disease, dyslipidemia, diabetes, anemia, asthma, FSGS, menopausal symptoms and osteoporosis. Our partners include several of the world’s leading pharmaceutical companies such as Novartis, Amgen, Merck, Pfizer, Baxter, and Eli Lilly.

Significant Developments

Portfolio Program Progress

Promacta®/Revolade®

Novartis announced Q3 2016 net sales of Promacta® of $168 million, a $51 million or 44% increase over Q3 2015. Novartis also announced that Promacta is now approved in more than 100 countries.

Kyprolis® (carfilzomib), an Amgen Product Utilizing Captisol

On September 27, 2016, Amgen announced top-line results of the Phase 3 CLARION trial, which evaluated an investigational regimen of Kyprolis® (carfilzomib), melphalan and prednisone (KMP) versus Velcade® (bortezomib), melphalan and prednisone (VMP) for 54 weeks in patients with newly diagnosed multiple myeloma who were ineligible for hematopoietic stem-cell transplant. The trial did not meet the primary endpoint of superiority in progression-free survival (PFS). A Phase 3 study evaluating Kyprolis in combination with lenalidomide plus dexamethasone (KRd) versus Velcade in combination with lenalidomide plus dexamethasone (VRd) in newly diagnosed multiple myeloma patients, called ENDURANCE, is underway independently by the ECOG-ACRIN Cancer Research Group.
On July 3, 2016, Amgen announced that the European Commission approved an expanded indication for Kyprolis®, to be used in combination with dexamethasone alone, for adult patients with multiple myeloma who have received at least one prior therapy.
Also, Ono Pharmaceuticals, holder of Kyprolis® marketing rights in Japan, announced approval in Japan for treatment of patients with relapsed or refractory multiple myeloma.

Additional Pipeline and Partner Developments

Retrophin announced positive top-line results from the Phase 2 DUET study of sparsentan for the treatment of focal segmental glomerulosclerosis. The study achieved statistical significance in the primary efficacy endpoint for the overall sparsentan treatment group, demonstrating a greater than two-fold reduction of proteinuria compared to irbesartan after the eight-week, double-blind treatment period.
Additional data from the Phase 2 DUET study of sparsentan for the treatment of focal segmental glomerulosclerosis will be presented at the late-breaking High-Impact Clinical Trials oral session at the American Society of Nephrology (ASN) Kidney Week 2016.

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Lundbeck announced FDA approval of Carnexiv™ (carbamazepine) injection as a short-term replacement therapy for oral carbamazepine formulations in adults with certain seizure types when oral administration is temporarily not feasible. Ligand earned a $1.25 million milestone payment upon approval and is entitled to receive a royalty of 2.75% on net sales of Carnexiv.
Melinta Therapeutics announced that it has submitted NDAs to the FDA for approval of IV and oral Baxdela™ (delafloxacin) for the treatment of patients with acute bacterial skin and skin structure infections (ABSSSI). With the submission, Ligand earned a $1.5 million milestone payment. If approved, Ligand is entitled to receive a 2.5% royalty on net sales of the IV formulation of Baxdela and an additional $1.5 million approval milestone payment.
Baxdela was the subject of several poster presentations at IDWeek 2016, held October 26-30 at the New Orleans Ernest N. Morial Convention Center.
The FDA granted orphan designation to Merck’s Noxafil for treatment of invasive aspergillosis.
Viking Therapeutics announced first patient dosed in the company's Phase 2 clinical trial of VK2809 in patients with primary hypercholesterolemia and non-alcoholic fatty liver disease.
Viking Therapeutics announced positive top-line results from a proof-of-concept study of VK0214 in a mouse model of X-linked adrenoleukodystrophy (X-ALD), showing VK0214 rapidly reduced plasma very long chain fatty acid levels by more than 25% in treated animals compared with vehicle controls (p<0.01). Detailed study results were presented at the 86th Annual Meeting of the American Thyroid Association.
Aldeyra Therapeutics announced plans for ADX-102 (formerly NS2) for the first-ever vehicle-controlled Phase 3 clinical trial in noninfectious anterior uveitis, as well as a Phase 3 clinical trial in Sjögren-Larsson Syndrome. Aldeyra also announced the expected advancement of ADX-102 to a Phase 2b clinical trial in allergic conjunctivitis and the addition of a clinical program in dry eye syndrome.
Eli Lilly presented data on Prexasertib (LY2606368) demonstrating activity in patients with BRCA wild type sporadic high-grade serous ovarian cancer at the European Society for Medical Oncology 2016 Congress.
Merrimack Pharmaceuticals announced the FDA granted seribantumab (MM-121) Fast Track designation for development in patients with heregulin-positive, locally advanced or metastatic non-small cell lung cancer whose disease has progressed following immunotherapy.
Lubris BioPharma announced positive results of a clinical trial that showed recombinant human lubricin demonstrated significant improvement in both signs and symptoms of dry eye disease compared to sodium hyaluronate (HA). Results were published in the September issue of The Ocular Surface.
Opthea announced that the Phase 1 dose-escalation study of OPT-302 met its primary objective demonstrating safety and tolerability as monotherapy and in combination with the current wet AMD standard of care Lucentis®. Opthea is recruiting patients for its Phase 2a dose-expansion trial and expects data by the end of 2016.

New Licensing Deals

Ligand announced worldwide license agreements with Gilead Sciences, F-Star Biotechnology Limited and TeneoBio to use certain or all of the OmniAb platform technologies to discover fully human antibodies. Ligand is eligible to receive annual access payments, sublicensing fees, milestone payments and royalties on future net sales of any antibodies discovered under these licenses.
Ligand announced licensing rights to four programs to Seelos Therapeutics including aplindore for the treatment of various CNS disorders, a CRTH2 antagonist for the treatment of respiratory disorders, a Captisol-enabled™ acetaminophen program for pain and fever management and an H3 receptor antagonist program for the treatment of narcolepsy. Ligand is entitled to receive milestones and net sales royalties ranging from 4% to 10% for the various programs licensed.
Ligand announced a license agreement for its LTP technology with Nucorion Pharmaceuticals, a venture-funded biotechnology company focused on developing anti-cancer and anti-viral agents initially directed to China, of which Ligand is a minority shareholder. Three initial programs fall under the license: NUC-202, a targeted anticancer analog for the treatment of hepatocellular carcinoma; NUC-404, a targeted nucleotide analog for the treatment of hepatitis B; and NUC-101, a targeted nucleotide analog for the treatment of hepatitis C. Ligand is eligible to receive milestones in addition to royalties ranging from 5% to 9% on future net sales of any approved program.

Internal Glucagon Receptor Antagonist (GRA) Program

Ligand announced initiation of a Phase 2 clinical trial with LGD-6972 for the treatment of type 2 diabetes mellitus (T2DM). The randomized, double-blind, placebo-controlled study will evaluate the safety and efficacy of LGD-6972, as an adjunct to diet and exercise, in subjects with T2DM whose blood glucose levels are inadequately controlled with metformin.

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Results from two Phase 1 clinical trials with LGD-6972 were published in the August issue of the journal Diabetes, Obesity and Metabolism.


Results of Operations

QTD 2016 vs QTD 2015 and YTD 2016 vs YTD 2015

Revenue

(Dollars in thousands)
Q3 2016
 
Q3 2015
 
Change
 
% Change
 
YTD 2016
 
YTD 2015
 
Change
 
% Change
Royalty Revenue
$
15,698

 
$
9,755

 
$
5,943

 
61
 %
 
$
39,842

 
$
26,648

 
$
13,194

 
50
 %
Material Sales
4,219

 
6,046

 
(1,827
)
 
(30
)%
 
13,445

 
20,456

 
(7,011
)
 
(34
)%
License fees, milestones and other revenue
1,702

 
1,900

 
(198
)
 
(10
)%
 
17,500

 
3,618

 
13,882

 
384
 %
Total revenue
$
21,619

 
$
17,701

 
$
3,918

 
22
 %
 
$
70,787

 
$
50,722

 
$
20,065

 
40
 %

Total revenue for Q3 2016 increased $3.9 million or 22% compared with Q3 2015 and increased $20.1 million or 40% for the first three quarters of 2016 compared to the same period in 2015. Royalty revenue increased in Q3 2016 compared to Q3 2015 and for the first three quarters of 2016 compared to the same period in 2015 primarily due to an increase in Promacta and Kyprolis royalties. Material sales decreased in Q3 2016 compared to Q3 2015 and in the first three quarters of 2016 compared to the same period in 2015 due to timing of customer purchases of Captisol for use in clinical trials and in commercialized products. License fees, milestones and other revenue decreased in Q3 2016 compared to Q2 2015 due to timing of milestones and upfront fees earned. License fees, milestones and other revenue increased in the first three quarters of 2016 compared to the same period in 2015 primarily due to timing of significant milestones and upfront fees earned and revenues from OmniAb partners.

Operating Costs and Expenses

(Dollars in thousands)
Q3 2016
 
Q3 2015
 
Change
 
 
YTD 2016
 
YTD 2015
 
Change
 
Costs of sales
$
999

 
$
1,250

 
$
(251
)
 
 
$
2,674

 
$
4,923

 
$
(2,249
)
 
Amortization of intangibles
2,706

 
593

 
2,113

 
 
7,912

 
1,780

 
6,132

 
Research and development
5,898

 
1,945

 
3,953

 
 
14,813

 
8,730

 
6,083

 
General and administrative
6,305

 
4,971

 
1,334

 
 
19,995

 
18,190

 
1,805

 
Lease exit and termination costs
245

 
345

 
(100
)
 
 
863

 
786

 
77

 
Total operating costs and expenses
$
16,153

 
$
9,104

 
$
7,049

 
 
$
46,257

 
$
34,409

 
$
11,848

 

Total operating costs and expenses for Q3 2016 increased $7.0 million or 77% compared with Q3 2015 and increased $11.8 million or 34% for the first three quarters of 2016 compared to the same period in 2015. Cost of sales decreased in Q3 2016 compared with Q3 2015 and for the first three quarters of 2016 compared to the same period in 2015 primarily due to lower material sales as a result of timing of customer purchases. Amortization of intangibles increased in Q3 2016 compared with Q3 2015 and for the first three quarters of 2016 compared to the same period in 2015 due to the acquisition of OMT and the amortization of the corresponding definite lived intangible assets. Research and development expenses and General and administrative expenses increased in Q3 2016 compared with Q3 2015 and for the first three quarters of 2016 compared to the same period in 2015 due primarily to an increase in stock-based compensation expense, timing of internal development costs, increase in headcount related expenses and expenses associated with OMT which we acquired in January 2016.
    

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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.
    
Other Income (Expense)
(Dollars in thousands)
Q3 2016
 
Q3 2015
 
Change
 
 
YTD 2016
 
YTD 2015
 
Change
 
Interest expense, net
$
(3,116
)
 
$
(2,930
)
 
$
(186
)
 
 
$
(9,172
)
 
$
(8,875
)
 
$
(297
)
 
Decrease (increase) in contingent liabilities
(958
)
 
2,301

 
(3,259
)
 
 
(2,595
)
 
(4,976
)
 
2,381

 
Gain on deconsolidation of Viking Therapeutics

 

 

 
 

 
28,190

 
(28,190
)
 
Loss from Viking Therapeutics
(1,396
)
 
(2,169
)
 
773

 
 
(14,139
)
 
(3,040
)
 
(11,099
)
 
Other income (expense), net
1,215

 
1,485

 
(270
)
 
 
2,107

 
1,889

 
218

 
Total other income (expense), net
$
(4,255
)
 
$
(1,313
)
 
$
(2,942
)
 
 
$
(23,799
)
 
$
13,188

 
$
(36,987
)
 

Interest expense consisted primarily of accretion of discount on our 2019 Convertible Senior Notes. The increase in interest expense in Q3 2016 compared to Q3 2015 and for the first three quarters of 2016 compared to the same period in 2015 was due to a higher outstanding principal balance.
We recorded an increase in contingent liabilities of $1.0 million for Q3 2016 and a decrease of $2.3 million for Q3 2015 and for the first three quarters of 2016 and 2015 we recorded an increase of $2.6 million and $5.0 million, respectively. The increase for Q3 2016 primarily relates to amounts potentially due to holders of CVRs associated with our CyDex acquisition. The increase for the first three quarters of 2016 ended is primarily due to an increase in amounts potentially due to holders of the CyDex CVRs and CVRs associated with our Metabasis acquisition. 
Other income, net consisted primarily of short term investment transactions including, for the first three quarters of 2016, a $0.5 million gain representing the fair market value of the warrants receive as a result of Viking's partial repayment of the Viking note receivable and the Company's purchase of Viking common stock and warrants in April 2016.

Income Tax Expense
(Dollars in thousands)
Q3 2016
 
Q3 2015
 
Change
 
 
YTD 2016
 
YTD 2015
 
Change
 
Income (loss) before income taxes
$
1,211

 
$
7,284

 
$
(6,073
)
 
 
$
731

 
$
29,501

 
$
(28,770
)
 
Income tax benefit (expense)
(160
)
 
191,881

 
(192,041
)
 
 
28

 
191,602

 
(191,574
)
 
(Loss) income from operations
1,051

 
199,165

 
(198,114
)
 
 
759

 
221,103

 
(220,344
)
 
Effective tax rate
(13.2
)%
 
2,634.3
%
 


 
 
3.8
%
 
649.5
%
 


 

We recorded an income tax expense of $0.2 million and $0.0 million for the three and nine months ended September 30, 2016, respectively compared to income tax expense of $191.9 million and $191.6 million for the same periods in 2015. The income tax benefit for the three and nine months ended September 30, 2016 is based on the estimated annual effective tax rate of 42.0%. Income tax benefit for the three and nine months ended September 30, 2015 is primarily the result of releasing a valuation allowance against a significant portion of our deferred tax assets. The tax benefit is primarily comprised

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of U.S. federal and state net operating loss carryforwards, tax credits, and other temporary differences.
Discontinued Operations

In 2006, we entered into a purchase agreement with Eisai pursuant to which Eisai agreed to acquire our Oncology product line which included four marketed oncology drugs: ONTAK, Targretin capsules, Targretin gel and Panretin gel. Certain liabilities were recorded associated with the disposal of the product line. During the first three quarters of 2016 we recognized a $1.1 million gain due to subsequent changes in certain estimates and liabilities previously recorded.


Liquidity and Capital Resources

We have financed our operations through offerings of our equity securities, issuance of convertible notes, product sales and the subsequent sales of our commercial assets, royalties, collaborative research and development and other revenue, and operating lease transactions.

We had net income of $1.1 million for the quarter ended September 30, 2016. As of September 30, 2016, our cash, cash equivalents and marketable securities totaled $124.1 million, and we had a working capital deficit of $85.4 million. We believe that our currently available funds, cash generated from operations as well as existing sources of and access to financing will be sufficient to fund our anticipated operating, capital requirements and debt service requirement. We expect to build cash in future months as we continue to generate significant cash flow from royalty, license and milestone revenue and Captisol material sales primarily driven by continued increases in Promacta and Kyprolis sales, recent product approvals and regulatory developments, as well as revenue from anticipated new licenses and milestones. In addition, we anticipate that our liquidity needs can be met through other sources, including sales of marketable securities, borrowings through commercial paper and/or syndicated credit facilities and access to other domestic and foreign debt markets and equity markets.

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.

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 equity securities as a result of milestones and license fees received from licensees as well as warrants to purchase Viking common stock.

Borrowings and Other Liabilities

2019 Convertible Senior Notes

We have convertible debt outstanding as of September 30, 2016 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 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 September 2015, our Board of Directors authorized us to repurchase up to $200.0 million of our common stock from time to time over a period of up to three years. During the three months ended September 30, 2016, the Company repurchased 15,500 shares for $1.6 million in the aggregate. Subsequent to September 30, 2016, the Company repurchased 25,000 shares of its common stock for $2.3 million in the aggregate.

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Contingent Liabilities

CyDex

In connection with the acquisition of CyDex in January 2011, we issued a series of CVRs and also assumed certain contingent liabilities. We may be required to make additional payments upon achievement of certain clinical and regulatory milestones to the CyDex shareholders and former license holders. In addition, we will pay CyDex shareholders, for each respective year through 2016, 20% of all CyDex-related revenue, but only to the extent that, and beginning only when, CyDex-related revenue for such year exceeds $15.0 million; plus an additional 10% of all CyDex-related revenue recognized during such year, but only to the extent that, and beginning only when aggregate CyDex-related revenue for such year exceeds $35.0 million. We have paid $25.0 million to the CyDex shareholders for revenue sharing payments under the terms of the CVR agreement. The estimated fair value of the contingent liabilities recorded as part of the CyDex acquisition at September 30, 2016 was $6.7 million, and as of December 31, 2015 was $9.5 million.

Metabasis

In connection with the acquisition of Metabasis in January 2010, we entered into four CVR agreements with Metabasis shareholders. 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, 2016 was $2.3 million, and as of December 31, 2015 was $4.0 million.
Leases and Off-Balance Sheet Arrangements

We lease our office and research facilities under operating lease arrangements with varying terms through November 2019. The agreements provide for increases in annual rents based on changes in the Consumer Price Index or fixed percentage increases ranging from 3.0% to 3.5%. We also sublease a portion of our facilities through leases which expire between 2015 and 2023. The sublease agreements provide for a 3% increase in annual rents. We had no off-balance sheet arrangements at September 30, 2016 and December 31, 2015.

Cash Flows

Operating Activities

Net cash provided by operating activities in the first three quarters of 2016 was $42.0 million compared to $28.1 million for the first three quarters of 2015.

The net cash provided for the first three quarters of 2016 reflects net income of $1.5 million, adjusted by $45.7 million of non-cash items to reconcile net income to net cash generated from operations. These reconciling items primarily reflect stock-based compensation of $13.7 million, amortization of debt discount and issuance fees of $8.1 million, depreciation and amortization of $8.3 million, loss from Viking Therapeutics of $14.1 million, realized gain on investments of $1.8 million, $2.6 million increase in the estimated fair value of contingent liabilities, fair value adjustment for Viking note receivable and warrants of $0.5 million and deferred income taxes of $0.3 million. The cash generated during the nine months ended September 30, 2016 is further impacted by changes in operating assets and liabilities due primarily to an increase in accounts receivable of $0.4 million, a decrease in accounts payable and accrued liabilities of $3.1 million and an increase in inventory of $2.4 million.

The net cash provided for the first three quarters of 2015 reflects net income of $221.1 million, adjusted by $194.6 million of non-cash items to reconcile net income to net cash generated from operations. These reconciling items primarily reflect stock-based compensation of $9.5 million, amortization of debt discount and issuance fees of $7.6 million, depreciation and amortization of $1.9 million, gain on deconsolidation of Viking of $28.2 million, loss on equity investment in Viking of $3.0 million, realized gain on investments of $2.0 million, $5.0 million increase in the estimated fair value of contingent liabilities and deferred income taxes of $191.6 million . The cash generated during the nine months ended September 30, 2015 is further impacted by changes in operating assets and liabilities due primarily to a decrease in accounts receivable of $7.1 million and a decrease in restricted cash of $0.7 million. Partially offsetting, cash generated for the period was impacted by an increase in other current assets of $0.4 million, a decrease in accounts payable and accrued liabilities of $5.0 million, an increase in other long-term assets of $0.5 million, and an increase in inventory of $0.2 million.
    

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Investing Activities