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 June 30, 2015
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Transition Period From ______ to ______ .
Commission File Number: 001-33093
________________________________________________________________________________________
LIGAND PHARMACEUTICALS INCORPORATED
(Exact name of registrant as specified in its charter)
________________________________________________________________________________________
Delaware
77-0160744
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
11119 North Torrey Pines Road, Suite 200
La Jolla, CA
92037
(Zip Code)
(Address of principal executive offices)
 
(858) 550-7500
(Registrant's Telephone Number, Including Area Code)
________________________________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer
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 August 1, 2015, the registrant had 19,854,830 shares of common stock outstanding.


Table of Contents


LIGAND PHARMACEUTICALS INCORPORATED
QUARTERLY REPORT

FORM 10-Q

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





Table of Contents

PART I.
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
LIGAND PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except share data)
 
June 30, 2015
 
December 31, 2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
108,238

 
$
160,203

Short-term investments
73,371

 
7,133

Accounts receivable
5,532

 
12,634

Note receivable
5,547

 

Inventory
802

 
269

Capitalized expenses (Viking IPO)

 
2,268

Current debt issuance costs
834

 
809

Restricted investments
600

 
1,261

Other current assets
1,801

 
1,842

Total current assets
196,725

 
186,419

Property and equipment, net
405

 
486

Investment in Viking Therapeutics
33,996

 

Intangible assets, net
49,535

 
50,723

Goodwill
12,238

 
12,238

Commercial license rights
8,598

 
4,568

Long-term debt issuance costs
2,964

 
3,388

Other assets
301

 
207

Total assets
$
304,762

 
$
258,029

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable (including $0 and $2,211 related to a VIE, respectively)
$
2,708

 
$
7,698

Accrued liabilities
5,629

 
4,866

Current contingent liabilities
7,674

 
6,796

Current lease exit obligations
1,638

 
2,356

Other current liabilities
300

 
1,063

Total current liabilities
17,949

 
22,779

Long-term deferred revenue, net
2,083

 
2,085

Long-term lease exit obligations
228

 
934

Deferred income taxes
3,059

 
2,792

Long-term contingent liabilities
11,089

 
8,353

Long-term debt, net
200,567

 
195,908

Other long-term liabilities
734

 
770

Total liabilities
235,709

 
233,621

Commitments and Contingencies

 

Stockholders' equity:
 
 
 
Common stock, $0.001 par value; 33,333,333 shares authorized; 19,837,109 and 19,575,150 shares issued and outstanding at June 30, 2015 and December 31, 2014, respectively
20

 
20

Additional paid-in capital
692,765

 
680,660

Accumulated other comprehensive income
11,265

 
4,953

Accumulated deficit
(634,997
)
 
(659,315
)
Total stockholders' equity attributable to Ligand Pharmaceuticals
69,053

 
26,318

Noncontrolling interests

 
(1,910
)
Total liabilities and stockholders' equity
$
304,762

 
$
258,029

See accompanying notes.

3

Table of Contents

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

 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Royalties
$
6,606

 
$
5,241

 
$
16,893

 
$
13,091

Material sales
10,681

 
3,476

 
14,410

 
9,191

Collaborative research and development and other revenues
1,131

 
1,891

 
1,717

 
4,284

Total revenues
18,418

 
10,608

 
33,020

 
26,566

Operating costs and expenses:
 
 
 
 
 
 
 
Cost of goods
2,600

 
1,186

 
3,673

 
3,637

Research and development
4,010

 
2,689

 
7,972

 
5,821

General and administrative
7,225

 
5,239

 
13,219

 
10,310

Lease exit and termination costs
218

 
136

 
441

 
340

Total operating costs and expenses
14,053

 
9,250

 
25,305

 
20,108

Income from operations
4,365

 
1,358

 
7,715

 
6,458

Other (expense) income:
 
 
 
 
 
 
 
Interest expense, net
(2,969
)
 
(181
)
 
(5,945
)
 
(429
)
Increase in contingent liabilities
(7,274
)
 
(1,312
)
 
(7,277
)
 
(3,260
)
Gain on deconsolidation of Viking Therapeutics
28,190

 

 
28,190

 

Equity in net losses from Viking Therapeutics
(870
)
 

 
(870
)
 

Other, net
850

 
1,376

 
404

 
621

Total other (expense) income, net
17,927

 
(117
)
 
14,502

 
(3,068
)
Income before income taxes
22,292

 
1,241

 
22,217

 
3,390

Income tax (expense) benefit
(265
)
 
47

 
(279
)
 
(6
)
Net income including noncontrolling interests:
22,027

 
1,288

 
21,938

 
3,384

Less: Net loss attributable to noncontrolling interests
(1,537
)
 
(304
)
 
(2,380
)
 
(304
)
Net income
$
23,564

 
$
1,592

 
$
24,318

 
$
3,688

 
 
 
 
 
 
 
 
Per share amounts attributable to Ligand common shareholders:
 
 
 
 
 
 
 
Basic net income per share
$
1.19

 
$
0.08

 
$
1.24

 
$
0.18

Diluted net income per share
$
1.11

 
$
0.07

 
$
1.16

 
$
0.17

 
 
 
 
 
 
 
 
Weighted-average number of common shares-basic
19,725,410

 
20,738,299

 
19,668,183

 
20,668,110

Weighted-average number of common shares-diluted
21,276,404

 
21,780,034

 
20,953,134

 
21,776,125


See accompanying notes.

4

Table of Contents

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

 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
23,564

 
$
1,592

 
$
24,318

 
$
3,688

Unrealized net gain (loss) on available-for-sale securities, net of tax of $0
3,230

 
(5,127
)
 
7,844

 
3,095

Less: Reclassification of net realized gains included in net income
(1,300
)
 
(774
)
 
(1,533
)
 
(968
)
Comprehensive income (loss)
$
25,494

 
$
(4,309
)
 
$
30,629

 
$
5,815


See accompanying notes.


5

Table of Contents

LIGAND PHARMACEUTICAL INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
Six months ended
 
June 30,
 
2015
 
2014
Operating activities
 
 
 
Net income including noncontrolling interests
$
21,938

 
$
3,384

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
7,277

 
3,261

Realized gain on sale of short-term investment
(502
)
 
(968
)
Gain on write-off of assets

 
(16
)
Depreciation and amortization
1,296

 
1,337

Amortization of discount on investments, net
(34
)
 

Amortization of debt discount and issuance fees
5,058

 

Stock-based compensation
6,675

 
5,093

Non-cash upfront fee

 
(1,211
)
Deferred income taxes
268

 
6

Accretion of note payable
16

 
169

Gain on deconsolidation of Viking Therapeutics, Inc.
(28,190
)
 

Loss on equity investment in Viking Therapeutics, Inc.
870

 

Changes in operating assets and liabilities:
 
 
 
     Accounts receivable
7,102

 
(911
)
     Inventory
(533
)
 
575

     Other current assets
(462
)
 
(136
)
     Other long-term assets
(598
)
 
(231
)
     Accounts payable and accrued liabilities
(3,107
)
 
(3,743
)
     Restricted investments
661

 

     Deferred revenue
(110
)
 
(24
)
Net cash provided by operating activities
17,625

 
6,585

Investing activities
 
 
 
Purchase of commercial license rights
(4,030
)
 

Payments to CVR holders and other contingency payments
(3,663
)
 
(1,668
)
Purchases of property and equipment
(27
)
 

Purchase of short-term investments
(60,432
)
 

Purchase of Viking common stock
(9,000
)
 

Proceeds from sale of property and equipment
1

 
125

Reduction of cash due to deconsolidation of Viking Therapeutics, Inc.
(247
)
 

Proceeds from sale of short-term investments
2,378

 
1,155

Other, net

 
(1
)
Net cash used in investing activities
(75,020
)
 
(389
)
Financing activities
 
 
 
Repayment of debt

 
(6,947
)
Net proceeds from stock option exercises and ESPP
5,430

 
3,648

Net cash provided by (used in) financing activities
5,430

 
(3,299
)
Net (decrease) increase in cash and cash equivalents
(51,965
)
 
2,897

Cash and cash equivalents at beginning of period
160,203

 
11,639

Cash and cash equivalents at end of period
$
108,238

 
$
14,536


Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
903

 
$
212

Taxes paid
$
13

 
$
3

Supplemental schedule of non-cash activity
 
 
 
Unrealized gain on AFS investments
$
7,844

 
$
3,095



6

Table of Contents

See accompanying notes

7

Table of Contents

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

1. Basis of Presentation

Ligand Pharmaceuticals Incorporated, a Delaware corporation (the "Company" or "Ligand") is a biopharmaceutical company with a business model that is based upon the concept of developing or acquiring royalty revenue generating assets and coupling them with a lean corporate cost structure. By diversifying the portfolio of assets across numerous technology types, therapeutic areas, drug targets, and industry partners, the Company offers investors an opportunity to invest in the increasingly complicated and unpredictable pharmaceutical industry. 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, focal segmental glomerulosclerosis ("FSGS"), menopausal symptoms and osteoporosis. Ligand has established multiple alliances with the world’s leading pharmaceutical companies including Novartis, Amgen, Merck, Pfizer, Baxter International, and Eli Lilly. The Company’s principal market is the United States. The Company sold its Oncology Product Line ("Oncology") and Avinza Product Line ("Avinza") on October 25, 2006 and February 26, 2007, respectively. The operating results for Oncology and Avinza have been presented in the accompanying condensed consolidated financial statements as "Discontinued Operations."

Principles of Consolidation
    
The accompanying 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 as of June 30, 2015 and for the three and six months ended June 30, 2015 and 2014 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. The Company’s unaudited condensed consolidated balance sheet at December 31, 2014 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position and results of operations of the Company and its subsidiaries, have been included. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. 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, 2014.

Use of Estimates

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


8

Table of Contents

Income Per Share

Basic income per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted income per share is computed by dividing net income by the weighted-average number of common shares and common stock equivalents of all dilutive securities calculated using the treasury stock method and the if-converted method. The total number of potential securities including stock options and warrants excluded from the computation of diluted income per share because their inclusion would have been anti-dilutive was 3.5 million and 0.4 million, as of June 30, 2015 and 2014, respectively.

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

 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
23,564

 
$
1,592

 
$
24,318

 
$
3,688

 
 
 
 
 
 
 
 
Shares used to compute basic income per share
19,725,410

 
20,738,299

 
19,668,183

 
20,668,110

Dilutive potential common shares:
 
 
 
 
 
 
 
Restricted stock
42,836

 
29,029

 
52,187

 
44,815

     Stock options
1,044,926

 
1,012,706

 
1,001,147

 
1,063,200

     0.75% Convertible Senior Notes, Due 2019
463,232

 

 
231,617

 

Shares used to compute diluted income per share
21,276,404

 
21,780,034

 
20,953,134

 
21,776,125

 
 
 
 
 
 
 
 
Basic per share amounts:
 
 
 
 
 
 
 
Net income
$
1.19

 
$
0.08

 
$
1.24

 
$
0.18

 
 
 
 
 
 
 
 
Diluted per share amounts:
 
 
 
 
 
 
 
Net income
$
1.11

 
$
0.07

 
$
1.16

 
$
0.17


Cash Equivalents
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 investment 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.

9

Table of Contents

Restricted Investments
Restricted investments consist of certificates of deposit held with a financial institution as collateral under a facility lease and third-party service provider arrangements.
The following table summarizes the various investment categories at June 30, 2015 and December 31, 2014 (in thousands):

 
Amortized cost
 
Gross unrealized
gains
 
Gross unrealized
losses
 
Estimated
fair value
June 30, 2015
 
 
 
 
 
 
 
Short-term investments
 
 
 
 
 
 


     Bank deposits
$
38,174

 
$
3

 
$
(3
)
 
$
38,174

     Corporate bonds
5,115

 

 
(5
)
 
5,110

     Commercial paper
3,498

 

 

 
3,498

     Asset backed securities
13,330

 

 
(3
)
 
13,327

     Corporate equity securities
1,988

 
11,274

 

 
13,262

Restricted investments
600

 

 

 
600

 
$
62,705

 
$
11,277

 
$
(11
)
 
$
73,971

December 31, 2014
 
 
 
 
 
 
 
Short-term investments
 
 
 
 
 
 
 
     Corporate equity securities
2,179

 
4,954

 

 
7,133

Restricted investments
1,261

 

 

 
1,261

 
$
3,440

 
$
4,954

 
$

 
$
8,394


Concentrations of Credit Risk

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

The Company invests its excess cash principally in U.S. government debt securities, investment-grade corporate debt securities and certificates of deposit. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The Company did not experience any significant losses on its cash equivalents, short-term investments or restricted investments for either of the periods ending June 30, 2015 and December 31, 2014.

Accounts receivable were $5.5 million and 88% was due from one customer at June 30, 2015. Accounts receivable were $12.6 million and 64% was due from two customers at December 31, 2014

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

Inventory

Inventory is stated at the lower of cost or market value. The Company determines cost using the first-in, first-out method. The Company analyzes its inventory levels periodically and writes down inventory to its net realizable value if it has become obsolete, has a cost basis in excess of its expected net realizable value or is in excess of expected requirements. There were no write downs related to obsolete inventory recorded for the three and six months ended June 30, 2015 and 2014.


10

Table of Contents

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts based on the best estimate of the amount of probable losses in the Company’s existing accounts receivable. Accounts receivable that are outstanding longer than their contractual payment terms, ranging from 30 to 90 days, are considered past due. When determining the allowance for doubtful accounts, several factors are taken into consideration, including historical write-off experience and review of specific customer accounts for collectability. Account balances are charged off against the allowance after collection efforts have been exhausted and the potential for recovery is considered remote. There was no allowance for doubtful accounts included in the balance sheets at June 30, 2015 and December 31, 2014.

Property and Equipment

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

 
June 30,
 
December 31,
 
2015
 
2014
Lab and office equipment
$
2,182

 
$
2,232

Leasehold improvements
273

 
273

Computer equipment and software
632

 
624

 
3,087

 
3,129

Less accumulated depreciation and amortization
(2,682
)
 
(2,643
)
     Total property and equipment, net
$
405

 
$
486


Depreciation of equipment is computed using the straight-line method over the estimated useful lives of the assets, which range from three to ten years. Leasehold improvements are amortized using the straight-line method over their estimated useful lives or their related lease term, whichever is shorter. Depreciation expense was recognized for each of the three and six months ended June 30, 2015 and 2014 of $0.1 million and $0.1 million, respectively. Depreciation expense is included in operating expenses.

Goodwill and Other Identifiable Intangible Assets

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

 
June 30,
 
December 31,
 
2015
 
2014
Indefinite lived intangible assets
 
 
 
     Acquired in-process research and development
$
12,556

 
$
12,556

     Goodwill
12,238

 
12,238

Definite lived intangible assets
 
 
 
     Complete technology
15,267

 
15,267

          Less: Accumulated amortization
(3,380
)
 
(2,999
)
     Trade name
2,642

 
2,642

          Less: Accumulated amortization
(586
)
 
(519
)
     Customer relationships
29,600

 
29,600

          Less: Accumulated amortization
(6,564
)
 
(5,824
)
Total goodwill and other identifiable intangible assets, net
$
61,773

 
$
62,961


Amortization of definite-lived intangible assets is computed using the straight-line method over the estimated useful life of the asset of 20 years. Amortization expense of $0.6 million and $1.2 million was recognized for each of the three and six months ended June 30, 2015 and 2014, respectively. Estimated amortization expense for the years ending December 31, 2015 through 2019 is $2.4 million per year.    


11

Table of Contents

The Company accounts for goodwill and other intangible assets in accordance with Accounting Standards Codification ("ASC") Topic 350 - Intangibles - Goodwill and Other which, among other things, establishes standards for goodwill acquired in a business combination, eliminates the amortization of goodwill and requires the carrying value of goodwill and certain non-amortizing intangibles to be evaluated for impairment on an annual basis. The Company uses the income approach and the market approach, each weighted at 50%, when performing its goodwill impairment analysis. For the income approach, the Company considers the present value of future cash flows and the carrying value of its assets and liabilities, including goodwill. The market approach is based on an analysis of revenue multiples of peer public companies. If the carrying value of the assets and liabilities, including goodwill, were to exceed the Company’s estimation of the fair value, the Company would record an impairment charge in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. The Company performs an evaluation of goodwill and other intangibles as of December 31 of each year, absent any indicators of earlier impairment, to ensure that impairment charges, if applicable, are reflected in the Company's financial results before December 31 of each year. When it is determined that impairment has occurred, a charge to operations is recorded. Goodwill and other intangible asset balances are included in the identifiable assets of the business segment to which they have been assigned. Any goodwill impairment, as well as the amortization of other purchased intangible assets, is charged against the respective business segments' operating income. For each of the three and six months ended June 30, 2015 and 2014, there was no impairment of goodwill.
Acquired In-Process Research and Development
    
Intangible assets related to acquired in-process research and development ("IPR&D") are considered to be indefinite-lived until the completion or abandonment of the associated research and development efforts. During the period the assets are considered to be indefinite-lived, they will not be amortized but will be tested for impairment on an annual basis and between annual tests if the Company becomes aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the IPR&D projects below their respective carrying amounts. If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets would be deemed definite-lived and would then be amortized based on their respective estimated useful lives at that point in time. For each of the three and six months ended June 30, 2015 and 2014, there was no impairment of IPR&D.

Commercial license rights
    
Commercial license rights represent a portfolio of future milestone and royalty payment rights acquired in accordance with two Royalty Stream and Milestone Payments Purchase Agreements entered into with Selexis SA ("Selexis") in April 2013 and April 2015. Individual commercial license rights acquired under the agreement are carried at allocated cost and approximate fair value. The carrying value of the license rights will be reduced on a pro-rata basis as revenue is realized over the term of the agreement. Declines in the fair value of individual license rights below their carrying value that are deemed to be other than temporary are reflected in earnings in the period such determination is made. As of June 30, 2015, 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.

Other Current Assets

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

 
June 30,
 
December 31,
 
2015
 
2014
Prepaid expenses
$
1,206

 
$
835

Other receivables
595

 
685

Co-promote receivable

 
322

     Total other current assets
$
1,801

 
$
1,842


Investment in Viking Therapeutics
 
Beginning May 2015, the Company deconsolidated a previously reported variable interest entity ("VIE"). The Company elected to record its investment in Viking Therapeutics ("Viking") under the equity method of accounting as Viking is no longer considered a VIE and the Company does not have voting control or other elements of control that would require consolidation. The investment is subsequently adjusted for the Company’s share of Viking's operating results, and if applicable,

12

Table of Contents

cash contributions and distributions, which is reported on a separate line in our condensed consolidated statement of operations called “Equity in net losses of Viking Therapeutics”. On the condensed consolidated balance sheet, the Company reports its investment in Viking on a separate line in the non-current assets section called “Investment in Viking Therapeutics”. See Note 3, Investment in Viking Therapeutics, Inc., for additional details.


Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

 
June 30,
 
December 31,
 
2015
 
2014
Compensation
$
1,399

 
$
1,708

Professional fees
545

 
459

Amounts owed to former licensees
1,960

 
925

Royalties owed to third parties
634

 
705

Other
1,091

 
1,069

     Total accrued liabilities
$
5,629

 
$
4,866


Other Long-Term Liabilities

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

 
June 30,
 
December 31,
 
2015
 
2014
Deposits
$
396

 
$
411

Deferred rent
306

 
327

Other
32

 
32

     Total other long-term liabilities
$
734

 
$
770

Contingent Liabilities
    
In connection with the Company’s acquisition of CyDex in January 2011, the Company recorded a $17.6 million contingent liability, inclusive of the $4.3 million payment made in January 2012, for amounts potentially due to holders of the CyDex contingent value rights ("CVRs") and former license holders. The liability is periodically assessed based on events and circumstances related to the underlying milestones, royalties and material sales. Any change in fair value is recorded in the Company’s consolidated 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 June 30, 2015 and December 31, 2014 was $10.4 million and $11.5 million, respectively. The Company recorded a fair-value adjustment to increase the liability by $1.0 million and $2.2 million for the three and six months ended June 30, 2015, respectively. There was a revenue-sharing payment of $3.2 million during the six months ended June 30, 2015. For the three and six months ended June 30, 2014, the Company recorded a fair-value adjustment to increase the liability by $3.2 million and $2.7 million, respectively. There was a revenue-sharing payment of $1.6 million made during the six months ended June 30, 2014.
    
In connection with the Company’s acquisition of Metabasis in January 2010, the Company issued to Metabasis stockholders four tradable CVRs, one CVR from each of four respective series of CVR, for each Metabasis share. The CVRs will entitle Metabasis stockholders to cash payments as frequently as every six months as cash is received by the Company from proceeds from the sale or partnering of any of the Metabasis drug development programs, among other triggering events. The fair values of the CVRs are remeasured at each reporting date through the term of the related agreement. Changes in the fair values are reported in the statement of operations as income (decreases) or expense (increases). The carrying amount of the liability may fluctuate significantly based upon quoted market prices and actual amounts paid under the agreements may be materially different than the carrying amount of the liability. The fair value of the liability was estimated to be $8.4 million and $3.7 million as of June 30, 2015 and December 31, 2014, respectively. The Company recorded an increase in the liability for

13

Table of Contents

Metabasis-related CVRs of $6.4 million and $5.3 million for the three and six months ended June 30, 2015, respectively. The Company recorded a decrease in the liability for Metabasis-related CVRs of $1.9 million and an increase in the liability of $0.5 million for the three and six months ended June 30, 2014, respectively.

Fair Value of Financial Instruments
Fair value is defined as the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. The Company establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels are described in the below with level 1 having the highest priority and level 3 having the lowest:
Level 1 - Quoted prices in active markets;
Level 2 - Inputs other than the quoted prices in active markets that are observable either directly or indirectly; and
Level 3 - Unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions.
The Company evaluates its financial instruments at each reporting period to determine if any transfers between the various three-level hierarchy have occurred and appropriately reclassifies its financial instruments to the appropriate level within the hierarchy.

Revenue Recognition

Royalties on sales of products commercialized by the Company’s partners are recognized in the quarter reported to Ligand by the respective partner. Generally, the Company receives royalty reports from its licensees approximately one quarter in arrears due to the fact that its agreements require partners to report product sales between 30 and 60 days after the end of the quarter. The Company recognizes royalty revenues when it can reliably estimate such amounts and collectability is reasonably assured. Under this accounting policy, the royalty revenues reported are not based upon estimates and such royalty revenues are typically reported to the Company by its partners in the same period in which payment is received.
Revenue from material sales of Captisol is recognized upon transfer of title, which normally passes upon shipment to the customer, provided all other revenue recognition criteria have been met; however, we do not recognize revenue until all applicable substantive customer acceptance requirements have been met. The Company’s credit and exchange policy includes provisions for the return of product between 30 to 90 days, depending on the specific terms of the individual agreement, when that product (1) does not meet specifications, (2) is damaged in shipment (in limited circumstances where title does not transfer until delivery), or (3) is exchanged for an alternative grade of Captisol. All product returns are subject to approval by the Company and a 20% restocking fee. To date, product returns by customers have not been material to net material sales in any related period. The Company records revenue net of product returns, if any, and sales tax collected and remitted to government authorities during the period.

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

Other nonrefundable, upfront license fees are recognized as revenue upon delivery of the license, if the license is determined to have standalone value that is not dependent on any future performance by the Company under the applicable collaboration agreement. Nonrefundable contingent event-based payments are recognized as revenue when the contingent event is met, which is usually the earlier of when payments are received or collections are assured, provided that it does not require future performance by the Company. The Company occasionally has sub-license obligations related to arrangements

14

Table of Contents

for which it receives license fees, milestones and royalties. The Company evaluates the determination of gross versus net reporting based on each individual agreement.
Sales-based contingent payments from partners are accounted for similarly to royalties, with revenue recognized upon achievement of the sales targets assuming all other revenue recognition criteria for milestones are met. Revenue from development and regulatory milestones is recognized when earned, as evidenced by written acknowledgement from the collaborator, provided that (1) the milestone event is substantive, its achievability was not reasonably assured at the inception of the agreement, and the Company has no further performance obligations relating to that event, and (2) collectability is reasonably assured. If these criteria are not met, the milestone payment is recognized over the remaining period of the Company’s performance obligations under the arrangement.    
Revenue from research funding under our collaboration agreements is earned and recognized on a percentage-of completion basis as research hours are incurred in accordance with the provisions of each agreement.
In May 2014, the Company entered into a licensing agreement and research collaboration with Omthera Pharmaceuticals. The research collaboration targets the development of novel products that utilize the proprietary Ligand developed LTP TECHNOLOGY™ to improve lipid-lowering activity of certain omega-3 fatty acids. The Company is eligible to receive compensation and reimbursement from Omthera for internal research efforts and external costs incurred, as well as development and regulatory event-based payments. The completion of a proof of concept under the development program would trigger a $1.0 million payment which is determined to be a milestone under the milestone method of accounting as (1) it is an event that can only be achieved in part on the Company's past performance, (2) there was substantive uncertainty at the date the arrangement was entered into that the event would be achieved and (3) it results in additional payment being due to the Company. None of the other event-based payments represents a milestone under the milestone method of accounting. No event based payment or milestone was achieved during the periods presented. The Company received $0.5 million from Omthera in 2014 under the agreement and recognized $0.4 million as collaborative revenue based on the percentage of completion of the research program at December 31, 2014. No milestone payment or contingent payment was received in 2014 or in the six months ended June 30, 2015.

Accounting for Stock-Based Compensation

Stock-based compensation expense for awards to employees and non-employee directors is recognized on a straight-line basis over the vesting period until the last tranche vests. 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
 
Six months ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Stock-based compensation expense as a component of:
 
 
 
 
 
 
 
Research and development expenses
$
1,253

 
$
956

 
$
2,174

 
$
1,645

General and administrative expenses
2,507

 
2,071

 
4,501

 
3,448

 
$
3,760

 
$
3,027

 
$
6,675

 
$
5,093


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
 
Six months ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Risk-free interest rate
1.7%
 
1.9%
 
1.8%
 
1.9%
Dividend yield
 
 
 
Expected volatility
58%
 
67%
 
58%
 
69%
Expected term
6.6
 
6.4
 
6.6
 
6.4
Forfeiture rate
8.5%
 
8.6%
 
8.5%
 
8.6%-9.7%


15

Table of Contents

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

Cost of Material Sales

The Company determines cost using the first-in, first-out method. Cost of goods sold include all costs of purchase and other costs incurred in bringing the inventories to their present location and condition, including costs to store and distribute.
Preclinical Study and Clinical Trial Accruals
    
Substantial portions of the Company’s preclinical studies and all of the Company's clinical trials have been performed by third-party laboratories, contract research organizations, or other vendors (collectively "CROs"). Some CROs bill monthly for services performed, while others bill based upon milestone achievement. The Company accrues for each of the agreements it has with CROs on a monthly basis. For preclinical studies, accruals are estimated based upon the percentage of work completed and the contract milestones achieved. For clinical studies, accruals are estimated based upon a percentage of work completed, the number of patients enrolled and the duration of the study. The Company monitors patient enrollment, the progress of clinical studies and related activities to the extent possible through internal reviews of data reported to it by the CROs, correspondence with the CROs and clinical site visits. The Company's estimates are dependent upon the timelines and accuracy of the data provided by its CROs regarding the status of each program and total program spending. The Company periodically evaluates its estimates to determine if adjustments are necessary or appropriate based on information it receives concerning changing circumstances, and conditions or events that may affect such estimates. No material adjustments to preclinical study and clinical trial accrued expenses have been recognized to date.

Research and Development

Research and development expense consists of labor, material, equipment, and allocated facility costs of the Company’s scientific staff who are working pursuant to the Company’s collaborative agreements and other research and development projects. Also included in research and development expenses are third-party costs incurred for the Company’s research programs including in-licensing costs, CRO costs and costs incurred by other research and development service vendors. We expense these costs as they are incurred. When we make payments for research and development services prior to the services being rendered, we record those amounts as prepaid assets on our consolidated balance sheet and we expense them as the services are provided.

Income Taxes

                Income taxes are accounted for under the liability method.  This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the consolidated financial statements.  A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before the Company is able to realize their benefit or if future deductibility is uncertain.  As of June 30, 2015, the Company had provided a full valuation allowance against its deferred tax assets as recoverability was uncertain.  Developing the provision for income taxes requires significant judgment and expertise in federal and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets.  The Company's judgments and tax strategies are subject to audit by various taxing authorities.  While management believes the Company has provided adequately for its income tax liabilities in its consolidated financial statements, adverse determinations by these taxing authorities could have a material adverse effect on the Company's consolidated financial condition and results of operations. 

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


16

Table of Contents

Discontinued Operations - Oncology Product Line
    
In 2006, the Company and Eisai Inc. and Eisai Co., Ltd. (collectively "Eisai"), entered into an agreement whereby Eisai acquired all of the Company's worldwide rights in and to its oncology products. The Oncology product line included the Company's four marketed oncology drugs: Ontak, Targretin capsules, Targretin gel and Panretin gel.
    
Discontinued Operations - Avinza Product Line
    
In 2006, the Company and King Pharmaceuticals, now a subsidiary of Pfizer, entered into an agreement whereby Pfizer acquired all of the rights in and to Avinza in the United States, its territories and Canada. Pursuant to the terms of the agreement, the Company retained the liability for returns of product from wholesalers that had been sold by the Company prior to the close of the transaction. Accordingly, as part of the accounting for the gain on the sale of Avinza, the Company recorded a reserve for Avinza product returns.

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

Consolidation of Variable Interest Entities

The Company identifies an entity as a VIE if either: (1) the entity does not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) the entity's equity investors lack the essential characteristics of a controlling financial interest. The Company performs ongoing qualitative assessments of its VIEs to determine whether the Company has a controlling financial interest in any VIE and therefore is the primary beneficiary. If the Company is the primary beneficiary of a VIE, it consolidates the VIE under applicable accounting guidance. See Note 3, Investment in Viking Therapeutics, Inc., for additional details.

Convertible Debt

In August 2014, the Company completed a $245.0 million offering of convertible senior notes, which mature in 2019 and bear interest at 0.75% (the "2019 Convertible Senior Notes"). The Company accounts 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.
New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (1) identify the contract with the customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance

17

Table of Contents

obligations in the contract, (5) recognize revenue when (or as) the entity satisfies a performance obligation. Management is currently evaluating the effect the adoption of this standard will have on the Company's financial statements.

In February 2015, FASB issued ASU 2015-02 Consolidation (Topic 810): Amendments to the Consolidation Analysis. ASU 2015-02 changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. It is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. Management is currently evaluating the impact of the adoption of ASU 2015-02 on our consolidated financial statements.
    
In April 2015, FASB issued ASU 2015-03, Interest—Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. This update was issued to simplify the presentation for debt issuance costs. Upon adoption, such costs shall be presented on our consolidated balance sheets as a direct deduction from the carrying amount of the related debt liability and not as a deferred charge presented in Other assets on our consolidated balance sheets. This amendment will be effective for interim and annual periods beginning on January 1, 2016, and is required to be retrospectively adopted. Management expects to change the presentation on our consolidated balance sheets accordingly for all periods impacted upon the required adoption date.


2. Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including marketable securities, co-promote termination payments receivable and the related liability, contingent liabilities, and convertible note receivable from Viking.     

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 June 30, 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)
$
88,077

 
$

 
$
88,077

 
$

Short-term investments (2)
73,371

 
13,262

 
60,109

 

Note receivable Viking Therapeutics, Inc. (3)
5,547

 

 

 
5,547

     Total assets
$
166,995

 
$
13,262

 
$
148,186

 
$
5,547

Liabilities:
 
 
 
 
 
 
 
Current contingent liabilities-CyDex (4)
$
4,597

 
$

 
$

 
$
4,597

Current contingent liabilities-Metabasis (5)
3,077

 

 
3,077

 

Long-term contingent liabilities-CyDex (4)
5,773

 

 

 
5,773

Long-term contingent liabilities-Metabasis (5)
5,316

 

 
5,316

 

Liability for amounts owed to former licensees(6)
1,678

 
1,678

 

 

     Total liabilities
$
20,441

 
$
1,678

 
$
8,393

 
$
10,370


18

Table of Contents


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, 2014 (in thousands):

Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs *
 
Significant
Unobservable
Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents (1)
$
69,261

 
$

 
$
69,261

 
$

Current co-promote termination payments receivable (7)
322

 

 

 
322

Short-term investments (2)
7,133

 
7,133

 

 

     Total assets
$
76,716

 
$
7,133

 
$
69,261

 
$
322

Liabilities:
 
 
 
 
 
 
 
Current contingent liabilities-CyDex (4)
$
6,796

 
$

 
$

 
$
6,796

Current co-promote termination liability (7)
322

 

 

 
322

Long-term contingent liabilities-Metabasis (5)
3,652

 

 
3,652

 

Long-term contingent liabilities-CyDex (4)
4,701

 

 

 
4,701

Liability for amounts owed to former licensees (6)
773

 
773

 

 

     Total liabilities
$
16,244

 
$
773

 
$
3,652

 
$
11,819

*Adjusted to correct an error in disclosure that was deemed immaterial to the financial statements taken as a whole. Contingent liabilities related to Metabasis were reclassified from Level 1 to Level 2 as market is deemed inactive. Additionally, certain certificates of deposit with maturities less than 90 days were not previously disclosed in the table above.

(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 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 50% at June 30, 2015. Changes in these assumptions may materially affect the fair value estimate.
(4)
The fair value of the liabilities for CyDex contingent liabilities were determined based on the income approach using a Monte Carlo analysis. The fair value is subjective and is affected by changes in inputs to the valuation model including management’s assumptions regarding revenue volatility, probability of commercialization of products, estimates of timing and probability of achievement of certain revenue thresholds and developmental and regulatory milestones which may be achieved and affect amounts owed to former license holders and CVR holders. Changes in these assumptions can materially affect the fair value estimate.
(5)
The liability for CVRs for Metabasis are determined using quoted market prices in an inactive market for the underlying CVR.
(6)
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.
(7)
The co-promote termination payments receivable represents a receivable for future payments to be made by Pfizer related to product sales and is recorded at its fair value. The receivable and liability will remain equal. The fair value is determined based on a valuation model using an income approach.


19

Table of Contents


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

 
June 30, 2015
 
December 31, 2014
Range of annual revenue subject to revenue sharing (1)
$20.2 million-$21.8 million
 
$17.2 million-$17.3 million
Revenue volatility
30%
 
25%
Average probability of commercialization
80%
 
81%
Sales beta
0.50
 
0.60
Credit rating
B
 
B
Equity risk premium
6%
 
6%
(1)
Revenue subject to revenue sharing represent management’s estimate of the range of total annual revenue subject to revenue sharing (i.e. annual revenues in excess of $15 million) through December 31, 2016, which is the term of the CVR agreement.

A reconciliation of the level 3 financial instruments as of June 30, 2015 is as follows (in thousands):

Assets:
 
Fair value of level 3 financial instrument assets as of December 31, 2014
$
322

Assumed payments made by Pfizer or assignee
(390
)
Fair value adjustments to co-promote termination liability
68

Viking note receivable
5,547

Fair value of level 3 financial instrument assets as of June 30, 2015
$
5,547

 
 
Liabilities:
 
Fair value of level 3 financial instrument liabilities as of December 31, 2014
$
11,819

Assumed payments made by Pfizer or assignee
(390
)
Payments to CVR and other former license holders
(3,296
)
Fair value adjustments to contingent liabilities
2,169

Fair value adjustments to co-promote termination liability
68

Fair value of level 3 financial instrument liabilities as of June 30, 2015
$
10,370



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 market rate in an inactive market, which is classified as a Level 2 input, to estimate the current fair value of its 2019 Convertible Senior Notes. The estimated fair value of the 2019 Senior Convertible Notes was $353.6 million as of June 30, 2015. The carrying value of the notes does not reflect the market rate. See Note 7 Financing Arrangements for additional information.

Investment in Viking Therapeutics, Inc.

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 3 Investment in Viking Therapeutics, Inc. for additional information. The market value of the Company's investment in Viking was $34.2 million as of June 30, 2015. The carrying value of the investment in Viking does not reflect the market value.


20

Table of Contents

3. Investment in Viking Therapeutics, Inc.

Transaction History    

In May 2014, the Company entered into a Master License Agreement ("MLA") to license rights to five programs to Viking, an unrelated clinical-stage biopharmaceutical company focused on the development of novel therapies for metabolic and endocrine disorders. As an upfront payment under the MLA, Viking agreed to issue to the Company shares of Viking common stock having an aggregate value of approximately $29.0 million, subject to adjustment in certain circumstances, upon the consummation of Viking's initial public offering (the "Viking IPO") or certain other qualified financing events. In addition, Viking agreed to pay the Company royalties and milestone payments based on the progression and eventual sale of any products developed under the rights and licenses granted under the MLA. As part of this transaction, the Company extended a $2.5 million loan to Viking under a Loan and Security Agreement ("LSA") and evidenced by a convertible note. Under the terms of the LSA, the principal amount outstanding accrues interest at a fixed rate equal to 5%.

In April 2015, the Company entered into an amendment to the MLA with Viking (the "MLA Amendment") which among other things, caps the Company’s aggregate ownership of Viking common stock to 49.9% of the Viking capital stock outstanding following the closing of the Viking IPO. Additionally, the Company and Viking entered into an amendment to the LSA (the "LSA Amendment"), pursuant to which, the loans are no longer due and payable upon completion of the Viking IPO, but were extended to become due upon the earlier of: (i) a certain private qualified financing transaction with aggregate net proceeds to Viking of at least $20.0 million or (ii) a public offering subsequent to the Viking IPO with aggregate net proceeds to Viking of at least $20.0 million or (iii) one year after the closing of the Viking IPO. 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. As of June 30, 2015, the aggregate fair market value of the note receivable was $5.5 million.

In May 2015, Viking completed the Viking IPO selling 3.5 million shares of its common stock at an initial offering price of $8.00 per share for an aggregate offering price of $27.6 million before underwriting discounts and commissions. 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. In addition, pursuant to the amended MLA Amendment, the Company received approximately 3.7 million shares of Viking common stock having an aggregate value of approximately $29.2 million based on the initial public offering price of $8.00 per share. As a result, the Company including its related parties owned an aggregate of 48.8% of the outstanding common stock of Viking, based on the shares of outstanding Viking common stock at June 30, 2015. As of June 30, 2015, the carrying value of the Company's investment in Viking was $34.0 million.

Accounting Consideration

In May 2014, the Company determined it held a variable interest in Viking. The Company's variable interests in Viking included the convertible note issued pursuant to the LSA and the Company’s potential upfront payment of equity pursuant to the MLA. The Company considered certain criteria, including risk and reward sharing, experience and financial condition of its partner, voting rights, involvement in day-to-day operating decisions, the Company’s representation on Viking's executive committee, and level of economics between the Company and Viking. Based on these criteria, and using its judgment, the Company determined that it was the primary beneficiary of Viking and, as a result, the Company consolidated Viking on its financial statements as a variable interest entity (“VIE”). From May 21, 2014 through May 4, 2015, the date of Viking’s initial public offering (the “Viking IPO”), the Company recorded 100% of the losses incurred as net loss attributable to noncontrolling interest because it was a primary beneficiary with no equity interest in the VIE. The loans issued pursuant to the LSA was included as notes payable by Viking and were eliminated as long as the Company consolidated Viking on its financial statements.

Upon completion of the Viking IPO in May 2015, the Company determined that Viking was no longer a VIE. The Company also determined that it does not have voting control or other elements of control that would require consolidation of Viking. As a result of this assessment, the Company deconsolidated Viking on May 4, 2015 by derecognizing its assets, liabilities, and noncontrolling interest from the Company's consolidated financial statements. Applying deconsolidation accounting guidance, the Company determined, based on an independent valuation, the fair value of its equity investment in Viking upon deconsolidation was approximately $34.9 million after applying a discount on the Viking IPO price due to applicable transfer restrictions applicable to the Company as an affiliate of Viking pursuant to Rule 144 under the Securities Act of 1933. Based on a separate independent valuation, the Company determined that the fair value of the convertible notes receivable was approximately $5.5 million upon deconsolidation. The Company recorded a $28.2 million gain on deconsolidation of Viking in its consolidated statement of operations as of June 30, 2015.


21

Table of Contents

Following the deconsolidation, the Company accounts for its equity investment in Viking under the equity method. For each of the three and six months ended June 30, 2015, the Company reported approximately $0.9 million as equity in net losses from Viking. The Company has opted to account for the Viking convertible notes receivable at fair value. For each of the three and six months ended June 30, 2015, the Company recorded no change in the fair value of the Viking convertible notes since the deconsolidation date. See Note 2, Fair Value Measurements for additional details.

Viking's Assets and Liabilities
    
As of June 30, 2015, Viking's total assets were $22.3 million, total liabilities were $4.9 million and net losses for the three and six months ended June 30, 2015 were $7.9 million and $13.6 million, respectively. As of December 31, 2014 Viking's assets and liabilities which were consolidated for the period shown were as follows (in thousands):

 
December 31, 2014
Cash and cash equivalents
$
756

Other current assets
18

Capitalized IPO expenses
2,268

     Total current assets
$
3,042

 
 
Other assets
$
1

     Total assets
$
3,043

 
 
Accounts payable
$
2,211

Accrued liabilities
77

Current portion of notes payable
334

     Total current liabilities
$
2,622

 
 
Long-term portion of notes payable
2,331

     Total liabilities
$
4,953


Metabasis CVR payouts

In connection with the shares of Viking common stock received pursuant to the MLA, the Company will make a cash payment to the holders of certain Metabasis CVRs. The Company made a cash payment to certain holders of Metabasis CVRs of $0.4 million during the three and six months ended June 30, 2015. Additionally, the Company made a cash payment to certain holders of Metabasis CVRs of $0.5 million in July 2015. The Company estimates that the remaining cash payment, expected to be made in January 2016, will be approximately $2.6 million. See Note 1. Basis of Presentation-Contingent Liabilities for additional information on the Metabasis CVRs.


22

Table of Contents

4. Lease Obligations

The Company leases office and laboratory facilities in California, Kansas and New Jersey. These leases expire between 2015 and 2019, some of which are subject to annual rent increases which range from 3.0% to 3.5%. The Company currently subleases office and laboratory space in California and New Jersey. The following table provides a summary of operating lease obligations and payments expected to be received from sublease agreements as of June 30, 2015 (in thousands):

Operating lease obligations:
 
Lease
Termination
Date
 
Less than 1
year
1 year
2 years
3 years
4 years
Total
Corporate headquarters-
San Diego, CA
 
June 2019
 
$
691

$
709

$
727

$
747

$

$
2,874

Bioscience and Technology Business Center-
Lawrence, KS
 
December 2017
 
54

54

27



135

Vacated office and research facility-San Diego, CA
 
August 2015
 
191





191

Vacated office and research facility-
Cranbury, NJ
 
August 2016
 
2,614

436




3,050

Total operating lease obligations
 
 
 
$
3,550

$
1,199

$
754

$
747

$

$
6,250

 
 
 
 
 
 
 
 
 
 
Sublease payments expected to be received:
 
 
 
 
 
 
 
 
 
Corporate headquarters-
San Diego, CA
 
June 2019
 
$
436

$
446

$
457

$
469

$

$
1,808

Vacated office and research facility-
San Diego, CA
 
August 2015
 
78





78

Office and research facility-
Cranbury, NJ
 
August 2016
 
212

35




247

Net operating lease obligations
 
 
 
$
2,824

$
718

$
297

$
278

$

$
4,117



As of June 30, 2015 and December 31, 2014, the Company had lease exit obligations of $1.9 million and $3.3 million, respectively. For the three and six months ended June 30, 2015, the Company made cash payments, net of sublease payments received of $0.9 million and $1.9 million, respectively. The Company recognized adjustments for accretion and changes in leasing assumptions of $0.2 million and $0.4 million for the three and six months ended June 30, 2015, respectively. For the three and six months ended June 30, 2014, the Company made cash payments, net of sublease payments received of $0.9 million and $1.8 million, respectively. The Company recognized adjustments for accretion and changes in leasing assumptions of $0.1 million and $0.2 million for the three and six months ended June 30, 2014, respectively.
Total rent expense under all office leases for each of the three and six months ended June 30, 2015 was $0.1 million and $0.2 million, respectively. Total rent expense for the three and six months ended June 30, 2014 was $0.2 million and $0.4 million, respectively. The Company recognizes rent expense on a straight-line basis. Deferred rent at both June 30, 2015 and December 31, 2014 was $0.3 million, and is included in other long-term liabilities.


23

Table of Contents

5. Segment Reporting
The Company evaluates performance based on the operating income (loss) of the respective business segments. The segment results may not represent actual results that would be expected if they were independent, stand-alone businesses. Segment information is as follows (in thousands):
Balance Sheet Data:
As of June 30, 2015
 
Ligand
 
CyDex
 
Total
Total assets
$
239,133

 
$
65,629

 
$
304,762

 
 
 
 
 
 
 
As of December 31, 2014
 
Ligand
 
CyDex
 
Total
Total assets
$
184,215

 
$
73,814

 
$
258,029

 
 
 
 
 
 
Operating Data:
For the three months ended June 30, 2015
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
$
5,200

 
$
13,218

 
$
18,418

Depreciation and amortization expense
$
38

 
$
597

 
$
635

Operating (loss) income
$
(4,465
)
 
$
8,830

 
$
4,365

Interest expense, net
$
2,969

 
$

 
$
2,969

Income tax (expense) benefit
$
(254
)
 
$
(11
)
 
$
(265
)
 
 
 
 
 
 
 
For the three months ended June 30, 2014
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
$
5,692

 
$
4,916

 
$
10,608

Depreciation and amortization expense
$
68

 
$
601

 
$
669

Operating (loss) income
$
(867
)
 
$
2,225

 
$
1,358

Interest expense, net
$
181

 
$

 
$
181

Income tax (expense) benefit
$
45

 
$
2

 
$
47

 
 
 
 
 
 
 
For the six months ended June 30, 2015
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
$
14,206

 
$
18,814

 
$
33,020

Depreciation and amortization expense
$
102

 
$
1,194

 
$
1,296

Operating (loss) income
$
(4,007
)
 
$
11,722

 
$
7,715

Interest expense, net
$
5,945

 
$

 
$
5,945

Income tax (expense) benefit
$
(268
)
 
$
(11
)
 
$
(279
)
 
 
 
 
 
 
 
For the six months ended June 30, 2014
 
Ligand
 
CyDex
 
Total
Net revenues from external customers
$
12,483

 
$
14,083

 
$
26,566

Depreciation and amortization expense
$
134

 
$
1,203

 
$
1,337

Operating (loss) income
$
(938
)
 
$
7,396

 
$
6,458

Interest expense, net
$
429

 
$

 
$
429

Income tax (expense) benefit
$
(6
)
 
$

 
$
(6
)

6. Financing Arrangements

The Company fully repaid its secured term loan credit facility on July 31, 2014. Under the terms of the secured debt, the Company made interest-only payments through February 2013. Subsequent to the interest-only payments, the note

24

Table of Contents

amortized with principal and interest payments through the remaining term of the loan. Additionally, the Company made an additional final payment equal to 6% of the total amount borrowed which was due at maturity and was accreted over the life of the loan.

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

In accordance with accounting guidance for debt related to conversion and other options, the Company separately accounted for the debt and equity components of the 2019 Convertible Senior Notes by allocating the $245.0 million total proceeds between the debt component and the embedded conversion option, or equity component, due to Ligand's ability to settle the 2019 Convertible Senior Notes in cash for the principal portion and to settle any premium in cash or common stock, at the Company's election. The debt allocation was performed in a manner that reflected the Company's non-convertible borrowing rate for similar debt of 5.83% derived from independent valuation analysis. The initial debt value of $192.5 million accretes at 5.83% to reach $245.0 million at the maturity date. The equity component of the 2019 Convertible Senior Notes was recognized as a debt discount and represents the difference between the $245.0 million proceeds at issuance of the 2019 Convertible Senior Notes and the fair value of the debt allocation on their respective issuance dates. The debt discount is amortized to interest expense using the effective interest method over the expected life of a similar liability without an equity component. The notes will have a dilutive effect to the extent the average market price per share of common stock for a given reporting period exceeds the conversion price of $75.05. As of June 30, 2015, the “if-converted value” exceeded the principal amount of the 2019 Convertible Senior Notes by $77.8 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 were recorded as assets on the balance sheet.  The portions allocated to the liability components are amortized to interest expense using the effective interest method over the expected life of the 2019 Convertible Senior Notes.
 
The Company determined the expected life of the debt discount for the 2019 Convertible Senior Notes to be equal to the original five-year term of the notes. The carrying value of the equity component related to the 2019 Convertible Senior Notes as of June 30, 2015 and December 31, 2014, net of issuance costs, was $51.3 million.


25

Table of Contents

Convertible Bond Hedge and Warrant Transactions

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

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

Viking Therapeutics, Inc.

Prior to the completion of the Viking IPO in May 2015, the Company held a variable interest in Viking and consolidated Viking in its consolidated financial statements. As a result, Viking had convertible notes payable of $0.3 million, which were included in the Company's financing arrangements for the period ended December 31, 2014. The notes were converted to Viking common stock upon completion of the Viking IPO in May 2015.

The carrying values and the fixed contractual coupon rates of the Company's financing arrangements as of June 30, 2015 and December 31, 2014 were as follows (in thousands):

 
June 30, 2015
 
December 31, 2014
2019 Convertible Senior Notes
 
 
 
     Principal amount outstanding
$
245,000

 
$
245,000

     Unamortized discount
(44,433
)
 
(49,092
)
          Net carrying amount
200,567

 
195,908

Convertible notes payable, Viking Therapeutics, Inc.

 
334

Total notes payable
$
200,567

 
$
196,242


7. Stockholders’ Equity

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

Stock Option Activity

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


26

Table of Contents

 
Shares
 
Weighted-
Average
Exercise
Price
 
Weighted-Average
Remaining
Contractual Term in
Years
 
Aggregate
Intrinsic Value
(In thousands)
Balance as of December 31, 2014
1,800,697

 
$
28.78

 
7.3
 
$
51,558

Granted
262,747

 
$
58.84

 
 
 
 
Exercised
(212,349
)
 
$
25.58

 
 
 
 
Forfeited
(78,685
)
 
$
45.75

 
 
 
 
Balance as of June 30, 2015
1,772,410

 
$
32.86

 
7.0
 
$
120,588

Exercisable as of June 30, 2015
1,139,894

 
$
23.62

 
6.1
 
$
88,090

Options vested and expected to vest as of June 30, 2015
1,772,410

 
$
32.86

 
7.0
 
$
120,588


The weighted-average grant date fair value of all stock options granted during the six months ended June 30, 2015 was $33.66 per share. The total intrinsic value of all options exercised during the six months ended June 30, 2015 and 2014 was approximately $12.4 million and $13.7 million, respectively. As of June 30, 2015, there was $16.0 million of total unrecognized compensation cost related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 2.6 years.

Net cash received from options exercised during the six months ended June 30, 2015 and 2014 was approximately $5.3 million and $3.6 million, respectively. There is no current tax benefit related to options exercised because of net operating losses for which a full valuation allowance has been established.

As of June 30, 2015, 0.8 million shares were available for future option grants or direct issuance under the Company's 2002 Stock Incentive Plan, as amended.

Restricted Stock Activity

Restricted stock activity for the six months ended June 30, 2015 was as follows:

 
Shares
 
Weighted-
Average Grant
Date Fair Value
Nonvested at December 31, 2014
82,673

 
$
45.76

Granted
100,954

 
$
58.62

Vested
(48,066
)
 
$
44.78

Cancelled
(15,512
)
 
$
54.91

Nonvested at June 30, 2015
120,049

 
$
55.79


Restricted stock awards generally vest over three years. As of June 30, 2015, there was $5.4 million of total unrecognized compensation cost related to nonvested restricted stock. That cost is expected to be recognized over a weighted-average period of 2.0 years.

Employee Stock Purchase Plan

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

The Amended ESPP allows employees to purchase Ligand common stock at the end of each six month period at a price equal to 85% of the lesser of fair market value on either the start date of the period or the last trading day of the period (the "Lookback Provision"). The 15% discount and the Lookback Provision make the Amended ESPP compensatory.  There were 2,654 and 2,230 shares of common stock issued under the amended ESPP during either of the six months ended June 30, 2015 and 2014, respectively. The Company recorded compensation expense related to the ESPP of $36,000 and $31,000 for

27

Table of Contents

the six months ended June 30, 2015 and 2014, respectively. As of June 30, 2015, 73,087 shares were available for future purchases under the Amended ESPP and 0.2 million shares of common stock had been issued under the Amended ESPP to employees. For shares purchased under the Company's Amended ESPP, a weighted-average expected volatility of 36% and 39% and an expected term of 6 months was used for the period ended June 30, 2015 and 2014, respectively.


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 ASC Topic 450-Contingencies. As additional information becomes available, the Company assesses the potential liability related to its pending litigation and revises its estimates. Revisions in the Company's estimates of potential liability could materially impact its results of operations.

Securities Litigation
    
On June 8, 2012, a federal securities class action and shareholder derivative lawsuit was filed in the Eastern District of Pennsylvania alleging that the Company and its CEO aided and abetted 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 May 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 on March 20, 2015. The court has set oral argument to be held in September. The Company intends to continue to vigorously defend against the claims against the Company and its CEO. Due to the complex nature of the legal and factual issues involved, however, the outcome of the matter is not presently determinable.

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

Caution: This discussion and analysis may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed in Part II, Item 1A:"Risk Factors." This outlook represents our current judgment on the future direction of our business. These statements include those related to our Captisol-related revenues, our Promacta, Kyprolis, and other product royalty revenues, product returns, and product development. Actual events or results may differ materially from our expectations. For example, there can be no assurance that our revenues or expenses will meet any expectations or follow any trend(s), that we will be able to retain our key employees or that we will be able to enter into any strategic partnerships or other transactions. We cannot assure you that we will receive expected Promacta, Kyprolis, Captisol and other product revenues to support our ongoing business or that our internal or partnered pipeline products will progress in their development, gain marketing approval or achieve success in the market. In addition, ongoing or future arbitration, or litigation or disputes with third parties may have a material adverse effect on us. Such risks and uncertainties, and others, could cause actual results to differ materially from any future performance suggested. We undertake no obligation to make any revisions to these forward-looking statements to reflect events or circumstances arising after the date of this quarterly report. This caution is made under the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act.

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

References to "Ligand Pharmaceuticals Incorporated," "Ligand," the "Company," "we" or "our" include Ligand Pharmaceuticals Incorporated and our wholly owned subsidiaries.


28

Table of Contents

Overview
    
We are a biotechnology company with a business model that is based upon the concept of developing or acquiring royalty revenue generating assets and coupling them with a lean corporate cost structure. Our goal is to create a sustainably profitable business and generate meaningful value for our stockholders. Since a portion of our business model is based on the goal of partnering with other pharmaceutical companies to commercialize and market our assets, a significant amount of our revenue is based largely on payments made to us by partners for royalties, milestones, event-based payments, and license fees. We offer investors an opportunity to invest in the increasingly complicated and unpredictable pharmaceutical industry. In comparison to our peers, we believe we have assembled one of the largest and most diversified asset portfolios in the industry with the potential to generate significant revenue in the future. The therapies in our development portfolio address the unmet medical needs of patients for a broad spectrum of diseases including thrombocytopenia, multiple myeloma, hepatitis, ventricular fibrilation, muscle wasting, Alzheimer’s disease, dyslipidemia, diabetes, anemia, asthma, focal segmental glomerulosclerosis ("FSGS), menopausal symptoms and osteoporosis.. We have established multiple alliances with the world’s leading pharmaceutical companies including Novartis, Amgen, Merck, Pfizer, Baxter International, and Eli Lilly.

Highlights from year-to-date 2015 include:

In January, our partner, Retrophin, Inc. announced that they have received orphan drug designation from FDA for Sparsentan for the treatment of FSGS.
In February, our partner, Amgen, announced that the European Medicines Agency (EMA) has accepted the Marketing Authorization Application (MAA) of Kyprolis®(carfilzomib) for injection for the treatment of patients with relapsed multiple myeloma who have received at least one prior therapy. The MAA has been granted accelerated assessment by the EMA.
In February, Ligand announced a license agreement with Sermonix for oral lasofoxifene for the United States and additional territories. Under the terms of the agreement, Ligand is entitled to receive up to $45 million in potential regulatory and commercial milestone payments and tiered royalties of 6% to 10% on future net sales.
In April, our partner, SAGE Therapeutics Inc., announced a positive end-of-phase 2 meeting with FDA on SAGE-547 for the treatment of patients with super-refractory status epilepticus (SRSE) and completion of treatment for the first patient enrolled in its Phase 3 expanded access protocol for SAGE-547.
In May, the Viking IPO closed, pursuant to which Viking sold 3.45 million shares of its common stock at an initial offering price of $8.00 per share.
In connection with the Viking IPO, we purchased 1.1 million shares of Viking common stock for an aggregate price of $9.0 million at the price offered to the public. In addition, we received an aggregate of approximately 3.7 million shares of Viking common stock pursuant to the closing of the Viking IPO.
In May, we acquired financial rights to potential future milestones and royalties for more than 15 biologic development programs from Selexis SA. Each acquired program is fully funded by a development partner. Selexis is a privately held global life science company based in Switzerland focused on drug discovery for lead identification and cell line development for scale-up and manufacturing of therapeutic protein drugs. We previously acquired a portfolio of biologic development programs from Selexis in April, 2013.
In June, we announced results from a Phase 1b clinical trial with LGD-6972 that demonstrated favorable safety, tolerability and pharmacokinetics in normal healthy volunteers and in subjects with type 2 diabetes mellitus. The trial results also demonstrated a robust, dose-dependent reduction of fasting plasma glucose. 
In June, our partner, Viking, announced the submission of an IND application to the to initiate clinical development of VK5211 in patients with acute hip fracture. Initial studies will evaluate safety, tolerability and pharmacokinetic profile of VK5211 in healthy elderly subjects.
In June, our partner, Novartis, announced that the FDA approved Promacta® (eltrombopag) for the treatment of children six years and older with chronic immune thrombocytopenia (ITP) who have had an insufficient response to corticosteroids, immunoglobulins or splenectomy.
In July, our partner, Amgen, announced that the FDA approved the sNDA for Kyprolis® for injection in combination with Revlimid® (lenalidomide) and dexamethasone for the treatment of patients with multiple myeloma who have received one to three prior lines of therapy. The FDA approved the expanded indication for Kyprolis based on data from the ASPIRE

29

Table of Contents

study which showed that patients treated in the dexamethasone arm lived 50% longer (8.7 months longer) without their disease worsening compared to patients treated with Revlimid and low-dose dexamethasone alone.
Ligand entered into a worldwide agreement with Sanofi for the development and commercialization of SAR-125844, a Captisol-enabled™ program. Ligand will receive undisclosed milestones, tiered royalties and revenue from Captisol material sales. Sanofi is responsible for all development costs relating to the program.
In July, we entered into a new clinical-stage agreement with AiCuris GmbH & Co for an undisclosed anti-infective Captisol-enabled™ program.



Results of Operations

Three and six months ended June 30, 2015 and 2014
Total revenues for the three and six months ended June 30, 2015 were $18.4 million and $33.0 million, respectively, compared to $10.6 million and $26.6 million, respectively, for the same periods in 2014. We reported net income attributable to common stock holders of $23.6 million and $24.3 million for the three and six months ended June 30, 2015, respectively, compared to $1.6 million and $3.7 million, respectively, for the same periods in 2014.

Royalty Revenue
Royalty revenues were $6.6 million and $16.9 million for the three and six months ended June 30, 2015, respectively, compared to $5.2 million and $13.1 million, respectively, for the same periods in 2014. The increase in royalty revenue is primarily due to an increase in Promacta and Kyprolis royalties.

Material Sales
We recorded material sales of $10.7 million and $14.4 million for the three and six months ended June 30, 2015, respectively, compared to $3.5 million and $9.2 million, respectively, for the same periods in 2014. The increase in material sales of $7.2 million and $5.2 million for the three and six months ended June 30, 2015, respectively, is due to an increase in Captisol purchases for use in clinical trials and in commercialized products.

Collaborative Research and Development and Other Revenue
We recorded collaborative research and development and other revenue of $1.1 million and $1.7 million for the three and six months ended June 30, 2015, respectively, compared to $1.9 million and $4.3 million, respectively, for the same periods in 2014. The decrease of $0.8 million and $2.6 million for the three and six months ended June 30, 2015, respectively, is primarily due to significant milestones and upfront fees earned in the first half of 2014.

Cost of Sales
Cost of sales were $2.6 million and $3.7 million for the three and six months ended June 30, 2015, respectively, compared to $1.2 million and $3.6 million, respectively, for the same periods in 2014. The increase of $1.4 million and $0.1 million for the three and six months ended June 30, 2015, respectively, is primarily due to higher material sales in the first half of 2015 offset by invoking lower pricing tiers from our contract manufacturer due to higher quantities of Captisol material ordered.

Research and Development Expenses
Research and development expenses were $4.0 million and $8.0 million for the three and six months ended June 30, 2015, respectively, compared to $2.7 million and $5.8 million, respectively, for the same periods in 2014. The increase of $1.3 million and $2.2 million for the three and six months ended June 30, 2015, respectively, is primarily due to timing of costs associated with internal programs.

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


30

Table of Contents

Program
 
Disease/Indication
 
Development
Phase
 
 
 
 
 
Glucagon Receptor Antagonist
 
Diabetes
 
Phase I/II
Oral Human Granulocyte Colony Stimulating Factor
 
Neutropenia
 
Preclinical
LTP Platform
 
Metabolic and Cardiovascular
 
Preclinical
Kinase Inhibitors
 
Multiple
 
Preclinical
HepDirect
 
Liver
 
Preclinical

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

General and Administrative Expenses
General and administrative expenses were $7.2 million and $13.2 million for the three and six months ended June 30, 2015, respectively, compared to $5.2 million and $10.3 million, respectively, for the same periods in 2014. The increase of $2.0 million and $2.9 million for three and six months ended June 30, 2015, respectively, is primarily due to an increase in stock-based compensation expense and costs associated with business development activities.

Lease Exit and Termination Costs
In September 2010, we ceased use of our facility located in Cranbury, New Jersey. As a result, during the three months ended September 30, 2010, we recorded lease exit costs of $9.7 million for costs related to the difference between the remaining lease obligations of the abandoned operating leases, which run through August 2016, and management’s estimate of potential future sublease income, discounted to present value. Actual future sublease income may differ materially from our estimate, which would result in us recording additional expense or reductions in expense. In addition, we wrote-off approximately $5.4 million of property and equipment related to the facility closure and recorded approximately $1.8 million of severance related costs. Lease exit and termination costs were $0.2 million and $0.4 million for each of the three and six months ended June 30, 2015, respectively, compared to $0.1 million and $0.3 million, respectively, for the same periods in 2014.

Interest Expense, net
Interest expense, net was $3.0 million and $5.9 million for the three and six months ended June 30, 2015, respectively, compared to $0.2 million and $0.4 million, respectively, for the same periods in 2014. The increase in interest expense of $2.8 million and $5.5 million for the three and six months ended June 30, 2015, respectively, is due to cash interest expense and non-cash debt related costs related to our $245.0 million aggregate principal amount of 0.75% Convertible Senior Notes due 2019, or the 2019 Convertible Senior Notes, partially offset by interest expense related to the term loan facility which was paid off in July 2014.

(Increase) decrease in Contingent Liabilities
We recorded an increase in contingent liabilities of $7.3 million and $7.3 million for the three and six months ended June 30, 2015, respectively, compared to an increase of $1.3 million and $3.3 million, respectively, for the same periods in 2014. The increase for the three and six months ended June 30, 2015 primarily relates to an increase in the liability for amounts potentially due to holders of CVRs related to our CyDex acquisition of $1.0 million and an increase of $6.4 million in the liability for amounts potentially due to holders of CVRs associated with our Metabasis acquisition. The increase for the three months ended June 30, 2014 primarily relates to an increase in the liability for amounts potentially due to holders of CVRs related to our CyDex acquisition of $3.2 million and is partially offset by a decrease of $1.9 million in the liability for amounts potentially due to holders of CVRs associated with our Metabasis acquisition. The increase for the six months ended June 30, 2014 primarily relates to an increase of $2.7 million in the liability for amounts potentially due to holders of CVRs related to our CyDex acquisition and an increase of $0.5 million in the liability for amounts potentially due to holders of CVRs associated with our Metabasis acquisition.

31

Table of Contents


Income Tax Expense
We recorded income tax expense from continuing operations of $0.3 million and 0.3 million for the three and six months ended June 30, 2015, respectively, compared to an income tax benefit from continuing operations of $47,000 and income tax expense of 6,000, respectively, for the same periods in 2014. Our estimated annual effective rate of 1.1% is primarily attributable to an increase in our deferred tax liability associated with the tax amortization of acquired indefinite lived IPR&D intangible assets. 


Liquidity and Capital Resources

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

We had net income of $23.6 million for the quarter ended June 30, 2015. As of June 30, 2015, our cash, cash equivalents and marketable securities totaled $182.2 million, and we had working capital of $178.8 million with net long-term convertible debt of $200.6 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. See our Annual Report on Form 10-K for the year ended December 31, 2014, Item 1A. Risk Factors - If our business does not perform according to our expectations, we may not have sufficient resources to operate our business as currently contemplated.

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, which are classified as short-term investments, as a result of an event-based payment and an upfront license payment received from licensees in December 2012 and June 2014 respectively.     

Borrowings and Other Liabilities

Term Loan Facility
    
In January 2011, we entered into a $20.0 million secured term loan credit facility with Oxford Financial Group. The loan was amended in January 2012 to increase the secured credit facility to $27.5 million. The maturity date of the term loan was August 1, 2014, and we fully repaid the loan as of July 31, 2014.


0.75% Convertible Senior Notes Due 2019

We have convertible debt outstanding as of June 30, 2015 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

32

Table of Contents

In August 2014, 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 one year. During the three and six months ended June 30, 2015 we did not repurchase any common shares pursuant to the repurchase program.

Public Offerings

In October 2013, we filed a universal shelf registration statement with the SEC. During the three and six months ended June 30, 2015, we did not issue any common shares through this at-the-market equity issuance program.
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 from 2014 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 $7.5 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 June 30, 2015 was $10.4 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 June 30, 2015 was $8.4 million, and as of December 31, 2014 was $3.7 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 2016. The sublease agreements provide for a 3% increase in annual rents. We had no off-balance sheet arrangements at June 30, 2015 and December 31, 2014.

Cash Flows

Operating Activities

Operating activities generated cash of $17.6 million for the six months ended June 30, 2015, compared to $6.6 million for the same period in 2014.

The cash generated for the six months ended June 30, 2015 reflects net income of $21.9 million, adjusted by $7.3 million of non-cash items to reconcile net income to net cash generated from operations. These reconciling items primarily reflect stock-based compensation of $6.7 million, amortization of debt discount and issuance fees of $5.1 million, depreciation and amortization of $1.3 million, gain on deconsolidation of Viking of $28.2 million, loss on equity investment in Viking of $0.9 million, realized gain on investments of $0.5 million, and deferred income taxes of $0.3 million. The cash generated during the six months ended June 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 $0.5 million, a decrease in accounts payable and accrued liabilities of $3.1 million, an increase in other long-term assets of $0.6 million, and an increase in inventory of $0.5 million.


33

Table of Contents

The cash generated for the six months ended June 30, 2014 reflects net income of $3.4 million, adjusted by $7.7 million of non-cash items to reconcile net income to net cash generated from operations. These reconciling items primarily reflect an increase in the estimated fair value of contingent liabilities of $3.3 million, depreciation and amortization of $1.3 million, stock-based compensation of $5.1 million, and accretion of notes payable of $0.2 million, partially offset by a non-cash upfront fee received of $1.2 million and a realized gain on investments of $1.0 million. The cash generated during the six months ended June 30, 2014 is further impacted by changes in operating assets and liabilities due primarily to an increase in accounts receivable of $0.9 million, a decrease in other current assets of $0.1 million, a decrease in other long-term assets of $0.2 million and a decrease in accounts payable and accrued liabilities of $3.7 million, partially offset by an increase in inventory of $0.6 million.

Investing Activities

Investing activities used cash of $75.0 million for the six months ended June 30, 2015, compared to $0.4 million for the same period in 2014.

Cash used by investing activities during the six months ended June 30, 2015 primarily reflects the purchase of short-term investments of $60.4 million, investment in Viking of $9.0 million, purchase of commerical license rights of $4.0 million, payments to CVR holders and other contingency payments of $3.7 million, and reduction in cash from deconsolidation of Viking of $0.2 million partially offset by proceeds from short-term investments of $2.4 million.

Cash used by investing activities during the six months ended June 30, 2014 primarily reflects payments to CVR holders of $1.7 million, partially offset by proceeds from short-term investments of $1.2 million and proceeds from the sale of equipment of $0.1 million.

Financing Activities

Financing activities provided cash of $5.4 million for the six months ended June 30, 2015, compared to use of cash of $3.3 million for the same period in 2014.

Cash provided by financing activities for the six months ended June 30, 2015 reflects $5.4 million of proceeds received from stock option exercises and our employee stock purchase plan.
    
Cash used by financing activities for the six months ended June 30, 2014 primarily reflects $6.9 million of repayment of debt, partially offset by proceeds from stock option exercises and our employee stock purchase plan of $3.6 million.

Contractual Obligations

As of June 30, 2015, future minimum payments due under our contractual obligations were as follows (in thousands):

 
Payments Due by Period
 
Total
 
Less than 1 year
 
1-2 years
 
3-4 years
 
Obligations for uncertain tax positions (1)
$

 
$

 
$

 
$

 
Purchase obligations (2)
$
24,053

 
$
14,633

 
$
9,420

 
$

 
Contingent liabilities (3)
$
3,840

 
$
3,840

 
$

 
$

 
Note and interest payment obligations (4)
$
253,269

 
$
1,838

 
$
3,675

 
$
247,756

 
Operating lease obligations (5)
$
6,250

 
$
3,550

 
$
1,953

 
$
747

 

(1)
Expected payments related to obligations for uncertain tax positions cannot be reasonably estimated.
(2)
Purchase obligations represent our commitments under our supply agreement with Hovione, LLC for Captisol purchases.
(3)
Contingent liabilities to former shareholders and licenseholders are subjective and affected by changes in inputs to the valuation model including management’s assumptions regarding revenue volatility, probability of commercialization of products, estimates of timing and probability of achievement of certain revenue thresholds and developmental and regulatory milestones and affect amounts owed to former license holders and CVR holders. Only payments due as a result of achievement of revenue thresholds or development and regulatory milestones are included in the table above.
(4)
Note and interest payment obligations represent principal and interest payments due under the 2019 Convertible Senior Notes.
(5)
We lease office and research facilities that we have fully vacated under operating lease arrangements expiring in August 2015 and August 2016. We sublet portions of these facilities through the end of our lease. As of June 30, 2015, we expect to receive aggregate future minimum lease

34

Table of Contents

payments totaling $2.1 million (nondiscounted) over the duration of the sublease agreement (not included in the table above) as follows: less than one year: $0.7 million, and one to two years: $0.9 million, and 3 to 4 years $0.5 million.
    
We are also required under our CyDex CVR Agreement to invest at least $1.5 million per year, inclusive of employee expenses, in the acquired business through the year ended 2015. As of June 30, 2015, we expect to exceed that amount for the year ended December 31, 2015.

Critical Accounting Policies

Certain of our policies require the application of management judgment in making estimates and assumptions that affect the amounts reported in our consolidated financial statements and the disclosures made in the accompanying notes. Those estimates and assumptions are based on historical experience and various other factors deemed applicable and reasonable under the circumstances. The use of judgment in determining such estimates and assumptions is by nature, subject to a degree of uncertainty. Accordingly, actual results could differ materially from the estimates made. Except for the accounting for our investment in Viking Therapeutics, Inc., there have been no material changes in our accounting policies as disclosed in our annual report on Form 10-K for the year ended December 31, 2014.

35

Table of Contents

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk from interest rates and equity prices which could affect our results of operations, financial condition and cash flows. We manage our exposure to these market risks through our regular operating and financing activities.

Investment Portfolio Risk
At June 30, 2015, our investment portfolio included investments in available-for-sale equity securities of $73.4 million. These securities are subject to market risk and may decline in value based on market conditions.

Equity Price Risk

Our 2019 Convertible Senior Notes include conversion and settlement provisions that are based on the price of our common stock at conversion or maturity of the notes, as applicable. The minimum amount of cash we may be required to pay is $245.0 million, but will ultimately be determined by the price of our common stock. The fair values of our 2019 Convertible Senior Notes are dependent on the price and volatility of our common stock and will generally increase or decrease as the market price of our common stock changes. In order to minimize the impact of potential dilution to our common stock upon the conversion of the 2019 Convertible Senior Notes, we entered into convertible bond hedges covering 3,264,643 shares of our common stock. Concurrently with entering into the convertible bond hedge transactions, we entered into warrant transactions whereby we sold warrants with an exercise price of approximately $125.08 per share, subject to adjustment. Throughout the term of the 2019 Convertible Senior Notes, the notes may have a dilutive effect on our earnings per share to the extent the stock price exceeds the conversion price of the notes. Additionally, the warrants may have a dilutive effect on our earnings per share to the extent the stock price exceeds the strike price of the warrants.

Foreign currency risk

Through our licensing and business operations, we are exposed to foreign currency risk. Foreign currency exposures arise from transactions denominated in a currency other than the functional currency and from foreign denominated revenues and profit translated into U.S. dollars. Our collaborative partners sell our products worldwide in currencies other than the U.S. dollar. Because of this, our revenues from royalty payments are subject to risk from changes in exchange rates.

We purchase Captisol from Hovione, located in Lisbon, Portugal. Payments to Hovione are denominated and paid in U.S. dollars, however the unit price of Captisol contains an adjustment factor which is based on the sharing of foreign currency risk between the two parties. The effect of an immediate 10% change in foreign exchange rates would not have a material impact on our financial condition, results of operations or cash flows. We do not currently hedge our exposures to foreign currency fluctuations.

Interest rate risk
We are exposed to market risk involving rising interest rates. To the extent interest rates rise, our interest costs could increase. An increase in interest costs of 10% would not have a material impact on our financial condition, results of operations or cash flows.


36

Table of Contents

ITEM 4.
CONTROLS AND PROCEDURES

As of June 30, 2015, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Interim Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon and as of the date of that evaluation, our Chief Executive Officer and Interim Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit pursuant to the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Our disclosure controls were designed to provide reasonable assurance that the controls and procedures would meet their objectives. Our management, including the Chief Executive Officer and Interim Chief Financial Officer, does not expect that our disclosure controls will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable assurance of achieving the designed control objectives and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusions of two or more people, or by management override of the control. Because of the inherent limitations in a cost-effective, maturing control system, misstatements due to error or fraud may occur and not be detected.

There have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter of the fiscal year to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



37

Table of Contents

PART II.
OTHER INFORMATION

Item 1.
Legal Proceedings

From time to time we are subject to various lawsuits and claims with respect to matters arising out of the normal course of our business. Due to the uncertainty of the ultimate outcome of these matters, the impact on future financial results is not subject to reasonable estimates.

Securities Litigation
On June 8, 2012, a federal securities class action and shareholder derivative lawsuit was filed in the Eastern District of Pennsylvania alleging that we and our CEO aided and abetted various breaches of fiduciary duties based on our purchase of a licensing interest in a development-stage pharmaceutical program from the Genaera Liquidating Trust in May 2010 and the subsequent sale of half of our interest in the transaction to Biotechnology Value Fund, Inc. Plaintiff filed a second amended complaint in February 2015, which we moved to dismiss on March 20, 2015. The court has set oral argument to be held in September. We intend to continue to vigorously defend against the claims against us and our CEO. Due to the complex nature of the legal and factual issues involved, however, the outcome of the matter is not presently determinable.

38

Table of Contents


ITEM 1A.
RISK FACTORS

The following is a summary description of some of the many risks we face in our business. You should carefully review these risks in evaluating our business, including the businesses of our subsidiaries. You should also consider the other information described in this report.

Revenues based on Promacta and Kyprolis represent a substantial portion of our overall current and/or expected future revenues.

GSK is obligated to pay us royalties on its sales of Promacta and we receive revenue from Amgen based on both sales of Kyprolis and purchases of Captisol material for clinical and commercial uses. These payments are expected to be a substantial portion of our ongoing revenues for some time. As a result, any setback that may occur with respect to Promacta or Kyprolis could significantly impair our operating results and/or reduce the market price of our stock. Setbacks for Promacta and Kyprolis could include problems with shipping, distribution, manufacturing, product safety, marketing, government regulation or reimbursement, licenses and approvals, intellectual property rights, competition with existing or new products and physician or patient acceptance of the product, as well as higher than expected total rebates, returns, discounts, or unfavorable exchange rates.

Revenue from sales of Captisol material to our collaborative partners represents a significant portion of our current revenue and our continued development and supply of Captisol is subject to a number of risks.

In January 2011, we completed our merger with CyDex. All of CyDex's products and product candidates, as well as the technology that it outlicenses, are based on Captisol. As a result, any setback that may occur with respect to Captisol could significantly impair our operating results and/or reduce the market price of our stock. Setbacks for Captisol could include problems with shipping, distribution, manufacturing, product safety, marketing, government regulation or reimbursement, licenses and approvals, intellectual property rights, competition with existing or new products and physician or patient acceptance of the products using Captisol, as well as higher than expected total rebates, returns or discounts for such products.

If products or product candidates incorporating Captisol technology were to cause any unexpected adverse events, the perception of Captisol safety could be seriously harmed. If this were to occur, we may not be able to market Captisol products unless and until we are able to demonstrate that the adverse event was unrelated to Captisol, which we may not be able to do. Further, whether or not the adverse event was a result of Captisol, we could be required by the FDA to submit to additional regulatory reviews or approvals, including extensive safety testing or clinical testing of products using Captisol, which would be expensive and, even if we were to demonstrate that the adverse event was unrelated to Captisol, would delay our marketing of Captisol-enabled products and receipt of revenue related to those products, which could significantly impair our operating results and/or reduce the market price of our stock.

We obtain Captisol from a sole source supplier, and if this supplier were to cease to be able, for any reason, to supply Captisol to us in the amounts we require, or decline to supply Captisol to us, we would be required to seek an alternative source, which could potentially take a considerable length of time and impact our revenue and customer relationships.

We currently depend on our arrangements with our outlicensees to sell products using our Captisol technology. These agreements generally provide that outlicensees may terminate the agreements at will. If our outlicensees discontinue sales of products using our Captisol technology, fail to obtain regulatory approval for products using our Captisol technology, fail to satisfy their obligations under their agreements with us, or choose to utilize a generic form of Captisol should it become available, or if we are unable to establish new licensing and marketing relationships, our financial results and growth prospects would be materially affected. We maintain inventory of Captisol, which has a five year shelf life, at three geographically spread storage locations in the United States and Europe.  If we were to encounter problems maintaining our inventory, such as natural disasters, at one or all three of these locations, it could lead to supply interruptions. Further, under most of our Captisol outlicenses, the amount of royalties we receive will be reduced or will cease when the relevant patent expires. Our high purity patents, U.S. Patent Nos. 7,635,773 and 8,410,077 and foreign equivalents, are not expected to expire until 2029 and our morphology patents, U.S. Patent Nos. 7,629,331 and 8,049,003 and foreign equivalents, are not expected to expire until 2025, but the initially filed patents relating to Captisol expired starting in 2010 in the United States and will expire by 2016 in most countries outside the United States. If our other intellectual property rights are not sufficient to prevent a generic form of Captisol from coming to market and if in such case our outlicensees choose to terminate their agreements with us, our Captisol revenue may decrease significantly. 


39

Table of Contents

Furthermore, we maintain significant accounts receivable balances with certain customers purchasing Captisol materials. As of June 30, 2015, accounts receivable from one customer were 88% of total accounts receivable. We generally do not require any collateral from our customers to secure payment of these accounts receivable. If any of our major customers were to default in the payment of their obligations to us, our business, financial condition, operating results and cash flows could be adversely affected.


The product candidates of our partners and us face significant development and regulatory hurdles prior to partnering and/or marketing which could delay or prevent licensing, sales and/or milestone revenue.

Before we or our partners obtain the approvals necessary to sell any of our unpartnered assets or partnered programs, we must show through preclinical studies and human testing that each potential product is safe and effective. We and/or our partners have a number of partnered programs and unpartnered assets moving toward or currently awaiting regulatory action. Failure to show any product's safety and effectiveness could delay or prevent regulatory approval of a product and could adversely affect our business. The drug development and clinical trials process is complex and uncertain. For example, the results of preclinical studies and initial clinical trials may not necessarily predict the results from later large-scale clinical trials. In addition, clinical trials may not demonstrate a product's safety and effectiveness to the satisfaction of the regulatory authorities. A number of companies have suffered significant setbacks in advanced clinical trials or in seeking regulatory approvals, despite promising results in earlier trials. The FDA may also require additional clinical trials after regulatory approvals are received. Such additional trials may be expensive and time-consuming, and failure to successfully conduct those trials could jeopardize continued commercialization of a product.

The rates at which we complete our scientific studies and clinical trials depends on many factors, including, but are not limited to, our ability to obtain adequate supplies of the products to be tested and patient enrollment. Patient enrollment is a function of many factors, including the size of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the trial and other potential drug candidates being studied. Delays in patient enrollment for our trials may result in increased costs and longer development times. In addition, our collaborative partners have rights to control product development and clinical programs for products developed under our collaborations. As a result, these collaborative partners may conduct these programs more slowly or in a different manner than expected. Moreover, even if clinical trials are completed, we or our collaborative partners still may not apply for FDA approval in a timely manner or the FDA still may not grant approval.


40

Table of Contents

We rely heavily on collaborative relationships, and any disputes or litigation with our collaborative partners or termination or breach of any of the related agreements could reduce the financial resources available to us, including milestone payments and future royalty revenues.

Our strategy for developing and commercializing many of our potential products, including products aimed at larger markets, includes entering into collaboration agreements with corporate partners and others. These agreements give our collaborative partners significant discretion when deciding whether or not to pursue any development program. Our existing collaborations may not continue or be successful, and we may be unable to enter into future collaborative arrangements to develop and commercialize our unpartnered assets.

For instance, our collaboration with Viking includes a $2.5 million loan that we made to Viking to be repaid one year after Vikings initial public offering or upon certain other financing events. Viking recently completed its initial public offering and while we expect that Viking will be able to repay the loan in April 2016, there is no guaranty that they will have the resources to do so at that time. Despite our expectations, if Viking is unable to repay the loan at that time, we may decide to extend the term of our loan to Viking, invest additional capital, or terminate our agreements with Viking. We cannot make any assurances on the collectibility of our loan to Viking.

In addition, our collaborators may develop drugs, either alone or with others that compete with the types of drugs they are developing with us (or that we are developing on our own). This would result in increased competition for our or our partners' programs. If products are approved for marketing under our collaborative programs, revenues we receive will depend on the manufacturing, marketing and sales efforts of our collaborative partners, who generally retain commercialization rights under the collaborative agreements. Generally, our current collaborative partners also have the right to terminate their collaborations at will or under specified circumstances. If any of our collaborative partners breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully (for example, by not making required payments when due, or at all), our product development under these agreements will be delayed or terminated. Disputes or litigation may also arise with our collaborators (with us and/or with one or more third parties), including those over ownership rights to intellectual property, know-how or technologies developed with our collaborators. Such disputes or litigation could adversely affect our rights to one or more of our product candidates. Any such dispute or litigation could delay, interrupt or terminate the collaborative research, development and commercialization of certain potential products, create uncertainty as to ownership rights of intellectual property, or could result in litigation or arbitration. The occurrence of any of these problems could be time-consuming and expensive and could adversely affect our business.

Expirations of, challenges to or failure to secure patents and other proprietary rights may significantly hurt our business.

Any conflicts resulting from the patent rights of others could significantly reduce the coverage of our patents and limit our ability to obtain meaningful patent protection. We have had and will continue to have discussions with our current and potential collaborative partners regarding the scope and validity of our patents and other proprietary rights. If a collaborative partner or other party successfully establishes that our patent rights are invalid, we may not be able to continue our existing collaborations beyond their expiration. Any determination that our patent rights are invalid also could encourage our collaborative partners to seek early termination of our agreements. Such invalidation could adversely affect our ability to enter into new collaborations.

We may also need to initiate litigation, which could be time-consuming and expensive, to enforce our proprietary rights or to determine the scope and validity of others' rights. If this occurs, a court may find our patents or those of our licensors invalid or may find that we have infringed on a competitor's rights. In addition, if any of our competitors have filed patent applications in the United States which claim technology we also have invented, the United States Patent and Trademark Office may require us to participate in expensive interference proceedings to determine who has the right to a patent for the technology.

We also rely on unpatented trade secrets and know-how to protect and maintain our competitive position. We require our employees, consultants, collaborative partners and others to sign confidentiality agreements when they begin their relationship with us. These agreements may be breached, and we may not have adequate remedies for any breach. In addition, our competitors may independently discover our trade secrets.

Generally, our success will depend on our ability and the ability of us and our licensors to obtain and maintain patents and proprietary rights for our potential products both in the United States and in foreign countries. Patents may not be issued from any of these applications currently on file, or, if issued, may not provide sufficient protection. Our patent position, like that of many biotechnology and pharmaceutical companies, is uncertain and involves complex legal and technical questions for

41

Table of Contents

which important legal principles are unresolved. We may not develop or obtain rights to products or processes that are patentable. Even if we do obtain patents, such patents may not adequately protect the technology we own or have licensed. In addition, others may challenge, seek to invalidate, infringe or circumvent any patents we own or license and rights we receive under those patents may not provide competitive advantages to us. For example, our European patent related to Agglomerated forms of Captisol was limited during an opposition proceeding and could be challenged further on appeal, and the rejection of our European patent application related to High Purity Captisol is currently being appealed.

We have obtained patent protection in the United States through 2025 on one or more Agglomerated forms of Captisol and through 2029 on one or more High Purity forms of Captisol. We also have filed patent applications covering the Captisol product that if issued, would not be set to expire until 2033 (for example, our patent WO 2013/130666, filed February 27, 2013, contains composition of matter and use claims). There is no guarantee that our patents will be sufficient to prevent competitors from creating a generic form of Captisol and competing against us, or from developing combination patents for products that will prevent us from developing products using those APIs. In addition, most of the agreements in our Captisol outlicensing business, provide that once the relevant patent expires, the amount of royalties we receive will be reduced or eliminated.

Our collaborative partners may change their strategy or the focus of their development and commercialization efforts with respect to our partnered programs, and the success of our partnered programs could be adversely affected.

If our collaborative partners terminate their collaborations with us or do not commit sufficient resources to the development, manufacture, marketing or distribution of our partnered programs, we could be required to devote additional resources to our partnered programs, seek new collaborative partners or abandon such partnered programs, all of which could have an adverse effect on our business. For example, Pfizer recently informed us they have stopped selling Avinza to wholesalers and we expect future revenues, if any, for Avinza to be minimal.

Third party intellectual property may prevent us or our partners from developing our potential products and we may owe a portion of any payments we receive from our collaborative partners to one or more third parties.

Our success will depend on our ability and the ability of our collaborative partners to avoid infringing the proprietary rights of others, both in the United States and in foreign countries. In addition, disputes with licensors under our license agreements may arise which could result in additional financial liability or loss of important technology and potential products and related revenue, if any. Further, the manufacture, use or sale of our potential products or our collaborative partners' products or potential products may infringe the patent rights of others. This could impact Captisol, Promacta, Kyprolis, Avinza, Duavee, Viviant, Conbriza, Nexterone, and other products or potential products.

Several drug companies and research and academic institutions have developed technologies, filed patent applications or received patents for technologies that may be related to our business. Others have filed patent applications and received patents that conflict with patents or patent applications we have licensed for our use, either by claiming the same methods or compounds or by claiming methods or compounds that could domin