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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
Mark One
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2004
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 No. 0-20720
LIGAND PHARMACEUTICALS INCORPORATED
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  77-0160744
(IRS Employer
Identification No.)
     
10275 Science Center Drive
San Diego, CA
(Address of Principal Executive Offices)
  92121-1117
(Zip Code)
Registrant’s telephone number, including area code: (858) 550-7500
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Preferred Share Purchase Rights
(Title of Class)
     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 o No þ
     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o
     Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ
     The aggregate market value of the Registrant’s voting and non-voting stock held by non-affiliates as of June 30, 2004, computed by reference to the closing price as quoted by the NASDAQ National Stock Market as of that date, was approximately $1.27 billion. For purposes of this calculation, shares of Common Stock held by directors, officers and 10% stockholders known to the Registrant have been deemed to be owned by affiliates which should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant or that such person is controlled by or under common control with the Registrant.
     As of October 31, 2005, the Registrant had 74,131,283 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE — NONE
 
 

 


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 EXHIBIT 10.278
 EXHIBIT 10.279
 EXHIBIT 10.280
 EXHIBIT 10.281
 EXHIBIT 10.282
 EXHIBIT 23.1
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2
AVAILABLE INFORMATION:
     We file electronically with the Securities and Exchange Commission (or SEC) our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and, as necessary, amendments to these reports, pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is <http://www.sec.gov>.
     You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports which are posted as soon as reasonably practicable after filing on our website at <http://www.ligand.com>, by contacting the Investor Relations Department at our corporate offices by calling (858) 550-7500 or by sending an e-mail message to investors@ligand.com. You may also request information via the Investor Relations page of our website.

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INTRODUCTORY NOTE
     The Company’s Annual Report on Form 10-K (the “Form 10-K”) for the year ended December 31, 2004, includes amended and restated consolidated financial statements and related financial information for the years ended December 31, 2003 and 2002. This Form 10-K also includes restated quarterly information for 2004 and 2003. This information is disclosed in Notes 2 and 19 of Notes to Consolidated Financial Statements.
Background of the Restatement
     On March 17, 2005, the Company announced that in connection with the preparation of its consolidated financial statements for 2004 and the audit of those consolidated financial statements, the Audit Committee of the Board of Directors would conduct a review, with the assistance of management, of the Company’s revenue recognition policies and accounting for product sales, including its estimates of product returns under SFAS 48 — “Revenue Recognition When Right of Return Exists” (“SFAS 48”) and Staff Accounting Bulletin (“SAB”) No. 101 -“Revenue Recognition”, as amended by SAB 104 (hereinafter referred to as “SAB 104”). The review included the Company’s revenue recognition policies and practices for current and past periods as well as the Company’s internal control over financial reporting as it related to those items. The Company also reviewed the accounting and classification of its sales of royalty rights in its consolidated statements of operations. The Audit Committee retained Dorsey & Whitney LLP as independent counsel. The Audit Committee and independent counsel subsequently retained PricewaterhouseCoopers as their independent accounting consultants to assist in the review. In addition, the Company, through its counsel, Latham & Watkins LLP, retained FTI Ten Eyck to provide an independent accounting perspective in connection with the accounting issues under review.
     On May 20, 2005, the Company announced that the Audit Committee had completed its accounting review and that the Company would restate its consolidated financial statements as of December 31, 2003 and for the years ended December 31, 2003 and 2002, and as of and for the first three quarters of 2004 and for the quarters of 2003. The Audit Committee and management independently reviewed the Company’s revenue recognition practices and policies for product sales for 2003 and 2002 and each of the three quarters in the period ended September 30, 2004. These reviews focused on whether the Company had properly recognized revenue on product shipments to distributors under SFAS 48 and SAB 104. Based on these reviews, the Company determined that it had not met all of the criteria under SFAS 48 and SAB 104 to recognize revenue upon shipment. As a result of this error, the Company determined to restate its financial results and to report financial results under the sell-through revenue recognition method for the domestic product shipments of AVINZA®, ONTAK®, Targretin® capsules, and Targretin® gel. The Company also announced that it was continuing its work to review the accounting and classification of its sales of royalty rights in its consolidated statements of operations and that the Audit Committee review found no evidence of improper or fraudulent actions or practices by any member of management or that management acted in bad faith in adopting and administering the Company’s historical revenue recognition policies.
     Subsequent to the Company’s announcement that it would restate its consolidated financial statements, the Company’s previous auditors declined to be re-engaged to audit the restatement. As a result, the Audit Committee engaged BDO Seidman, LLP (“BDO”), the Company’s current independent registered public accounting firm, to re-audit the consolidated financial statements for the fiscal years ended December 31, 2003 and 2002. During the course of the re-audits other errors were identified that affect the restated consolidated financial statements.
     In connection with the restatement, the SEC instituted a formal investigation concerning the Company’s consolidated financial statements. These matters were previously the subject of an informal SEC inquiry. Ligand has been cooperating fully with the SEC and will continue to do so in order to bring the investigation to a conclusion as promptly as possible.

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The Restatement and Other Related Matters
     Set forth below is a summary of the significant determinations regarding the restatement and additional matters addressed in the course of the restatement.
     Revenue Recognition. The restatement corrects the recognition of revenue for transactions involving each of the Company’s products that did not satisfy all of the conditions for revenue recognition contained in SFAS 48 and SAB 104. The Company’s products impacted by this restatement are the domestic product shipments of AVINZA, ONTAK, Targretin capsules, and Targretin gel. Specifically, although the Company believed it had met each of the criteria for recognizing revenue upon shipment of each of its products, management subsequently determined that based upon SFAS 48 and SAB 104 it did not have the ability to make reasonable estimates of future returns because there was (i) a lack of sufficient visibility into the wholesaler and retail distribution channels; (ii) an absence of historical experience with similar products; (iii) increasing levels of inventory in the wholesale and retail distribution channels as a result of increasing demand of the Company’s new products among other factors; and (iv) a concentration of a few large distributors. As a result, the Company could not make reliable and reasonable estimates of returns which precluded it from recognizing revenue at the time of product shipment, and therefore such transactions must be restated using the sell-through method. The restatement of product revenue under the sell-through method requires the correction of other accounts whose balances are largely based upon the prior accounting policy. Such accounts include gross to net sales adjustments and cost of goods (products) sold. Gross to net sales adjustments include allowances for returns, rebates, chargebacks, discounts, and promotions, among others. Cost of product sold includes manufacturing costs and royalties.
     The restatement did not affect the revenue recognition of Panretin or the Company’s international product sales. For Panretin, our wholesalers only stock minimal amounts of product, if any. As such, wholesaler orders are considered to approximate end-customer demand for the product. For international sales, our products are sold to third-party distributors, for which we have had minimal returns. For these sales, we believe that the Company has met the SFAS 48 and SAB 104 criteria for recognizing revenue.
     Specific models were developed for: AVINZA, including a separate model for each dosage strength (a retail-stocked product for which the sell-through revenue recognition event is prescriptions as reported by a third party data provider, IMS Health Incorporated, or IMS); Targretin capsules and gel (for which revenue recognition is based on wholesaler out-movement as reported by IMS); and ONTAK (for which revenue recognition is based on wholesaler out-movement as reported to the Company by its wholesalers as the product is generally not stocked in pharmacies). Separate models were also required for each of the adjustments associated with the gross to net sales adjustments and cost of goods sold. The Company also developed separate demand reconciliations for each product to assess the reasonableness of the third party information described above which was used in the restatement and will be used on a going-forward basis.
     Under the sell-through method used in the restatement and to be used on a going-forward basis, the Company does not recognize revenue upon shipment of product to the wholesaler. For these shipments, the Company invoices the wholesaler, records deferred revenue at gross invoice sales price less estimated cash discounts and, for ONTAK, end-customer returns, and classifies the inventory held by the wholesaler as “deferred cost of goods sold” within “other current assets.” Additionally, for royalties paid to technology partners based on product shipments to wholesalers, the Company records the cost of such royalties as “deferred royalty expense” within “other current assets.” Royalties paid to technology partners are deferred as the Company has the right to offset royalties paid for product that are later returned against subsequent royalty obligations. Royalties for which the Company does not have the ability to offset (for example, at the end of the contracted royalty period) are expensed in the period the royalty obligation becomes due. The Company recognizes revenue when inventory is “sold through” (as discussed below), on a first-in first-out (FIFO) basis. Sell-through for AVINZA is considered to be at the prescription level or at the time of end user consumption for non-retail prescriptions. Thus, changes in wholesaler or retail pharmacy inventories of AVINZA do not affect the Company’s product revenues, but will be reflected on the balance sheet as a change to deferred product revenue. Sell-through for ONTAK, Targretin capsules, and Targretin gel is considered to be at the time the product moves from the wholesaler to the wholesaler’s customer. Changes in wholesaler inventories for all the Company’s products, including product that the wholesaler returns to the Company for credit, do not affect product revenues but will be reflected as a change in deferred product revenue.

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     The Company’s revenue recognition is subject to the inherent limitations of estimates that are based on third-party data, as certain-third party information is itself in the form of estimates. Accordingly, the Company’s sales and revenue recognition under the sell-through method reflect the Company’s estimates of actual product sold through the distribution channel. The estimates by third parties include inventory levels and customer sell-through information the Company obtains from wholesalers which currently account for a large percentage of the market demand for its products. The Company also uses third-party market research data to make estimates where time lags prevent the use of actual data. Certain third-party data and estimates are validated against the Company’s internal product movement information. To assess the reasonableness of third-party demand (i.e. sell-through) information, the Company prepares separate demand reconciliations based on inventory in the distribution channel. Differences identified through these demand reconciliations outside an acceptable range are recognized as an adjustment to the third-party reported demand in the period those differences are identified. This adjustment mechanism is designed to identify and correct for any material variances between reported and actual demand over time and other potential anomalies such as inventory shrinkage at wholesalers or retail pharmacies.
     As a result of the Company’s adoption of the sell-through method, it recorded reductions to net product sales in the amounts of $12.8 million, $8.1 million and $9.2 million for the quarters ended September 30, 2004, June 30, 2004 and March 31, 2004, respectively, and $25.5 million, $13.4 million, $12.8 million, and $7.5 million for the quarters ended December 31, 2003, September 30, 2003, June 30, 2003, and March 31, 2003, respectively. Additionally, for the years ended December 31, 2003 and 2002, the Company recorded a reduction to net product sales in the amounts of $59.2 million and $24.2 million, respectively. These amounts do not include other adjustments also affected by the change to the sell-through method such as cost of products sold and royalties. Revenue which has been deferred will be recognized as the product sells through in future periods as discussed above.
     Sale of Royalty Rights. In March 2002, the Company entered into an agreement with Royalty Pharma AG (“Royalty Pharma”) to sell a portion of its rights to future royalties from the net sales of three selective estrogen receptor modulator (SERM) products now in late stage development with two of the Company’s collaborative partners, Pfizer Inc. and American Home Products Corporation, now known as Wyeth, in addition to the right, but not the obligation, to acquire additional percentages of the SERM products’ net sales on future dates by giving the Company notice. When the Company entered into the agreement with Royalty Pharma and upon each subsequent exercise of its options to acquire additional percentages of royalty payments to the Company, the Company recognized the consideration paid to it by Royalty Pharma as revenue. Cumulative payments totaling $63.3 million were received from Royalty Pharma from 2002 through 2004 for the sale of royalty rights from the net sales of the SERM products.
     The Company determined that, while the current accounting classification is appropriate, a portion of the revenue recognized under the Royalty Pharma agreement should have been deferred since Pfizer and Wyeth each had the right to offset a portion of future royalty payments for, and to the extent of, amounts previously paid to the Company for certain developmental milestones. Approximately $0.6 million of revenue was deferred in each of 2003 and 2002 related to the offset rights by the Company’s collaborative partners, Pfizer and Wyeth. The amounts associated with the offset rights against future royalty payments will be recognized as revenue upon receipt of future royalties from the respective partners or upon determination that no such future royalties will be forthcoming. Additionally, the Company determined to defer a portion of such revenue as it relates to the value of the option rights sold to Royalty Pharma until Royalty Pharma exercised such options or upon the expiration of the options. The value of Royalty Pharma options outstanding at the end of 2002 which was recognized in 2003 was approximately $0.1 million. The value of options outstanding at the end of 2003 which was recognized in 2004 was $0.2 million. As of December 31, 2004, all of the option revenue deferred during fiscal 2002 and 2003 has been recognized. Accordingly, for the years ended December 31, 2003 and 2002, the Company has restated revenue from the sale of royalty rights under the Royalty Pharma agreement, which reduced royalty revenue by approximately $0.7 million for each of the years ended December 31, 2003 and 2002.
Additional Matters Addressed in the Restatement
     Subsequent to May 20, 2005, the Company determined that it should also restate its consolidated financial statements as they relate to the following matters:

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     Buy-Out of Salk Royalty Obligation. In March 2004, the Company paid The Salk Institute $1.12 million in connection with the Company’s exercise of an option to buy out milestone payments, other payment-sharing obligations and royalty payments due on future sales of lasofoxifene, a product under development by Pfizer for which a NDA was expected to be filed in 2004. At the time of the Company’s exercise of its buyout right, the payment was accounted for as a prepaid royalty asset to be amortized on a straight-line basis over the period for which the Company had a contractual right to the lasofoxifene royalties. This payment was included in “Other assets” on the Company’s consolidated balance sheet at September 30, 2004, June 30, 2004, and March 31, 2004. Pfizer filed the NDA for lasofoxifene with the United States Food and Drug Administration in the third quarter of 2004. Because the NDA had not been filed at the time the Company exercised its buyout right, the Company determined in the course of the restatement that the payment should have been expensed. Accordingly, the Company corrected such error and recognized the Salk payment as development expense for the quarter ended March 31, 2004 and the year ended December 31, 2004.
     X-Ceptor Therapeutics, Inc. In June 1999, the Company invested $6.0 million in X-Ceptor Therapeutics, Inc. (“X- Ceptor”) through the acquisition of convertible preferred stock. Additionally, in October 1999, the Company issued warrants to X-Ceptor investors, founders and certain employees to purchase 950,000 shares of Ligand common stock with an exercise price of $10.00 per share and an expiration date of October 6, 2006. At the time of issuance, the warrants were recorded at their fair value of $4.20 per warrant or $4.0 million as deferred warrant expense within stockholders’ deficit and were amortized to operating expense through June 2002. The Company determined during the course of the restatement that the warrant issuance should have been capitalized as an asset rather than treated as a deferred expense within equity since the warrant issuance was deemed to be consideration for the right granted to the Company by X-Ceptor to acquire all of the outstanding stock of X-Ceptor (the “Purchase Right”). Accordingly, the Company recorded the Purchase Right as an other asset in the amount of $4.0 million. The effect of this change resulted in a decrease in expense for the year ended December 31, 2002 of $0.7 million. This asset was subsequently written off to “Other, net expense” in the quarter ended March 31, 2003, the period the Company determined that the Purchase Right would not be exercised.
     Pfizer Settlement Agreement and Elan Shares. In April 1996, the Company and Pfizer entered into a settlement agreement with respect to a lawsuit filed in December 1994 by the Company against Pfizer. In connection with a collaborative research agreement the Company entered into with Pfizer in 1991, Pfizer purchased shares of the Company’s common stock. Under the terms of the settlement agreement, at the option of either the Company or Pfizer, milestone and royalty payments owed to the Company can be satisfied by Pfizer by transferring to the Company shares of the Company’s common stock at an exchange ratio of $12.375 per share. At the time of the settlement, the Company accounted for the prior issuance of common stock to Pfizer as equity on its balance sheet.
     Additionally, in 1998, Elan International (Elan) agreed to exclusively license to the Company in the United States and Canada its proprietary product AVINZA. In connection with the November 2002 restructuring of the AVINZA license agreement with Elan, the Company agreed to repurchase approximately 2.2 million shares of the Company’s common stock held by an affiliate of Elan (the “Elan Shares”) for $9.00 a share. At the time of the November 2002 agreement, the shares were classified as equity on the Company’s balance sheet. The Elan Shares were repurchased and retired in February 2003.
     In conjunction with the restatement, the remaining common stock issued and outstanding to Pfizer following the settlement and the Elan Shares were reclassified as “common stock subject to conditional redemption/repurchase” (between liabilities and equity) in accordance with Emerging Issue Task Force Topic D-98, “Classification and Measurement of Redeemable Securities” (EITF D-98), which was issued in July 2001.
     EITF D-98 requires the security to be classified outside of permanent equity if there is a possibility of redemption of securities that is not solely within the control of the issuer. Since Pfizer has the option to settle with Company’s shares milestone and royalties payments owed to the Company and, as of December 31, 2002, the Company was required to repurchase the Elan shares, the Company determined that such factors indicated that the redemptions were not within the Company’s control, and accordingly, EITF D-98 was applicable to the treatment of the common stock issued to Pfizer and the Elan Shares. These adjustments totaling $34.6 million only had an effect on the balance sheet classification, not on the consolidated statements of operations. Of the total adjustments, $14.6 million related to the Pfizer shares and $20.0 million related to the Elan Shares.

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     Seragen Litigation. On December 11, 2001, a lawsuit was filed in the United States District Court for the District of Massachusetts against the Company by the Trustees of Boston University and other former stakeholders of Seragen. The suit was subsequently transferred to federal district court in Delaware. The complaint alleges breach of contract, breach of the implied covenants of good faith and fair dealing and unfair and deceptive trade practices based on, among other things, allegations that the Company wrongfully withheld approximately $2.1 million in consideration due the plaintiffs under the Seragen acquisition agreement. This amount had been previously accrued for in the Company’s consolidated financial statements in 1998. The complaint seeks payment of the withheld consideration and treble damages. The Company filed a motion to dismiss the unfair and deceptive trade practices claim. The Court subsequently granted the Company’s motion to dismiss the unfair and deceptive trade practices claim (i.e. the treble damages claim), in April 2003. In November 2003, the Court granted Boston University’s motion for summary judgment, and entered judgment for Boston University. In January 2004, the district court issued an amended judgment awarding interest of approximately $0.7 million to the plaintiffs in addition to the approximately $2.1 million withheld. The Court award of interest was previously not accrued. Although the Company has appealed the judgment in this case as well as the award of interest and the calculation of damages, in view of the judgment, the Company revised its consolidated financial statements in the fourth quarter of 2003 to record a charge of $0.7 million.
     Other. In conjunction with the restatement, the Company also made other adjustments and reclassifications to its accounting for various other errors, in various years, including, but not limited to: (1) a correction to the Company’s estimate of the accrual for clinical trials; (2) corrections to estimates of other accrued liabilities; (3) royalty payments made to technology partners; (4) straight-line recognition of rent expense for contractual annual rent increases; and (5) corrections to estimates of future obligations and bonuses to employees.
     For the quarters ended September 30, 2004, June 30, 2004, and March 31, 2004, the restatement increased the net loss by $11.7 million or $0.16 per share; $7.8 million or $0.11 per share; and $8.8 million or $0.12 per share, respectively. For the quarter ended December 31, 2003, the restatement decreased net income by $24.6 million or $0.34 per share and increased net loss for the quarters ended September 30, 2003, June 30, 2003, and March 31, 2003 by $11.6 million or $0.16 per share; $12.0 million or $0.18 per share; and $10.8 million or $0.15 per share, respectively. The restatement increased the net loss in 2003 by $59.0 million or $0.83 per share to $96.5 million or $1.36 per share. The restatement increased the net loss in 2002 by $19.7 million or $0.29 per share to $52.3 million or $0.76 per share. For periods prior to 2002, the restatement was effectuated through an aggregate adjustment as of January 1, 2002 of $15.1 million to the Company’s accumulated deficit. Additionally, for periods prior to 2002, restatement of the Pfizer settlement agreement was effectuated as of January 1, 2002 through a reduction of additional paid in capital and a corresponding increase to “common stock subject to conditional redemption/repurchase” (between liabilities and equity) of $14.6 million. The restatement regarding the Elan shares had no effect on periods prior to 2002 since it was effectuated as of November 2002 through a reduction of additional paid in capital and a corresponding increase to “common stock subject to conditional redemption/repurchase” of $20.0 million.
     For further discussion of the restatement adjustments and the net effects of all of the restatement adjustments on our balance sheet and statements of operations, please refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Restatement of Consolidated Financial Statements”, and Note 2 to the Consolidated Financial Statements.
     Internal Control Over Financial Reporting. Material weaknesses in our internal control over financial reporting as of December 31, 2004 have been identified and reported to our Audit Committee. Please see “Item 9A. Controls and Procedures” for a description of these matters, and of certain remediation measures that we have implemented during 2005 to date, as well as additional steps we plan to take to strengthen our internal control over financial reporting.

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     Reliance on Prior Consolidated Financial Statements. We have not amended our previously filed annual reports on Form 10-K or quarterly reports on Form 10-Q for the periods affected by the restatement. The information that has been previously filed or otherwise reported for these periods is superseded by the information in this Form 10-K. As such, other than our Form 10-K for the year ended December 31, 2004, we do not anticipate amending our previously filed annual reports on Form 10-K or our quarterly reports on Form 10-Q for any prior periods. Accordingly, the consolidated financial statements and related financial information contained in such previously filed reports should no longer be relied upon.

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Glossary
     
    Products And Indications
ONTAK® (denileukin diftitox)
ONZAR™
  Approved in February 1999 for sale in the U.S. for the treatment of patients with persistent or recurrent cutaneous T-cell lymphoma whose malignant cells express the CD25 component of the Interleukin-2 receptor.
 
   
Targretin® (bexarotene) capsules
  Approved in December 1999 for sale in the U.S. and in March 2001 for sale in Europe for the treatment of cutaneous manifestations of cutaneous T-cell lymphoma in patients who are refractory to at least one prior systemic therapy.
 
   
Targretin® (bexarotene) gel 1%
  Approved in June 2000 for sale in the U.S. for the topical treatment of cutaneous lesions in patients with cutaneous T-cell lymphoma (Stage 1A and 1B) who have refractory or persistent disease after other therapies or who have not tolerated other therapies.
 
   
Panretin® gel (alitretinoin) 0.1%
  Approved in February 1999 for sale in the U.S. and in October 2000 for sale in Europe for the topical treatment of cutaneous lesions of patients with AIDS-related Kaposi’s sarcoma.
 
   
AVINZA®
  Approved in March 2002 for sale in the U.S. for the once-daily treatment of moderate-to-severe pain in patients who require continuous, around-the-clock opioid therapy for an extended period of time.
 
   
CTCL
  Cutaneous T-cell lymphoma
HIV
  Human immunodeficiency virus
HT
  Hormone therapy
KS
  Kaposi’s sarcoma
NHL
  Non-Hodgkin’s lymphoma
NSCLC
  Non-small cell lung cancer
CLL
  Chronic lymphocytic leukemia
GVHD
  Graft-versus-host disease
SCIENTIFIC TERMS
   
AR
  Androgen Receptor
ER
  Estrogen Receptor
GR
  Glucocorticoid Receptor
IR
  Intracellular Receptor
JAK
  Janus Kinase family of tyrosine protein kinases
MR
  Mineralocorticoid Receptor
PPAR
  Peroxisome Proliferation Activated Receptor
PR
  Progesterone Receptor
RAR
  Retinoic Acid Receptor
RR
  Retinoid Responsive Intracellular Receptor
RXR
  Retinoid X Receptor
SARM
  Selective Androgen Receptor Modulator
SERM
  Selective Estrogen Receptor Modulator
SGRM
  Selective Glucocorticoid Receptor Modulator
STAT
  Signal Transducer and Activator of Transcription
REGULATORY TERMS
   
CPMP
  Committee for Proprietary Medicinal Products (Europe)
EC
  European Commission
EMEA
  European Agency for the Evaluation of Medicinal Products
FDA
  United States Food and Drug Administration
IND
  Investigational New Drug Application (United States)
MA
  Marketing Authorization (Europe)
MAA
  Marketing Authorization Application (Europe)
NDA
  New Drug Application (United States)

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PART I
Item 1. Business
     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 Item 1 – Business at “Risks and Uncertainties.” This outlook represents our current judgment on the future direction of our business. These statements include those related to compliance with the NASDAQ Listing Qualifications Panel requirements and the potential relisting of the Company’s securities. Actual events or results may differ materially from Ligand’s expectations. There can be no assurance of when the Company’s subsequent processes such as compliance with NASDAQ Listing Qualifications Panel requirements will be completed, that the Company will achieve relisting by the NASDAQ Stock Market and if so, when relisting will occur, that the Company’s currently ongoing or future litigation (including private litigation and the SEC investigation) will not have an adverse effect on the Company, that the Company will be able to successfully remediate any identified material weakness or significant deficiencies, or that the sell-through revenue recognition models will not require adjustment and not result in a subsequent restatement. In addition, the Company’s financial results and stock price may suffer as a result of the previously announced restatement and delisting action by NASDAQ and its relationships with its vendors, stockholders or other creditors may suffer. Such risks and uncertainties could cause actual results to differ materially from any future performance suggested. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date of this annual report. This caution is made under the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 as amended.
     Our trademarks, trade names and service marks referenced in this annual report include Ligandâ, ONTAK, Panretin, Targretin, and AVINZA. Each other trademark, trade name or service mark appearing in this annual report belongs to its owner.
     References to Ligand Pharmaceuticals Incorporated (“Ligand”, the “Company”, “we” or “our”) include our wholly owned subsidiaries — Ligand Pharmaceuticals (Canada) Incorporated; Ligand Pharmaceuticals International, Inc.; Seragen, Inc. (“Seragen”); and Nexus Equity VI LLC (“Nexus”).
     We were incorporated in Delaware in 1987. Our principal executive offices are located at 10275 Science Center Drive, San Diego, California, 92121. Our telephone number is (858) 550-7500.
Overview
     Our goal is to build a profitable pharmaceutical company that discovers, develops and markets new drugs that address critical unmet medical needs in the areas of cancer, men’s and women’s health, skin diseases, osteoporosis, and metabolic, cardiovascular and inflammatory diseases. We strive to develop drugs that are more effective and/or safer than existing therapies, that are more convenient (taken orally or topically administered) and that are cost effective. We plan to build a profitable pharmaceutical company by generating income from the specialty pharmaceutical products we develop and market, and from research, milestone and royalty revenues resulting from our collaborations with large pharmaceutical partners, which develop and market products in large markets that are beyond our strategic focus or resources.
     We currently market four oncology products in the United States: Panretin gel, ONTAK and Targretin capsules, each of which was approved by the FDA in 1999; and Targretin gel, which was approved by the FDA in 2000. Our fifth and newest product, AVINZA, is a treatment for chronic, moderate-to-severe pain that was approved by the FDA in March 2002. In Europe, the EC granted an MA for Panretin gel in October 2000 and an MA for Targretin capsules in March 2001. We also continue efforts to acquire or in-license other products, like ONTAK and AVINZA, which have near-term prospects of FDA approval and which can be marketed by our specialty sales forces. We are developing additional products through our internal development programs and currently have various products in clinical development, including marketed products that we are testing for larger market indications such as NSCLC, CLL, NHL and hand dermatitis.
     We have formed research and development collaborations with numerous global pharmaceutical companies, including Abbott Laboratories, Allergan, Inc., Bristol-Myers Squibb, Eli Lilly & Company, GlaxoSmithKline,

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Organon (Akzo Nobel), Parke-Davis, Pfizer Inc., TAP Pharmaceutical Products, Inc. (TAP), and Wyeth. As of August 31, 2005, our corporate partners had 13 Ligand products in human development and numerous compounds on an IND track or in preclinical and research stages. These corporate partner products are being studied for the treatment of large market indications such as osteoporosis, diabetes, contraception and cardiovascular disease. One of these partner products, lasofoxifene, is being developed by Pfizer for osteoporosis and other indications. Pfizer filed a NDA with the FDA in August 2004 for the use of lasofoxifene in the prevention of osteoporosis and then filed a supplemental NDA in December 2004 for the use of lasofoxifene in the treatment of vaginal atrophy. Two of these partner products are in pivotal Phase III clinical trials: bazedoxifene, which is being developed by Wyeth as monotherapy for osteoporosis and in combination with Wyeth’s PREMARIN for osteoporosis prevention, and vasomotor symptoms of menopause. A fourth partner product, LY519818, is being developed by Eli Lilly & Company for the treatment of type 2 diabetes. Lilly has announced plans to advance this product into Phase III registration studies after completion of two-year carcinogenicity studies and appropriate consultation with the FDA. Another Lilly product, LY674 has recently advanced into Phase II development for atherosclerosis and LY929 is in Phase I development for type 2 diabetes. Two additional partner products being developed by GlaxoSmithKline are in Phase II: GSK516 for cardiovascular disease and dislipidemia and SB497115 for thrombocytopenia. Other partner products in Phase II include pipendoxifene (formerly ERA-923) being developed by Wyeth for breast cancer and NSP-989 for contraception and NSP-989 combo for contraception in Phase I. In February 2005, GlaxoSmithKline commenced Phase I studies of SB-449448, a second product for thrombocytopenia and TAP commenced Phase I studies for LGD 2941 for the treatment of osteoporosis and frailty. Additionally, in September 2005, Pfizer announced the receipt of a non-approvable letter from the FDA for the prevention of osteoporosis. However, lasofoxifene continues in Phase III clinical trials by Pfizer for the treatment of osteoporosis.
     Internal and collaborative research and development programs are built around our proprietary science technology, which is based on our leadership position in gene transcription technology. Panretin gel, Targretin capsules, and Targretin gel as well as our corporate partner products currently on human development track are modulators of gene transcription, working through key cellular or intracellular receptor targets discovered using our IR technology.
Business Strategy
     Our goal is to become a profitable pharmaceutical research, development and marketing company that generates significant cash flow. Building primarily on our proprietary IR technology, our strategy is to generate cash flow primarily from the sale of specialty pharmaceutical products we develop, acquire or in-license, and from research, milestone and royalty revenues from the development and sale of products our collaborative partners develop and market.
Building a Specialty Pharmaceutical Franchise.
     Our strategy with respect to specialty pharmaceutical products is to develop a product pipeline based on our IR technologies and acquired and in-licensed products, and to market these products initially with a specialized sales force in the U.S. and through marketing partners in selected international markets. Our execution of this strategy to date has been implemented in the U.S., Europe and Latin America. We expect to address additional global markets when and where practicable. Ligand’s current international distribution partners are Zeneus (principally in Western and Eastern Europe), Ferrer (in Spain, Portugal, Greece, Central and South America) and Sigma Tau (in Italy). In October 2005, the Italian distribution rights were transferred from Alfa Wasserman to Sigma Tau.
     Focusing initially on niche pharmaceutical and dermatology indications with the possibility of expedited regulatory approval has allowed us to bring products to market quickly. This strategy also has allowed us to spread the cost of our sales and marketing infrastructure across multiple products. Our goal is to expand the markets for our products through approvals in additional indications and in international markets. To further leverage our sales forces, we intend to acquire selectively or license-in complementary technology and/or products currently being marketed or in advanced stages of development.

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Building a Collaborative-Based Business in Large Product Markets.
     Our strategy in our collaborative research and development business is to share the risks and benefits of discovering and developing drugs to treat diseases that are beyond our strategic focus or resources. These diseases typically affect large populations often treated by primary care physicians. Drugs to treat these diseases may be more costly to develop and/or market effectively with a small specialty sales force. On the other hand, drugs approved for these indications may have large market potential – often in excess of $1 billion annually in global sales.
     We have entered into a number of collaborative arrangements with global pharmaceutical companies focusing on a broad range of disease targets. The table below lists those of our corporate partners which have one or more compounds identified in our collaborative research efforts moving through clinical development.
         
    Initiation of    
Corporate Collaborator   Collaboration   Focus
Pfizer Inc.
  May 1991   Osteoporosis, breast cancer prevention, vaginal atrophy
 
       
GlaxoSmithKline (Glaxo Wellcome plc)
  September 1992   Cardiovascular diseases
 
       
Wyeth
  September 1994   Women’s health, oncology
 
       
GlaxoSmithKline (SmithKline Beecham)
  February 1995   Blood disorders
 
       
Eli Lilly & Company
  November 1997   Type II diabetes, metabolic and cardiovascular diseases
 
       
TAP Pharmaceutical Products, Inc.
  June 2001   Men’s and women’s health, osteoporosis
     In addition to the collaborations listed above, we have also entered into collaborations with Allergan, Inc. (in June 1992 focused on skin disorders), Abbott Laboratories (in July 1994 focused on inflammatory diseases) and Organon (in February 2000 in women’s health). Allergan, Abbott and Organon retain the right to move compounds identified during our collaborative research activities forward into clinical development, although we believe none of them is currently doing so. Two other collaborative partners, Parke-Davis and Bristol-Myers Squibb, no longer have rights to move compounds forward into clinical development.
     Our collaborative programs focus on discovering drugs for cardiovascular, inflammatory, metabolic and other diseases, as well as broad applications for women’s and men’s health. We believe that our collaborators have the resources, including clinical and regulatory experience, manufacturing capabilities and marketing infrastructure, needed to develop and commercialize drugs for these large markets. The arrangements generally provide for collaborative discovery programs funded largely by the corporate partners aimed at discovering new therapies for diseases treated by primary care physicians. In general, drugs resulting from these collaborations will be developed, manufactured and marketed by the corporate partners. Our collaborative agreements provide for us to receive: research revenue during the drug discovery stage; milestone revenue for compounds successfully moving through clinical development and regulatory submission and approval; and royalty revenue from the sale of approved drugs developed through collaborative efforts. In some instances, we have sold a portion of our rights to future royalties to Royalty Pharma AG. See “Royalty Pharma Agreement.”

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Ligand Marketed Products
     U.S. Specialty Pharmaceutical Franchise. We currently market five pharmaceutical products in the U.S.
             
            Additional Indications
Marketed Product   Approved Indication   European Status   Studied or in Development
AVINZA
  Chronic, moderate-to-severe pain   N/A   None
 
           
ONTAK
  CTCL   MAA withdrawn (ONZAR)   CLL, B-cell NHL, other T-cell lymphomas, NSCLC
 
           
Targretin capsules
  CTCL   MA issued   NSCLC, renal cell cancer, breast, prostate/colon cancer and other solid tumors
 
           
Targretin gel
  CTCL   MAA withdrawn   Hand dermatitis, psoriasis
 
           
Panretin gel
  KS   MA issued   None
     AVINZA. AVINZA was approved by the FDA in March 2002 for the once-daily treatment of moderate-to-severe pain in patients who require continuous, around-the-clock opioid therapy for an extended period of time. We launched the product in the second quarter of 2002. AVINZA consists of two components: an immediate-release component that rapidly achieves morphine concentrations in plasma, and an extended-release component that maintains plasma concentrations throughout a 24-hour dosing interval. This unique drug delivery technology makes AVINZA the first true once-daily sustained release opioid. AVINZA was developed by Elan, which licensed the U.S. and Canadian rights to us in 1998. The U.S. sustained-release opioid market grew to approximately $4.1 billion in 2004, the largest initial market we have entered. Because tens of thousands of U.S. physicians prescribe sustained-release opioids, our goal was to co-promote the product with another company to maximize its potential. Early in 2003, we finalized a co-promotion agreement with Organon. The details of this co-promotion agreement are discussed below.
     CTCL Market. CTCL is a type of NHL that appears initially in the skin, but over time may involve other organs. CTCL is a cancer of T-lymphocytes, white blood cells that play a central role in the body’s immune system. The disease can be extremely disfiguring and debilitating. Median survival for late-stage patients is less than three years. The prognosis for CTCL is based in part on the stage of the disease when diagnosed. CTCL is most commonly a slowly progressing cancer, and many patients live with the complications of CTCL for 10 or more years after diagnosis. However, some patients have a much more aggressive form of this disease. CTCL affects an estimated 16,000 people in the U.S. and 12,000 to 14,000 in Europe. With ONTAK, Targretin capsules, and Targretin gel currently approved in the U.S. for the treatment of CTCL, our strategy is to have multiple products available for treating this disease.
     ONTAK. ONTAK was approved by the FDA and launched in the U.S. in February 1999 as our first product for the treatment of patients with CTCL. ONTAK was the first treatment to be approved for CTCL in nearly 10 years. ONTAK is currently in Phase II clinical trials for the treatment of patients with CLL, B-cell NHL, other T-cell lymphomas, NSCLC, and GVHD. Results from several of these studies were reported in 2002, 2003 and 2004. Ligand’s top priorities for additional ONTAK development are B-cell NHL and T-cell NHL. We began a Phase II CLL study in 2003 which is still continuing as are Phase II studies in NHL. Clinical trials using ONTAK for the treatment of patients with psoriasis and rheumatoid arthritis also have been conducted, and further trials are being considered. These indications provide significantly larger market opportunities than CTCL. A European MAA for CTCL was filed in December 2001, which we withdrew in April 2003. It was our assessment that the cost of the additional clinical and technical information requested by the European Agency for the EMEA would be better spent on the acceleration of the second generation ONTAK formulation development. We expect to resubmit the ONZAR (the tradename for ONTAK in the EU) application with the second generation product in 2006 or early 2007.

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     Targretin capsules. We launched U.S. sales and marketing of Targretin capsules in January 2000 following receipt of FDA approval in December 1999. Targretin capsules offer the convenience of a daily oral dose administered by the patient at home. In March 2001, the EC granted marketing authorization for Targretin capsules in Europe for the treatment of patients with CTCL, and our network of distributors began marketing the drug in the fourth quarter of 2001 in Europe. We are developing Targretin capsules in a variety of larger market opportunities, including NSCLC and other solid tumors. NSCLC is Ligand’s largest and most important development program. In March 2005, we announced that the final data analysis for Targretin capsules in NSCLC showed that the trials did not meet their primary endpoints of improved overall survival and projected two-year survival. We are continuing to analyze the data and apply it to the continued development of Targretin in NSCLC. The details of the final data analysis for Targretin capsules in NSCLC are discussed below.
     Targretin gel. We launched U.S. sales and marketing of Targretin gel in September 2000 following receipt of FDA approval in June 2000. Targretin gel offers patients with refractory, early stage CTCL a novel, non-invasive, self-administered treatment topically applied only to the affected areas of the skin. Targretin gel is currently in clinical development for hand dermatitis. In 2002 and early 2003, we reported positive Phase I/II data that showed nearly 40% of patients with chronic, severe hand dermatitis improved by 90% or more after being treated with Targretin gel monotherapy and nearly 80% responded with greater than 50% improvement. Based on these promising results, we intend to design and implement Phase II/III registration trials in hand dermatitis. We filed an MAA in Europe for CTCL in March of 2001, but withdrew it in 2002. Due to the small size of the European early stage CTCL market and the limited revenue potential of Targretin gel, we believed that the additional comparative clinical studies requested by the EMEA were not economically justified.
     Panretin gel. Panretin gel was approved by the FDA and launched in February 1999 as the first FDA-approved patient-applied topical treatment for AIDS-related KS. Panretin gel represents a non-invasive option to the traditional management of this disease. Most approved therapies require the time and expense of periodic visits to a healthcare facility, where treatment is administered by a doctor or nurse. AIDS-related KS adversely affects the quality of life of thousands of people in the U.S. and Europe. Panretin gel was approved in Europe for the treatment of patients with KS in October 2000, and was launched through our distributor network in the fourth quarter of 2001 in Europe.
     AVINZA Co-Promotion Agreement with Organon. In February 2003, we entered into an agreement for the co-promotion of AVINZA with Organon Pharmaceuticals USA Inc. (Organon). Under the terms of the agreement, Organon committed to specified minimum numbers of primary and secondary product calls delivered to high prescribing physicians and hospitals beginning in March 2003 as well as additional sales calls as approved by the companies’ joint steering committee in annual marketing plans.
     At the time we entered into the agreement, Organon brought strong relationships in primary care, anesthesiology, hospitals and managed care to support AVINZA. Through the agreement with Organon, Ligand gained strong partner resource commitments in primary care, hospitals and managed care to maximize AVINZA’s potential as our largest near-term commercial opportunity. In addition, the agreement included a risk/return-balanced set of economics that incentivizes Organon to achieve much greater success than Ligand could alone, with a goal of providing a positive operational earnings driver to Ligand, and enabling an attractive return on our cumulative investments in AVINZA. Finally, the agreement was intended to strengthen our capabilities in retail and wholesale distribution, medical marketing and managed care to support AVINZA. Joint co-promotion efforts began in March of 2003.
     According to IMS Health National Prescription Audit (IMS NPA) data, AVINZA ended 2004 with a market share of prescriptions in the sustained-release opioid market of 3.9% compared to 1.4% at the end of 2003. Quarterly prescription market share for the three months ended December 31, 2004 was 4.3% compared to 2.7% for the three months ended December 31, 2003.
     In March 2004, Ligand and Organon announced plans to increase sales calls in 2004 to primary care physicians through increased call activity by Organon’s primary care sales force and by Ligand hiring an additional 36 representatives calling on top decile primary care physicians in a mirrored activity to Organon’s. The companies also announced plans for 2004 for increased calls to long-term care and hospice market segments through the

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Organon sales and LTC/hospice infrastructure. Although these initiatives were in place during the second, third and fourth quarters of 2004, the sales call expansion and prescription increases anticipated were slower than expected.
     As part of an overall larger sales force realignment in Organon, a comprehensive territory rebalancing and AVINZA sales force restructuring was implemented in November 2004. This restructuring created approximately 370 AVINZA primary care territories with an estimated 60 AVINZA primary care physicians in each, eliminated the specialty sales force and placed specialty physicians into the hospital sales force call universe, and solidified a hospital sales force of 110 representatives. The primary care sales force was essentially focused on AVINZA and the hospital sales force called on specialists with AVINZA in position one.
     While the increased focus of the primary care representatives and the territory balancing of physicians was intended to be positive and increase sales call productivity over time, the immediate and near term effects including sales force turnover are believed to have impacted the quantity and quality of expected sales calls in 2004 and continuing into 2005. In addition, the Organon reorganization impacted the infrastructure and personnel available to execute the long-term care and hospice initiatives in the second half of 2004. The Organon reorganization and rebalancing, and the Ligand primary care sales force expansion may still improve sales call productivity in primary care over time, however, reacceleration of prescription demand and market share gains have not yet responded in the expected timeframes or in the expected quantities. This remains one of the key challenges of the co-promotion partners going forward.
     Under the companies’ agreement, Ligand records all sales of AVINZA. Organon’s compensation is structured as a percentage of net sales, based on Ligand’s standard accounting principles and generally accepted accounting principles (GAAP), which pays Organon for their efforts and also provides Organon an economic incentive for performance and results. In exchange, Ligand pays Organon a percentage of AVINZA’s net sales based on the following schedule:
         
    % of Incremental Net Sales
Annual Net Sales of AVINZA   Paid to Organon by Ligand
$0-35 million (2003 only)
  0% (2003 only)
$0-150 million
    30 %
$150-300 million
    40 %
$300-425 million
    50 %
> $425 million
    45 %
     Through the announcement of the restatement, Ligand calculated and paid Organon’s compensation according to its prior application of GAAP and its prior standard accounting principles. The restatement corrects the recognition of revenue for transactions involving AVINZA that did not satisfy all of the conditions for revenue recognition contained in SFAS 48 and SAB 104. Shipments made to wholesalers for AVINZA did not meet the revenue recognition criteria under GAAP and such transactions were restated using the sell-through method as opposed to the sell-in method previously used.
     Under the sell-through method used in the restatement and to be used on a going-forward basis, Ligand does not recognize revenue upon shipment of AVINZA to the wholesaler. As a result, Ligand believes it has overpaid Organon under the terms of the agreement by approximately $18.6 million through December 31, 2004. Ligand has notified Organon regarding the overpayment and its intention to apply such overpayment to future amounts due under the co-promotion agreement calculated under GAAP and its standard accounting principles. Organon has expressed its disagreement with this position and Ligand is currently in discussions with Organon. While the discussions continue, the payments made and under discussion are reflected in Ligand’s 2004 and 2003 consolidated financial statements as “co-promotion expense,” $9.2 million in 2004 and $9.4 million in 2003, respectively. Therefore, the consolidated financial statements included herein do not recognize the overpayment pending resolution of the matter. Until this matter is resolved, Ligand will continue to account for co-promotion expense based on net sales determined using the sell-in method.
     Additionally, both companies share equally all costs for advertising and promotion, medical affairs and clinical trials. Each company is responsible for its own sales force costs and other expenses. Both companies have made

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significant commitments to conduct a minimum number of sales calls, with AVINZA in primary or secondary position, over the term of the agreement.
     The initial term of the co-promotion agreement, which applies only to the U.S. market, is 10 years. Any time prior to the end of year five, Organon has an option to extend the agreement to 2017, the end of the term of a key AVINZA patent, by making a $75 million payment to us. Either party may terminate the agreement in the event that net sales of AVINZA during 2007 are less than a specified level. Further, either party may terminate the agreement upon material breach of the other party, including a failure of the other party to meet at least 95% of its minimum sales calls obligations or to use commercially reasonable efforts to market and promote AVINZA in accordance with the mutually agreed marketing plan, which includes the number, targeting and frequency of sales calls.
     To provide overall governance of the partnership, Organon and Ligand established a steering committee with three senior executives from each company. The chair of the steering committee alternates between Organon and Ligand on an annual basis. Organon and Ligand also formed a commercial committee to design and coordinate all sales, marketing and distribution activities for AVINZA. The commercial committee is co-chaired by one Organon and one Ligand employee. The commercial committee established a clinical/regulatory subcommittee to design and coordinate all medical, clinical and regulatory activities for AVINZA.
Ligand Product Development Programs
     We are developing several proprietary products for which we have worldwide rights for a variety of cancers and skin diseases, as summarized in the table below. This table is not intended to be a comprehensive list of our internal research and development programs. Many of the indications being pursued may present larger market opportunities for our currently marketed products. Our clinical development programs are primarily based on products discovered through our IR technology, with the exception of ONTAK, which was developed using Seragen’s fusion protein technology, and AVINZA, which was developed by Elan. Five of the products in our proprietary product development programs are retinoids, discovered and developed using our proprietary IR technology. Our research is based on our IR technology. See “Technology” for a discussion of our IR technology and retinoids.
     General Product Development Process. There are three phases in product development — the research phase, the preclinical phase and the clinical trials phase. See “Government Regulation” for a more complete description of the regulatory process involved in developing drugs. At Ligand, activities during the research phase include research related to specific IR targets and the identification of lead compounds. Lead compounds are chemicals that have been identified to meet pre-selected criteria in cell culture models for activity and potency against IR targets. More extensive evaluation is then undertaken to determine if the compound should enter preclinical development. Once a lead compound is selected, chemical modification of the compound is undertaken to create an optimal drug candidate.
     The preclinical phase includes pharmacology and toxicology testing in preclinical models (in vitro and in vivo), formulation work and manufacturing scale-up to gather necessary data to comply with applicable regulations prior to commencing human clinical trials. Development candidates are lead compounds that have successfully undergone in vitro and in vivo evaluation to demonstrate that they have an acceptable profile that justifies taking them through preclinical development with the intention of filing an IND and initiating human clinical testing.
     Clinical trials are typically conducted in three sequential phases that may overlap. In Phase I, the initial introduction of the pharmaceutical into humans, the emphasis is on testing for adverse effects, dosage tolerance, absorption, metabolism, distribution, excretion and clinical pharmacology. Phase II involves studies in a representative patient population to determine the efficacy of the pharmaceutical for specific targeted indications, to determine dosage tolerance and optimal dosage, and to identify related adverse side effects and safety risks. Once a compound is found to be effective and to have an acceptable safety profile in Phase II studies, Phase III trials are undertaken to evaluate clinical efficacy further and to test further for safety. Sometimes Phase I and II trials or Phase II and III trials are combined. In the U.S., the FDA reviews both clinical plans and results of trials, and may discontinue trials at any time if there are significant safety concerns. Once a product has been approved, Phase IV post-market clinical studies may be performed to support the marketing of the product.

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Program   Disease/Indication   Development Phase
AVINZA
  Chronic, moderate-to-severe pain   Marketed in U.S.
Phase IV
 
       
ONTAK
  CTCL   Marketed in U.S., Phase IV
 
  CLL   Phase II
 
  Peripheral T-cell lymphoma   Phase II
 
  B-cell NHL   Phase II
 
  NSCLC third line   Phase II
 
       
Targretin capsules
  CTCL   Marketed in U.S. and Europe
 
  NSCLC first-line   Phase III
 
  NSCLC monotherapy   Planned Phase II/III
 
  NSCLC second/third line   Planned Phase II/III
 
  Advanced breast cancer   Phase II
 
  Renal cell cancer   Phase II
 
       
Targretin gel
  CTCL   Marketed in U.S.
 
  Hand dermatitis (eczema)   Planned Phase II/III
 
  Psoriasis   Phase II
 
       
LGD4665 (Thrombopoietin oral mimic)
  Chemotherapy-induced thrombocytopenias (TCP), other TCPs   IND Track
 
       
LGD5552 (Glucocorticoid agonists)
  Inflammation, cancer   IND Track
 
       
Selective androgen receptor modulators, e.g., LGD3303 (agonist/antagonist)
  Male hypogonadism, female & male osteoporosis, male & female sexual dysfunction, frailty. Prostate cancer, hirsutism, acne, androgenetic alopecia.   Pre-clinical
AVINZA Development Programs
     AVINZA (oral morphine sulfate extended-release capsules) is the first true once-a-day treatment for chronic moderate-to-severe pain in patients who require continuous, around-the-clock opioid therapy for an extended period of time. Approved by the FDA in March 2002, AVINZA consists of two components: an immediate-release component that rapidly achieves morphine concentrations in plasma, and an extended-release component that maintains plasma concentrations throughout a 24-hour dosing interval.
     In a poster presented at the American Pain Society (APS) annual meeting in March of 2005, AVINZA showed better control of chronic pain and improved sleep in a large study comparing once-daily AVINZA (once-a-day morphine sulfate extended-release capsules) to twice-daily OxyContin® (oxycodone hydrochloride controlled-release). In initial results of the first phase of the study, with 212 evaluable patients (105 in the AVINZA arm and 107 in the oxycodone CR arm) followed through two months, the study showed that at lower, mean morphine-equivalent doses, patients receiving AVINZA once daily demonstrated statistically significant better around the clock pain control (evaluated using the Brief Pain Inventory assessment instrument), statistically significant better quality of sleep (evaluated using the Pittsburgh Sleep Quality Index assessment instrument), and a statistically significant reduction in the total number of rescue medications. The final study results for all patients enrolled are expected later in 2005. The results from an additional four-month treatment phase to collect long-term comparator data are expected to be reported at the American Pain Society meeting in 2006.
     A second poster at the March 2005 APS meeting presented the initial results of a study evaluating AVINZA’s effects on various sleep measures for patients with chronic, moderate-to-severe osteoarthritis pain of the hip or knee who self-report trouble sleeping. This was a 29-patient, placebo/baseline-controlled, single blind study using both polysomnography and subjective sleep measurements to assess and better quantify sleep parameters. Preliminary results demonstrated AVINZA’s ability to provide improved quality and quantity of sleep as well as improved pain control. Final results are expected later in 2005.

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     A third study of AVINZA, involving 507 patients, extends the findings of previously published controlled studies. The primary objective of this study was to measure the efficacy of once-daily AVINZA when used according to the package insert in patients with chronic non-cancer pain. Patients were recruited by office-based physicians. They were interviewed 4 times over a period of 3 months using questionnaires assessing pain, sleep, functional status, and rescue medication use. Measures were collected at baseline and at Month 1, 2, and 3. Interviews were conducted by phone or via the internet. The interim analysis, presented in a poster session at the College on Problems of Drug Dependence in June of 2005, showed that for patients who continue to take AVINZA for 3 months, 88% report their pain to be better compared to baseline and 88% rate AVINZA as effective or extremely effective. Full results are expected in late 2005.
ONTAK Development Programs
     ONTAK is a fusion protein that represents the first of a new class of targeted cytotoxic biologic agents. Rights to ONTAK were acquired from Eli Lilly in 1997 and in the acquisition of Seragen in 1998. ONTAK is marketed in the U.S. for patients with CTCL, which affects approximately 16,000 people in the U.S. In addition to ongoing CTCL trials, we are conducting clinical trials with ONTAK in patients with CLL, peripheral T-cell lymphoma, B-cell NHL, NSCLC, and GVHD, indications that represent significantly larger market opportunities than CTCL.
     In early 1999, ONTAK entered Phase II trials for the treatment of patients with NHL. NHL affects approximately 300,000 people in the U.S. and Ligand estimates that more than 50,000 of these patients would be candidates for ONTAK therapy. One multicenter study conducted by the Eastern Cooperative Oncology Group (ECOG) assessed ONTAK in patients with certain types of low-grade B-cell NHL who have previously been treated with at least one systemic anti-cancer treatment. The study results were presented at ASCO 2005 and showed the efficacy of ONTAK in patients with small cell lymphocytic lymphoma. A second multicenter trial evaluated ONTAK in 54 patients with relapsed/refractory low or intermediate grade lymphoma. The results of this study are being analyzed and are expected to be presented in 2006.
     Separately, a Phase II study of ONTAK in 45 patients with relapsed/refractory B-cell NHL was conducted by researchers from the M.D. Anderson Cancer Center and published in 2004 in the Journal of Clinical Oncology. The study enrolled late-stage, heavily pretreated patients (median of 4 prior treatments) and showed that 25% of the patients achieved a complete or partial response and an additional 20% achieved stabilization of disease. Furthermore, this study showed that ONTAK could be administered in patients with low blood counts, a patient population that cannot tolerate treatment with chemotherapy or radio-immunotherapy. On the basis of these favorable findings, two Phase II studies of ONTAK in relapsed/refractory B-cell lymphoma were launched in 2004. One multicenter trial conducted by Ligand is evaluating ONTAK in patients with poor blood cell counts at entry and another study conducted by investigators at MD Anderson Cancer Center is evaluating ONTAK plus Rituxan® (a monoclonal antibody marketed for the treatment of relapsed low grade lymphoma) in patients who have failed prior treatment with Rituxan. The interim results of the latter study have been submitted for presentation at a scientific meeting later in 2005.
     Investigators at MD Anderson Cancer Center also conducted a Phase II study on ONTAK in relapsed/refractory T-cell NHL. Interim results of this study were presented at ASH in 2004, which showed that in 17 evaluable patients, there was a 53% response rate with an additional 29% of patients experiencing stable disease. The final results of this study, which enrolled a total of 26 patients, have been submitted for presentation at a scientific meeting later in 2005. The company is also conducting a multicenter Phase II study of ONTAK plus a chemotherapy regimen designated as CHOP as first line treatment of patients with T-cell NHL. Although the CHOP chemotherapy regimen is considered as the standard of care for patients with T-cell NHL, about 50% of patients fail to achieve a complete response and, of those who respond, over 50% relapse within 2 years. The trial is designed to demonstrate whether the addition of ONTAK to CHOP will increase the response rate and the duration of response. Interim results of the trial are expected in 2006.
     ONTAK is also being evaluated to treat CLL, which affects more than 60,000 people in the U.S. Researchers from Wake Forest University conducted a multicenter Phase II study of ONTAK in patients with CD25-positive CLL who have failed prior treatment with fludarabine. The results of this pilot study were published in the journal Clinical Cancer Research in 2003 and showed that ONTAK reduced CLL in blood cells, lymph nodes and bone marrow. In the study, nine of 10 patients who received at least three courses of ONTAK experienced reductions in

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peripheral CLL cells, with three of these patients showing reductions of at least 99%. In addition, six of 10 patients showed reductions in the diameter of their cancerous lymph nodes, with one patient showing an 80% reduction. One of 12 evaluable patients showed a partial remission, with 80% node shrinkage and 100% clearance of CLL cells from bone marrow. Based on these encouraging results, three multicenter Phase II studies were launched in 2003 to further evaluate the role of ONTAK in patients with relapsed/refractory CLL. Preliminary results from one study of 18 patients conducted by investigators from Wake Forest University were reported at ASH in 2004 , and showed there was a 40% response rate among the 10 evaluable patients with fludarabine-refractory B-cell chronic lymphocytic leukemia. The investigators concluded that ONTAK “has activity in CLL with toxicities that can be managed with adequate premedication and close monitoring.” The final results of this study and another study conducted by the Hoosier Oncology Group are expected to be published later in 2005. The Company conducted a third trial which is nearing completion.
     Clinical trials with ONTAK have demonstrated benefits in patients with steroid-resistant acute graft-versus-host disease (GVHD) after allogeneic bone marrow transplantation. One Phase I-II study conducted by investigators from the Dana Farber Cancer Center in Boston enrolled 30 patients and the results were published in the journal Blood in 2004. The study established a dose of ONTAK that is safe in this patient population and showed that ONTAK resulted in a 71% response rate. Another multicenter Phase I-II study conducted by investigators from the Texas Transplant Institute enrolled 21 patients and the results were published in the journal Biology of Blood and Marrow Transplantation in 2005. The study confirmed that ONTAK can be safely administered in this patient population and that ONTAK achieved a 47% response rate at Day 36 of treatment with an additional 31% of patients achieving a response by Day 100. On the basis of these promising results, a randomized 4-arm study is being conducted by the Bone Marrow Transplant Network with NCI funding to evaluate the efficacy and safety of ONTAK and three other investigational agents in the primary treatment of acute GVHD.
     A multicenter Phase II study exploring the use of ONTAK as a monotherapy for patients with relapsed/refractory advanced NSCLC was conducted by investigators from the University of Cincinnati and completed in late 2004. The preliminary study results reported at the American Society of Clinical Oncology (ASCO) meeting in May of 2005 showed that ONTAK resulted in an unconfirmed partial response or disease stabilization in 40% of patients and noted an association between disease stabilization and an increase in a subset of T-lymphocytes in the circulation, suggesting that ONTAK’s effect could be ascribed to an activation of the immune system. These findings were consistent with the results of a study conducted by investigators from Duke University and presented at an oral session at ASCO in 2004 which showed that ONTAK significantly activated the immune system in patients with solid tumors receiving ONTAK in combination with an investigational anti-tumor vaccine.
Targretin Capsules Development Programs
     Targretin capsules are marketed in the U.S. for patients with refractory CTCL. Ligand also is investigating the use of Targretin capsules in several cancer and skin disease markets that represent significantly larger market opportunities than CTCL.
     In August 2000, we reported that Phase I/II clinical results demonstrated that Targretin capsules, in conjunction with chemotherapy, may be an effective treatment for patients with NSCLC and renal cell cancer. These results were published in the May 2001 issue of the Journal of Clinical Oncology. These results add to a growing body of evidence that suggests Targretin therapy may delay disease progression and extend survival of patients with some forms of solid tumors. This body of evidence led us to begin two large-scale Phase III clinical studies in 2001 to demonstrate conclusively Targretin capsules’ benefit in the treatment of patients with NSCLC. The studies were designed to support a supplemental indication for Targretin capsules for first-line treatment of patients with advanced NSCLC. One of these multicenter studies evaluated Targretin in combination with the chemotherapy drugs cisplatin and vinorelbine, and was conducted primarily in Europe and Latin America. The other multicenter study examined Targretin in combination with carboplatin and paclitaxel, and was conducted mainly in the U.S. Both studies were randomized with approximately 600 patients each, and had survival as the primary endpoint. Patient enrollments were completed in August and September 2003, respectively. The original statistical plan called for efficacy data analysis at the later of 456 deaths or twelve months following the last patient entered into each study. That plan, combined with the actual pace of accrual rates as observed in the last six months of the second study, would have resulted in a limited number of patients whose actual survival could be observed for two years or longer. The final statistical plan was modified as agreed with the FDA to specify the analysis trigger to be at the

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456th death event or 18 months of follow-up from the date the last patient was entered into each study, whichever occurs later. Based on enrollment dates, that 18-month time point was reached in mid-March, 2005. This modification resulted in the majority of patients having between 1.5 and 2.5 years of follow-up observation based upon actual accrual rates. We also expected the assessment of projected two-year survival, the study secondary endpoint, to be enhanced by the revised statistical plan.
     We publicly released top-line data within approximately two weeks after the commencement of final data analysis showing that the trials did not meet their endpoints of improved overall survival and projected two-year survival. For both studies, the primary endpoint was overall survival and the secondary endpoint was Kaplan-Meier projected two-year survival. No statistically significant differences in primary or secondary endpoints in the intent to treat population were seen in either trial. In both trials, additional subset analysis completed after the initial intent to treat results were analyzed revealed a significant correlation between high-grade (grade 3 and 4) hypertriglyceridemia and increased survival, potentially identifying a large subgroup patient population that may receive significant survival benefit of added Targretin treatment in first line therapy. Data from both trials was presented during the plenary session at the 2005 annual ASCO meeting. Review of data from current and prior Phase II studies shows a similar correlation between hypertriglyceridemia and increased survival. The data will further shape our future plans for Targretin. If further studies are justified, they will be conducted on our own or with a partner or cooperative group.
     In 2003 we also began a Phase II study of Targretin as monotherapy for late-stage lung cancer patients who have failed at least two prior treatments with chemotherapy and/or biologic therapy. A poster presentation at the 2005 annual meeting of ASCO reported on the interim analysis of data covering all 146 patients enrolled. Patients in the study were heavily pre-treated, having received a median of three prior treatments, and 54% of these patients had already failed treatment with Iressa. Overall median survival was five months and overall one-year survival was 15 percent. The data was also analyzed to evaluate the survival of patients based on the triglyceride response to Targretin treatment, in view of the SPIRIT results reported earlier at this meeting that showed an improved survival in patients who showed high grade triglyceridemia after Targretin administration. With this subanalysis, two populations of patients were identified. Those with increased triglyceridemia (grade 1 – 4) had a median survival of 7 months (p<0.0001) and a projected 1 year survival of 23%, compared with those with no hypertriglyceridemia who had a median survival of 2 months and a projected 1 year survival of 5%. The data from this study provides new information for Targretin monotherapy for patients with third-line treatment or beyond and also adds additional support to the subgroup analysis that came out of our SPIRIT trials about a triglyceride biomarker that may identify patients with the potential to benefit from Targretin therapy. This information will factor into our evolving plans for further studies.
     The American Cancer Society estimates that approximately 170,000 Americans are diagnosed with lung cancer each year; of those approximately 80% were diagnosed with NSCLC.
     Our primary focus for Targretin capsules during 2005 continues to be NSCLC. We will, however, continue to explore in Phase II/III trials the potential of Targretin capsules in combination regimens for the treatment of patients in solid tumor indications.
Targretin Gel Development Program
     Targretin gel is marketed in the U.S. for patients with refractory CTCL. In 2002 and early 2003, we reported exciting Phase I/II data that showed 39% of patients with chronic, severe hand dermatitis improved by 90% or more after being treated with Targretin gel monotherapy. In addition, 79% of patients improved by at least 50%. Fifty-five patients with a history of chronic severe hand dermatitis for at least six months were enrolled in the 22-week, randomized, open-label study, which was designed to evaluate safety, tolerability and activity. Patients were treated with Targretin alone, Targretin in combination with a medium potency topical steroid, and Targretin in combination with a low potency topical steroid. Based on these promising results, we intend to design and implement Phase II/III registration trials in hand dermatitis in 2006/2007. There are many subtypes of hand dermatitis, and many causes. Most hand dermatitis is caused by contact with irritating environmental substances, such as chemicals, soaps and cleaning fluids, and some cases are caused by allergic reactions to a wide variety of environmental substances. We estimate that more than 4 million people in the United States have hand dermatitis and seek treatment.

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     We filed an MAA for Targretin gel in Europe for CTCL in March of 2001, but withdrew it in 2002. Due to the small size of the European early stage CTCL market and the limited revenue potential of Targretin gel, we believed that the additional comparative clinical studies requested by the EMEA were not economically justified.
Thrombopoietin (TPO) Research Programs
     In our TPO program, we seek to develop our own drug candidates that mimic the activity of thrombopoietin (TPO) for use in the treatment or prophylaxis of thrombocytopenia with indications in a variety of conditions including cancer and disorders of blood cell formation. In 2005, we selected a TPO mimetic, LGD4665, as a clinical candidate. Our goal is to complete the preclinical studies necessary for filing an IND for this in 2006. Our partner GlaxoSmithKline (GSK) has two TPO mimics that were part of our collaboration with GSK in clinical trials: SB-497115 in Phase II and SB-559448 in Phase I. For a discussion of these clinical trials, see “Collaborative Research and Development Program – TPO/Inflammatory Disease/Oncology – Collaborative Program – GSK Collaboration.”
Selective Glucocorticoid Receptor Modulators Research and Development Program
     As part of the research and development collaboration we entered into with Abbott in 1994, Ligand received exclusive worldwide rights for all anti-cancer products discovered in the collaboration. When the research phase of the collaboration ended in July 1999, Abbott retained rights to certain SGRMs. We retained rights to all other compounds discovered through the collaboration, as well as recapturing technology rights. As a result, we then initiated an internal effort to develop SGRMs for inflammation, oncology and other therapeutic applications. As a result of that effort, in 2001, we moved several SGRMs into late preclinical development. During 2003, LGD5552 was designated a clinical candidate. Phase I studies are being planned for LGD5552. Additional preclinical studies are being conducted to determine the appropriate formulation and timing of IND filing. These non-steroidal SGRM molecules have anti-inflammatory activity that may be useful against diseases such as asthma and rheumatoid arthritis, as well as anti-proliferative effects that could be beneficial in treating certain leukemias and myelomas. Our goal is to develop novel products that maintain the efficacy of corticosteroids but lack the side effects of current therapies, which can include osteoporosis, hyperglycemia and hypertension.
     Another group of SGRMs from this program, selected from a different chemical class, are being targeted for the treatment of multiple myeloma and other blood cancers. The profile of these molecules is to have activity equal to dexamethasone but a significant reduction in side effects, particularly in bone and other parameters affecting quality of life.
SARM Programs
     We are pioneering the development of tissue selective SARMs, a novel class of non-steroidal, orally active molecules that selectively modulate the activity of the AR in different tissues, providing a wide range of opportunities for the treatment of many diseases and disorders in both men and women. Tissue-selective AR agonists or antagonists may provide utility in male HT and the treatment of patients with male hypogonadism, female & male osteoporosis, male & female sexual dysfunction, frailty, prostate cancer, hirsutism, acne, androgenetic alopecia, and other diseases. The use of androgen antagonists has shown efficacy in the treatment of prostate cancer, with three androgen antagonists currently approved by the FDA for use in the treatment of the disease. However, we believe that there is a substantial medical need for improved androgen modulators for use in the treatment of prostate cancer due to the significant side effects seen with currently available drugs.
     SARM programs have been one of our largest programs over the past several years. We have assembled an extensive SARM compound library and one of the largest and most experienced AR drug discovery teams in the pharmaceutical industry. We intend to pursue the specialty applications emerging from SARMs internally, but may seek collaborations with major pharmaceutical companies to exploit broader clinical applications.
     Consistent with this strategy, we formed in June 2001 a joint research and development alliance with TAP Pharmaceutical Products to focus on the discovery and development of SARMs. In December 2004, we announced the second extension of this collaboration for an additional year through June, 2006. Please see the “Collaborative

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Research and Development Programs/Sex Hormone Modulators Collaborative Programs/TAP Collaboration” section below for more details on this alliance.
     As part of the TAP alliance, we exercised an option to select for development one compound and a back-up, LG 123303 and LG 123129, out of a pool of compounds available for development in the TAP field. The SARM agonist which we now refer to as LGD3303 was designated a clinical candidate in late 2004. Preclinical studies indicate that the compound may have utility for osteoporosis, male and female sexual dysfunction, frailty and male hypogonadism. In vivo studies in rodents indicate a favorable profile with anabolic effects on bone, but an absence of the prostatic hypertrophy that occurs with the currently marketed androgens.
Collaborative Research and Development Programs
     We are pursuing several major collaborative drug discovery programs to further develop the research and development of compounds based on our IR technologies. These collaborations focus on several large market indications as estimated (as of 2004, except contraception, which is as of 2002) in the table below.
       
Indication   Estimated U.S. Prevalence
Menopausal symptoms
  50 million
Osteoporosis/osteopenia (men and women)
  55 million
Dyslipidemias
  109 million
Contraception
  38 million
Type II diabetes
  18 million
Breast cancer
  .8 million
     As of August 31, 2005, 13 of our collaborative product candidates were in human development - lasofoxifene, bazedoxifene, bazedoxifene CE (PREMARIN combo), pipendoxifene, NSP989, NSP989 combo, LGD2941, GW516, LY818, LY929, LY674, SB497115, and SB559448. Please see Note 15 of the consolidated financial statements for a description of the financial terms of our key ongoing collaboration agreements. The table below summarizes our collaborative research and development programs, but is not intended to be a comprehensive summary of these programs.

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Program   Disease/Indication   Development Phase   Marketing Rights
SEX HORMONE MODULATORS            
 
               
SERMs            
 
               
  Lasofoxifene (1)   Osteoporosis prevention, vaginal
atrophy
  NDA and SNDA filed   Pfizer
 
               
  Lasofoxifene   Breast cancer prevention,
Osteoporosis treatment
  Phase III   Pfizer
 
               
  Bazedoxifene   Osteoporosis   Phase III   Wyeth
 
               
  Bazedoxifene CE   Osteoporosis prevention
Vasomoter symptoms
  Phase III   Wyeth
 
               
  Pipendoxifene (formerly ERA-923) (2)   Breast cancer   Phase II   Wyeth
 
               
PR modulators            
 
               
  NSP-989 (PR agonist) (3)   Contraception   Phase II   Wyeth
 
               
  NSP-989 combo (PR agonist) (3)   Contraception   Phase I   Wyeth
 
               
SARMs            
 
               
  LGD 2941 (androgen agonist)   Osteoporosis, frailty, HT and sexual dysfunction   Phase I   TAP
 
               
METABOLIC/CARDIOVASCULAR DISEASES            
 
               
PPAR modulators            
 
               
  GW516   Cardiovascular disease, dyslipidemia   Phase II   GlaxoSmithKline
 
               
  LY818 (naveglitazar) (4)   Type II diabetes   Phase II   Lilly
 
               
  LY929 (5)   Type II diabetes, metabolic
diseases, dyslipidemia
  Phase I   Lilly
 
               
  LY674   Atherosclerosis/dyslipidemia   Phase II   Lilly
 
               
  LYWWW (6)   Atherosclerosis   IND track   Lilly
 
               
  Selective PPAR modulators   Type II diabetes, metabolic
diseases, dyslipidemia
  IND track   Lilly
 
               
  LYYYY (6)   Atherosclerosis   Pre-clinical   Lilly
 
               
INFLAMMATORY DISEASES, ONCOLOGY            
 
               
  SB-497115 (TPO agonist)   Thrombocytopenia   Phase II   GlaxoSmithKline
 
               
  SB-559448 (TPO agonist)   Thrombocytopenia   Phase I   GlaxoSmithKline
 
(1)   In September 2005, Pfizer announced receipt of a non-approvable letter from the FDA for the prevention of osteoporosis.
 
(2)   Pipendoxifene development has been terminated for oncology; it is currently on hold as a potential back-up to bazedoxifene.
 
(3)   On internal hold; strategic alternatives for Phase III development being explored.
 
(4)   Lilly decision to advance to Phase III announced March 2004; timing of initiation delayed by new FDA guidelines.
 
(5)   Product placed on internal hold.
 
(6)   Compound number not disclosed.

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Sex Hormone Modulators Collaborative Programs
     The primary objective of our sex hormone modulators collaborative programs is to develop drugs for hormonally responsive cancers of men and women, hormone therapies, the treatment and prevention of diseases affecting women’s health, and hormonal disorders prevalent in men. Our programs, both collaborative and internal, target development of tissue-selective modulators of the PR, the ER and the AR. Through our collaborations with Pfizer and Wyeth, three SERM compounds are in development for osteoporosis, breast cancer, vaginal atrophy and vasomotor symptoms of menopause. In addition, we entered into a joint research and development program in 2001 with TAP Pharmaceutical Products to focus on the discovery and development of SARMs.
     Pfizer Collaboration. In May 1991, we entered into a research and development collaboration with Pfizer to develop better therapies for osteoporosis. In November 1993, we jointly announced the successful completion of the research phase of our alliance with the identification of a development candidate and backups for the prevention and treatment of osteoporosis. In preclinical studies, the candidates from the program mimic the beneficial effects of estrogen on bone and have an impact on blood serum lipids often associated with cardiac benefits without increasing uterine or breast tissue proliferation.
     We have milestone and royalty rights to lasofoxifene, which is being developed by Pfizer for osteoporosis prevention and other diseases. Portions of these royalty rights have been sold to Royalty Pharma AG. See “Royalty Pharma Agreement.”
     Lasofoxifene is a second-generation estrogen partial agonist discovered through our collaboration with Pfizer. Pfizer has retained marketing rights to the drug. Lasofoxifene has been shown in Phase II clinical studies to reduce bone loss and decrease low-density lipoprotein (“LDL” or “bad” cholesterol) levels. In September 2000, Pfizer announced that it initiated Phase III studies of lasofoxifene for the treatment and prevention of osteoporosis in post-menopausal women. In December 2001, Pfizer announced that two Phase III studies were fully enrolled with more than 1,800 patients, and that an additional Phase III risk reduction trial was underway to evaluate lasofoxifene’s effects on bone mineral density, lipid-lowering and breast cancer prevention. In January of 2003, Pfizer disclosed that this large, 7,500-patient risk-reduction study was fully enrolled.
     In August 2004, Pfizer submitted an NDA to the FDA for lasofoxifene for the prevention of osteoporosis in postmenopausal women. We earned a development milestone of approximately $2.0 million from Pfizer in connection with the filing. Under the terms of the agreement between Ligand and Pfizer, payment of milestones can occur in either cash or shares of Ligand common stock held by Pfizer. Pfizer elected to pay the milestone in stock and subsequently tendered 181,818 shares to the Company. We retired the tendered shares in September 2004. In September 2005, Pfizer announced the receipt of a non-approvable letter from the FDA for the prevention of osteoporosis. However, lasofoxifene continues in Phase III clinical trials by Pfizer for the treatment of osteoporosis.
     In December 2004, Pfizer filed a supplemental NDA for the use of lasofoxifene for the treatment of vaginal atrophy for which no additional milestone was due and which remains pending at the FDA.
     Wyeth Collaboration. In September 1994, we entered into a research and development collaboration with Wyeth-Ayerst Laboratories, the pharmaceutical division of American Home Products (AHP), to discover and develop drugs that interact with ERs or PRs for use in HT, anti-cancer therapy, gynecological diseases, and central nervous system disorders associated with menopause and fertility control. AHP has since changed its name to Wyeth. We granted Wyeth exclusive worldwide rights to all products discovered in the collaboration that are agonists or antagonists to the PR and ER for application in the fields of women’s health and cancer therapy.
     As part of this collaboration, we tested Wyeth’s extensive chemical library for activity against a selected set of targets. In 1996, Wyeth exercised its option to include compounds we discovered that modulate PRs, and to expand the collaboration to encompass the treatment or prevention of osteoporosis through the ER. Wyeth also added four advanced chemical compound series from its internal ER-osteoporosis program to the collaboration. The research phase of the collaboration ended in August 1998.
     Wyeth has ongoing clinical studies with two SERMs from the collaboration. Wyeth is developing bazedoxifene (TSE-424) and bazedoxifene CE for the treatment of post-menopausal osteoporosis. We have milestone and royalty

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rights for bazedoxifene (TSE-424) and bazedoxifene CE. Portions of these royalty rights have been sold to Royalty Pharma AG. See “Royalty Pharma Agreement.”
     Phase III trials for bazedoxifene (TSE-424) and bazedoxifene CE were initiated in June 2001. In late 2002, Wyeth disclosed that it had completed enrollment in a Phase III osteoporosis prevention trial, and that it expected enrollment in a bazedoxifene fracture prevention trial to finish in 2003, and that bazedoxifene is on track for regulatory submission in 2005. In January of 2005, Wyeth indicated that it is now targeting the bazedoxifene regulatory submission for the first half of 2006. Wyeth has reiterated its commitment to developing bazedoxifene CE as a progesterone-free treatment for menopausal symptoms in the wake of the well-publicized Women’s Health Initiative (WHI) study of hormone therapies. Ligand believes it is important to recognize that bazedoxifene is a synthetic drug that was specifically designed to increase bone density and reduce cholesterol levels while at the same time protecting breast and uterine tissue. In other words, bazedoxifene may represent a potential solution to some of the side effects associated with progestin in the WHI study.
     Wyeth also has conducted Phase II studies of pipendoxifene (formerly ERA 923) for the treatment of breast cancer. In 2003, Wyeth began Phase II studies of NSP-989, a progesterone agonist that may be useful in contraception. These studies were completed in 2004. Wyeth also continues to do preclinical work in the area of PR antagonists.
     Organon (Akzo Nobel) Collaboration. In February 2000, we entered into a research and development collaboration with Organon to focus on small molecule compounds with potential effects for the treatment and prevention of gynecological diseases mediated through the PR. The objective of the collaboration is the discovery of new non-steroidal compounds that are tissue-selective in nature and that may have fewer side effects. Such compounds may provide utility in hormone therapy, oral contraception, reproductive diseases, and other hormone-related disorders. The initial research phase concluded in February 2002.
     TAP Collaboration. In June 2001, we entered into a joint research and development alliance with TAP Pharmaceutical Products to focus on the discovery and development of SARMs. SARMs may contribute to the prevention and treatment of diseases including hypogonadism (low testosterone), sexual dysfunction, male and female osteoporosis, frailty, and male HT. The three-year collaboration carries an option to extend by up to two additional one-year terms. In December 2004, we announced the second extension of this collaboration for an additional year through June 2006.
     Under the terms of the agreement, TAP received exclusive worldwide rights to manufacture and sell any products resulting from the collaboration in its field, which would include treatment and prevention of hypogonadism, male sexual dysfunction, female osteoporosis, male HT and other indications not retained by Ligand. We may also receive milestones and up to double-digit royalties as compounds are developed and commercialized. LGD 2941, an androgen agonist targeting osteoporosis and frailty, commenced Phase I development in April 2005. Ligand retains certain rights in the androgen receptor field, including the prevention or treatment of prostate cancer, benign prostatic hyperplasia, acne and hirsutism.
     In addition, we had an option at the expiration of the original three-year term to develop one compound not being developed by TAP in its field, with TAP retaining an option to negotiate to co-develop and co-promote such compounds with Ligand. We recently exercised our option to select one compound and a back-up for development, LG 123303 and LG 123129, out of a pool of compounds available for development in the TAP field. TAP retains certain royalty rights and an option to negotiate to co-develop and co-promote such compounds with us up to the end of Phase II development.
Metabolic and Cardiovascular Disease Collaborative Programs
     We are exploring the role of certain IRs, including the PPARs, in cardiovascular and metabolic diseases. PPARs, a subfamily of orphan IRs, have been implicated in processes that regulate plasma levels of very low density lipoproteins and triglycerides. See “Technology/Intracellular Receptor Technology” for a discussion of PPARs and orphan IRs. Data implicate PPARs in the mechanism of action of lipid-lowering drugs such as Lopid®. There are three subtypes of the PPAR subfamily with defined novel aspects of their action — alpha, beta and gamma. The subtype PPAR alpha appears to regulate the metabolism of certain lipids and is useful in treating

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hyperlipidemia. PPAR gamma plays a role in fat cell differentiation and cellular responses to insulin. Modulators of PPAR gamma activity (e.g., the glitazone class of insulin sensitizers) have utility in managing type II diabetes. PPARs are believed to function in cells in partnership with RXRs. In addition to compounds that act directly on PPARs and that may have utility in various cardiovascular and metabolic diseases, certain retinoids (e.g., Targretin capsules) are able to activate this RXR/PPAR complex and may also have utility in these disorders. We have two collaborative partners, GlaxoSmithKline and Lilly, in the areas of cardiovascular and metabolic diseases, with four compounds in clinical development.
     GlaxoSmithKline Collaboration. In September 1992, we entered into a research and development collaboration with Glaxo Wellcome plc (now GlaxoSmithKline) to discover and develop drugs for the prevention or treatment of atherosclerosis and other disorders affecting the cardiovascular system. The collaboration focuses on discovering drugs that produce beneficial alterations in lipid and lipoprotein metabolism in three project areas: (1) regulation of cholesterol biosynthesis and expression of a receptor that removes cholesterol from the blood stream, (2) the IRs influencing circulating HDL levels, and (3) PPARs, the subfamily of IRs activated by lipid lowering drugs such as Lopid and Atromid-S. The research phase was successfully completed in 1997 with the identification of a novel lead structure that activates selected PPAR subfamily members and the identification of a different lead compound that shows activity in preclinical models for lowering LDL cholesterol by up-regulating LDL receptor gene expression in liver cells. We retain the right to develop and commercialize products arising from the collaboration in markets not exploited by GlaxoSmithKline, or where GlaxoSmithKline is not developing a product for the same indication.
     In 1999, two compounds were advanced to exploratory development: (1) GW544, a PPAR agonist for cardiovascular disease and dyslipidemia; and (2) GW516, a second candidate that is in clinical development for cardiovascular disease and dyslipidemia. GW516 remains in Phase II studies. The American Heart Association estimates that 62 million Americans have some form of cardiovascular disease, and that cardiovascular disease accounts for more than 40% of deaths in the U.S. annually.
     Eli Lilly Collaboration. In November 1997, we entered into a research and development collaboration with Eli Lilly & Co. (Lilly) for the discovery and development of products based upon our IR technology with broad applications in the fields of metabolic diseases, including diabetes, obesity, dyslipidemia, insulin resistance and cardiovascular diseases associated with insulin resistance and obesity. Under the collaboration, Lilly received: (1) worldwide, exclusive rights to our compounds and technology associated with the RXR receptor in the field; (2) rights to use our technology to develop an RXR compound in combination with a SERM in cancer; (3) worldwide, exclusive rights in certain areas to our PPAR technology, along with rights to use PPAR research technology with the RXR technology; and (4) exclusive rights to our HNF-4 receptor and obesity gene promoter technology. Lilly has the right to terminate the development of compounds under the agreements. We would receive rights to certain of such compounds in return for a royalty to Lilly, the rate of which is dependent on the stage at which the development is terminated. In April 2002, Lilly and Ligand announced the companies would extend the collaboration until November of 2003. In May 2003, the companies announced the second and final extension of the collaboration through November 2004.
     Under the Lilly collaboration, we retained or received: (1) exclusive rights to independently research, develop and commercialize Targretin and other RXR compounds in the fields of cancer and dermatology; (2) an option to obtain selected rights to one of Lilly’s specialty pharmaceutical products; and (3) rights to receive milestones, royalties and options to obtain certain co-development and co-promotion rights for the Lilly-selected RXR compound in combination with a SERM.
     Our rights under the initial agreements have changed. In connection with the acquisition of Seragen in 1998, we obtained from Lilly its rights to ONTAK in satisfaction of our option to obtain selected rights to one of Lilly’s specialty pharmaceutical products. In November 2004, Ligand and Lilly agreed to amend the ONTAK royalty agreement to add options in 2005 that if exercised would restructure our royalty obligations on net sales of ONTAK. Under the revised agreement, Ligand and Lilly each had two options. We received options exercisable in January 2005 and April 2005 to buy down a portion of the Company’s ONTAK royalty obligation on net sales in the United States for total consideration of $33.0 million. Lilly received two options exercisable in July 2005 and October 2005 to trigger the same royalty buy-downs for total consideration of up to $37.0 million dependent on whether we have exercised one or both of our options.

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     In January 2005 we exercised the first option which provided for a one-time payment of $20.0 million to Lilly in exchange for the elimination of our ONTAK royalty payment obligations in 2005 and a reduced reverse-tiered royalty scale on ONTAK sales in the U.S. thereafter. The second option, exercised in April 2005, provided for a one-time payment of $13.0 million to Lilly in exchange for the elimination of royalties on ONTAK net sales in the U.S. in 2006 and a reduced reverse-tiered royalty thereafter. Since both options were exercised, beginning in 2007 and throughout the remaining ONTAK patent life (2014), we will pay no royalties to Lilly on U.S. sales up to $38.0 million. Thereafter, we will pay royalties to Lilly at a rate of 20% on net U.S. sales between $38.0 million and $50.0 million; at a rate of 15% on net U.S. sales between $50.0 million and $72.0 million; and at a rate of 10% on net U.S. sales in excess of $72.0 million.
     In 1999, we agreed to focus our collaborative efforts on the RXR modulator second-generation program, which has compounds with improved therapeutic indices relative to the three first-generation compounds, and on co-agonists of the PPAR receptor program. In early 1999, Lilly opted not to proceed with the development of certain first-generation compounds, including Targretin, in the RXR program for diabetes. As a result of this decision, all rights to the oral form of Targretin reverted to us, and LGD1268 and LGD1324 returned to the pool of eligible RXR modulators for possible use in oncology in combination with a SERM under the collaboration agreement between Ligand and Lilly.
     In September 2001, we announced that we had earned an undisclosed milestone from Lilly as a result of Lilly’s filing with the FDA an IND for LY818 (naveglitazar), a PPAR modulator for type II diabetes and metabolic diseases. Naveglitazar entered Phase II studies early in 2003, resulting in a $1.5 million milestone payment. In March 2004, Lilly announced their decision to move naveglitazar into Phase III registration studies. Shortly afterwards, the FDA provided new guidance regarding preclinical and clinical safety assessments for current and future PPAR molecules in clinical development. Accumulated rodent data reviewed by the agency for a number of PPAR agonists (gamma, alpha or dual agonists), but not including naveglitazar, showed carcinogenicity findings that did not demonstrate adequate margins of safety to support continued clinical development with some members of this class of compounds. Based on this information, the new guidance provided by the FDA for all compounds in this class indicates that clinical studies longer than six months in duration cannot be initiated until two-year rodent carcinogenicity studies are completed and submitted for agency review. Any proposed studies of greater than six months duration have been placed on clinical hold until carcinogenicity data are reviewed and adequate margins of safety are demonstrated.
     Two-year carcinogenicity studies on naveglitazar are ongoing and data for evaluation should be available in 2005. While the full impact of these guidelines on naveglitazar clinical development plans and timelines is being reviewed, it is clear that, based on the timing of the completion of the carcinogenicity studies and subsequent FDA review of the data allowing the initiation of long-term safety studies, there will be an estimated delay of 18-24 months in the initiation of clinical studies of greater than six months duration. Lilly will review and revise their naveglitazar Phase III development plan accordingly.
     In June 2002, we announced that we had earned a $1.1 million milestone payment as a result of Lilly’s filing with the FDA an IND for LY929, a PPAR modulator for the treatment of Type II diabetes, metabolic diseases and dyslipidemias. In November 2002, we announced that we had earned a $2.1 million milestone payment as a result of Lilly’s filing with the FDA an IND for LY674, a PPAR modulator for the treatment of atherosclerosis. In July 2005, we announced that we had earned a $1.6 million milestone payment as a result of LY674 entering Phase II studies. We will receive additional milestones if these products continue through the development process, and royalties on product sales if the products receive marketing approval. Lilly also has two other PPAR compounds on IND track, the compound numbers for which have not been disclosed.
Inflammatory Disease Collaborative Program
     Abbott Collaboration. In July 1994, we entered into a research and development collaboration with Abbott Laboratories (“Abbott”) to discover and develop small molecule compounds for the prevention or treatment of inflammatory diseases. The collaborative program includes several molecular approaches to discovering modulators of glucocorticoid receptor activity that have significantly improved therapeutic profiles relative to currently known anti-inflammatory steroids such as prednisone and dexamethasone. The collaboration was focused on the

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development of novel non-steroidal glucocorticoids that maintain the efficacy of corticosteroids, but lack some or all of corticosteroids’ dose-limiting side effects. The research phase concluded in July 1999.
     When the research phase of the collaboration ended in July 1999, Abbott retained rights to certain selective glucorcorticoid receptor modulators, or SGRMs, whose development has now been slowed or halted. We retained rights to all other compounds discovered through the collaboration, as well as recaptured technology rights. Abbott will make milestone and royalty payments on products targeted at inflammation resulting from the collaboration. Each party will be responsible for the development, registration, and commercialization of the products in its respective field.
TPO / Inflamatory Disease / Oncology Collaborative Program
     GlaxoSmithKline Collaboration. In February 1995, we entered into a research and development collaboration with SmithKline Beecham (now GlaxoSmithKline) to use our proprietary expertise to discover and characterize small molecule, orally bioavailable drugs to control hematopoiesis (the formation and development of blood cells) for the treatment of a variety of blood cell deficiencies. In 1998, we announced the discovery of the first non-peptide small molecule that mimics in mice the activity of Granulocyte-Colony Stimulating Factor (“G-CSF”), a natural protein that stimulates production of infection-fighting neutrophils (a type of white blood cell). While this lead compound has only been shown to be active in mice, its discovery is a major scientific milestone and suggests that orally active, small-molecule mimics can be developed not only for G-CSF, but for other cytokines as well.
     A number of lead molecules have been found that mimic the activity of natural growth factors for white cells and platelets. In the fourth quarter of 2002, we earned a $2.0 million milestone payment from GlaxoSmithKline, which has begun human trials of SB-497115, an oral, small molecule drug that mimics the activity of thrombopoietin (TPO), a protein factor that promotes growth and production of blood platelets. In February 2005, we announced that we had earned a $1 million milestone payment from GlaxoSmithKline with that company’s commencement of Phase II trials of SB-497115. In June 2005, we earned a $2 million milestone payment as SB-559448, a second TPO agonist began Phase I development. There are no approved oral TPO agents for the treatment or prevention of thrombocytopenias (decreased platelet count). Investigational use of injectable forms of recombinant human TPO has been effective in raising platelet levels in cancer patients undergoing chemotherapy, and has led to accelerated hematopoietic recovery when given to stem cell donors. Some of these investigational treatments have not moved forward to registration due to the development of neutralizing antibodies. Thus, a small molecule TPO mimic with no apparent immunogenic potential and oral activity that may facilitate dosing may provide an attractive therapeutic profile for a major unmet medical need.
     The research phase of the collaboration concluded in February 2001. Under the collaboration, we have the right to select up to three compounds related to hematopoietic targets for development as anti-cancer products other than those compounds selected for development by GlaxoSmithKline. GlaxoSmithKline has the option to co-promote these products with us in North America and to develop and market them outside North America.
Dermatology Collaborative Program
     Allergan. In September 1997, in conjunction with the buyback of Allergan Ligand Retinoid Therapeutics, Inc. (ALRT), we agreed with Allergan to restructure the terms and conditions relating to research, development, and commercialization and sublicense rights for the ALRT compounds. Under the restructured arrangement, we received exclusive, worldwide development, commercialization, and sublicense rights to Panretin capsules and Panretin gel, LGD1550, LGD1268 and LGD1324. Allergan received exclusive, worldwide development, commercialization and sublicense rights to LGD4310, an RAR antagonist. Allergan also received LGD4326 and LGD4204, two advanced preclinical RXR selective compounds. In addition, we participated in a lottery with Allergan for each of the approximately 2,000 retinoid compounds existing in the ALRT compound library as of the closing date, with each party acquiring exclusive, worldwide development, commercialization, and sublicense rights to the compounds that they selected. We and Allergan will each pay the other a royalty based on net sales of products developed from the compounds selected by each in the lottery and the other ALRT compounds to which each acquires exclusive rights. We will also pay to Allergan royalties based on our net sales of Targretin for uses other than oncology and dermatology indications. In the event that we license commercialization rights to Targretin to a third party, we will pay to Allergan a percentage of royalties payable to us with respect to sales of Targretin

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other than in oncology and dermatology indications. During 2001, Allergan elected not to proceed with development of AGN4310 for mucocutaneous toxicity.
Royalty Pharma Agreement
     In March 2002, we announced an agreement with Royalty Pharma AG, which purchased rights to a share of future royalty payments from our collaborative partners’ sales of three SERMs in Phase III development. The SERM products included in the transaction are lasofoxifene, which is being developed for osteoporosis and other indications at Pfizer, bazedoxifene and bazedoxifene CE (PREMARIN combo) which are in development at Wyeth for osteoporosis and for vasomotor symptoms of menopause. (See the detailed discussions of these products under the Pfizer and Wyeth collaborations above.)
     Since March 2002, and following certain amendments to the original agreement, Royalty Pharma has acquired cumulative rights to 3.0125% of the potential future net sales of the three SERM products for an aggregate of $63.3 million. In addition, in December 2002 Royalty Pharma agreed to acquire a 1.0% royalty interest in the Company’s net sales of Targretin capsules from January 2003 through 2016 for $1.0 million.
     Under the terms of the agreements, payments from the royalty rights purchase are non-refundable, regardless of whether the products are ever successfully registered or marketed. Milestone payments owed by our partners as the products complete development and registration are not included in the Royalty Pharma agreement and will be paid to us as earned.
Technology
     In our successful efforts to discover new and important medicines, we and our academic collaborators and consultants have concentrated on two areas of research: advancing the understanding of the activities of hormones and hormone-related drugs, and making scientific discoveries related to IR technology. We believe that our expertise in this technology will enable us to develop novel, small-molecule drugs acting through IRs with more target-specific properties than currently available drugs. Our efforts may result in improved therapeutic and side effect profiles and new indications for IRs. IRs are families of transcription factors that change cell function by selectively turning on or off particular genes in response to circulating signals that impinge on cells. In addition to our proprietary IR technology, we have acquired fusion protein technology, which was used by Seragen in the development of ONTAK.
Intracellular Receptor Technology
     Hormones occur naturally within the body and control processes such as reproduction, cell growth and differentiation. Hormones generally fall into two classes, non-peptide hormones and peptide hormones. Non-peptide hormones include retinoids, sex steroids (estrogens, progestins and androgens), adrenal steroids (glucocorticoids and mineralocorticoids), vitamin D and thyroid hormone. These non-peptide hormones act by binding to their corresponding IRs to regulate the expression of genes in order to maintain and restore balanced cellular function within the body. Hormonal imbalances can lead to a variety of diseases. The hormones themselves and drugs that mimic or block hormone action may be useful in the treatment of these diseases. Furthermore, hormone mimics (agonists) or blockers (antagonists) can be used to treat diseases in which the underlying cause is not hormonal imbalance. The effectiveness of IRs as drug targets is clearly demonstrated by currently available drugs acting through IRs for several diseases. However, the use of most of these drugs has been limited by their often significant side effects. Examples of currently marketed hormone-related drugs acting on IRs are glucocorticoids (steroids used to treat inflammation), natural and synthetic estrogens and progesterones (used for hormone therapy and contraception), tamoxifen (an estrogen antagonist used in the treatment of breast cancer), and various retinoids such as Accutane® and Retin-A® (used to treat acne) and Dovonex® (used to treat psoriasis).
     We have built a strong proprietary position and accumulated substantial expertise in IRs applicable to drug discovery and development. Building on our scientific findings about the molecular basis of hormone action, we have created proprietary new tools to explore and manipulate non-peptide hormone action for potential therapeutic benefit. We employ a proprietary cell-culture based assay system for small molecules that can modulate IRs, referred to as the co-transfection assay. The co-transfection assay system simulates the actual cellular processes

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controlled by IRs and is able to detect whether a compound interacts with a particular human IR and whether this interaction mimics or blocks the effects of the natural regulatory molecules on target gene expression.
     The understanding of non-peptide hormones and their actions has increased substantially in the last 15 years. Driving this rapid expansion of knowledge has been the discovery of the family of IRs through which all known small-molecule, non-peptide hormones act. We and our academic collaborators and consultants have made major discoveries pertaining to IRs and to small molecule hormones and compounds that interact with these IRs. These discoveries include: (1) the identification of the IR superfamily, (2) the recognition of IR subtypes, (3) the heterodimer biology of RXR-selective compounds and (4) the discovery of orphan IRs. We believe that each of these broad areas of knowledge provides important opportunities for drug discovery.
     IR Superfamily. The receptors for non-peptide hormones are closely related members of a superfamily of proteins known as IRs. Human IRs for all the known non-peptide hormones now have been cloned, in many cases by our scientists or our collaborators. The structure and underlying mechanism of action of IRs have many common features, such that drug discovery insights about one IR often can be directly applied to other members of the IR superfamily, bringing synergy to our IR-focused drug discovery efforts. First-generation drugs were developed and commercialized for their therapeutic benefits prior to the discovery of IRs. As a result, they often cross-react with the IRs for hormones other than the intended target, which can result in significant side effects. The understanding that IRs are structurally similar has enabled us to determine the basis for the side effects of some first-generation drugs and to discover improved drug candidates.
     IR Subtypes. For some of the non-peptide hormones, several closely related but non-identical IRs, known as IR subtypes, have been discovered. These include six subtypes of the IRs for retinoids, two subtypes of the IRs for thyroid hormone, two subtypes for the ER, and three subtypes for the PPARs. Patent applications covering many of these IR subtypes have been exclusively licensed by us. We believe that drugs capable of selective modulation of IR subtypes will allow more specific pharmacological intervention that is better matched to therapeutic need. Targretin, an RXR-selective molecule, was discovered as a result of our understanding of retinoid receptor subtypes.
     Retinoid Responsive IRs. Retinoic acid, a derivative of Vitamin A, is one of the body’s natural regulatory hormones that has a broad range of biological actions, influencing cell growth, differentiation, programmed cell death and embryonic development. Many chemical analogues of retinoic acid, called retinoids, also have biological activity. Specific retinoids have been approved by the FDA for the treatment of psoriasis and certain severe forms of acne. Evidence also suggests that retinoids can be used to arrest and, to an extent, reverse the effects of skin damage arising from prolonged exposure to the sun. Other evidence suggests that retinoids are useful in the treatment of a variety of cancers, including kidney cancer and certain forms of leukemia. For example, all-trans-retinoic-acid has been approved by the FDA to treat acute promyelocytic leukemia. Retinoids also have shown an ability to reverse precancerous (premalignant) changes in tissues, reducing the risk of development of cancer, and may have potential as preventive agents for a variety of epithelial malignancies, including skin, head and neck, bladder and prostate cancer. Currently marketed retinoids, which were developed and commercialized prior to the discovery of retinoid-responsive IRs, cause significant side effects. These include severe birth defects if fetal exposure occurs, severe irritation of the skin and mucosal surfaces, elevation of plasma lipids, headache and skeletal abnormalities.
     The six RRs that have been identified to date can be grouped in two subfamilies — RARs and RXRs. Patent applications covering members of both families of RRs have been licensed exclusively to us primarily from The Salk Institute. The RR subtypes appear to have different functions, based on their distribution in various tissues within the body and data arising from in vitro and in vivo studies, including studies of transgenic mice. Several of the retinoids currently in commercial use are either non-selective in their pattern of RR subtype activation or are not ideal drugs for other reasons. We are developing chemically synthesized retinoids that, by selectively activating RR subtypes, may preserve desired therapeutic effects while reducing side effects.
     We have three retinoid products approved by the FDA (Panretin gel, Targretin capsules and Targretin gel) and two retinoid products in clinical trials (Targretin capsules and Targretin gel ). Panretin gel incorporates 9-cis retinoic acid, a retinoid isolated and characterized by us in 1991 in collaboration with scientists at The Salk Institute and Baylor College of Medicine. 9-cis retinoic acid is the first non-peptide hormone discovered in more than 25 years and appears to be a natural ligand for the RAR and RXR subfamilies of retinoid receptors. Bexarotene, the

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active substance in Targretin, is a synthetic retinoid developed by us that shows selective retinoid receptor subtype activity that is different from that of 9-cis retinoic acid, the active substance in Panretin. Targretin selectively activates a subclass of retinoid receptors called RXRs. RXRs play an important role in the control of a variety of cellular functions.
     RXRs. RXRs can form a dimer with numerous IRs, such as the PPAR, LXR, RAR, thyroid hormone and vitamin D receptors. While RXRs are widely expressed, their IR partners are more selectively expressed in different tissues, such as liver, fat or muscle. As a result, compounds that bind RXRs offer the unique potential to treat a variety of diseases, including cancer and metabolic diseases. In preclinical models of type II diabetes, RXR agonists appear to stimulate the physiological pathways responsive to RXR/PPAR receptor partners expressed in key target tissues that are involved in glucose metabolism. As a result, a discrete set of genes is activated in these tissues, resulting in a decrease in serum glucose levels and insulin.
     Orphan Receptors. More than 40 additional members of the IR superfamily that do not interact with the known non-peptide hormones have been discovered. These members of the IR superfamily have been designated orphan receptors. We believe that among the orphan IRs there may be receptors for uncharacterized small molecule hormones, and that the physiological roles of the various orphan IRs are likely to be diverse. We have devised strategies to isolate small molecules that interact with orphan IRs. In 1999, we invested in and exclusively licensed specified orphan IR technology to a new private corporation, X-Ceptor Therapeutics, Inc. (“X-Ceptor”). Under the 1999 license agreement, we will receive a royalty of 1.5% on net sales of any products which are discovered using the licensed technologies.
Fusion Protein Technology
     Our fusion protein technology was developed by Seragen, which we acquired in 1998. Seragen’s fusion proteins consist of a fragment of diphtheria toxin genetically fused to a ligand that binds to specific receptors on the surface of target cells. Once bound to the cell, the fusion proteins are designed to enter the cell and destroy the ability of the cell to manufacture proteins, resulting in cell death. Using this platform, Seragen genetically engineered six fusion proteins, each of which consists of a fragment of diphtheria toxin fused to a different targeting ligand, such as a polypeptide hormone or growth factor. ONTAK, which is approved in the U.S. for the treatment of patients with persistent or recurrent CTCL, is a fusion protein consisting of a fragment of diphtheria toxin genetically fused to a part of interleukin-2. In addition to treatment of CTCL, fusion proteins may have utility in oncology, dermatology, infectious diseases, and autoimmune diseases. Seragen has entered into exclusive license agreements with Harvard University and other parties for patents related to fusion protein technology and has been issued six U.S. patents for improvements in the technology licensed from Harvard University.
Academic Collaborations
     To date, we have licensed technology from The Salk Institute, Baylor College of Medicine and other academic institutions and developed relationships with key scientists to further the development of our core IR technology.
     The Salk Institute of Biological Studies. In 1988, we established an exclusive relationship with The Salk Institute, which is one of the research centers in the area of IR technology. We amended and restated this agreement in April 2002. Under our agreement, we have an exclusive, worldwide license to certain IR technology developed in the laboratory of Dr. Ronald Evans, a Salk professor and Howard Hughes Medical Institute Investigator. Dr. Evans cloned and characterized the first IR in 1985 and is an inventor of the co-transfection assay used by us to screen for IR modulators. Under the agreement, we are obligated to make certain royalty payments based on sales of certain products developed using the licensed technology, as well as certain minimum annual royalty payments and a percentage of milestones and certain other payments received. The agreement also provides that we have the option of buying out future royalty payments as well as milestone and other payment-sharing obligations on a product-by-product basis by paying the Salk a lump sum calculated using a formula in the agreement. In March 2004, we paid the Salk $1.12 million to exercise this buyout option with respect to lasofoxifene, a product under development by Pfizer for the prevention of osteoporosis in postmenopausal women. In December of 2004 Pfizer filed a supplemental NDA for the use of lasofoxifene for the treatment of vaginal atrophy. As a result of the supplemental lasofoxifene NDA filing, we exercised an option in January 2005 to pay The Salk Institute $1.12 million to buy out

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royalty payments due on future sales of the product in this additional indication. See the discussion above regarding “Collaborative Research and Development Programs.”
     We have also entered into a consulting agreement with Dr. Evans that continues through February 2008. Dr. Evans serves as Chairman of Ligand’s Scientific Advisory Board.
     Baylor College of Medicine. In 1990, we established an exclusive relationship with Baylor, which is a center of IR technology. We entered into a series of agreements with Baylor under which we have an exclusive, worldwide license to IR technology developed at Baylor and to future improvements made in the laboratory of Dr. Bert W. O’Malley through the life of the related patents. Dr. O’Malley is a professor and the Chairman of the Department of Cell Biology at the Baylor College of Medicine and the Director of the Center for Reproductive Biology. He leads IR research at Baylor.
     We work closely with Dr. O’Malley and Baylor in scientific IR research, particularly in the area of sex steroids and orphan IRs. Under our agreement, we are obligated to make certain royalty payments based on the sales of products developed using the licensed technology. Dr. O’Malley is a member of Ligand’s Scientific Advisory Board.
     In addition to the collaborations discussed above, we also have a number of other consulting, licensing, development and academic agreements by which we strive to advance our technology.
Manufacturing
     We currently have no manufacturing facilities and, accordingly, rely on third parties, including our collaborative partners, for commercial or clinical production of any products or compounds. During 2004, each of our major products was manufactured by a single supplier: Elan manufactures AVINZA; Cambrex manufactures ONTAK and Cardinal Health and Raylo manufacture Targretin capsules. In 2004, we entered into contracts with Cardinal Health to provide a second source for AVINZA, and with Hollister-Stier to fill and finish ONTAK. In July 2005, we announced that the FDA approved the Hollister-Stier facility for fill/finish of ONTAK. In August 2005, the FDA approved the production of AVINZA at a Cardinal Health facility which provides a second source of supply, thus diversifying the AVINZA supply chain and increasing production capacity.
     Certain raw materials necessary for the commercial manufacturing of our products are custom and must be obtained from a specific sole source. In addition, our finished products are produced by sole source manufacturers. We currently attempt to manage the risk associated with such sole source raw materials and production by actively managing our inventories and supply and production arrangements. We attempt to remain appraised of the financial condition of our suppliers and their ability to continue to supply our raw materials and finished products in an uninterrupted and timely manner. Unavailability of certain materials or the loss of current sources of production could cause an interruption in production and a reduced supply of finished product pending establishment of new sources, or in some cases, implementation of alternative processes. For a discussion of the risks associated with manufacturing, see “Risks and Uncertainties.”
Quality Assurance
     Our success depends in great measure upon customer confidence in the quality of our products and in the integrity of the data that support their safety and effectiveness. The quality of our products arises from our commitment to quality in all aspects of our business, including research and development, purchasing, manufacturing and distribution. Quality assurance procedures have been developed relating to the quality and integrity of our scientific information and production processes.
     Control of production processes involves rigid specifications for ingredients, equipment, facilities, manufacturing methods, packaging materials, and labeling. Control tests are made at various stages of production processes and on the final product to assure that the product meets all regulatory requirements and our standards. These tests may involve chemical and physical testing, microbiological testing, preclinical testing, human clinical trials, or a combination of these trials.

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Commercial
     In late 1998, we assembled a specialty oncology and HIV-center sales and marketing team to market in the U.S. products developed, acquired or licensed by us. In late 1999, we expanded our U.S. sales force from approximately 20 to approximately 40 sales representatives to support the launch of Targretin capsules and Targretin gel and increase market penetration of ONTAK and Panretin gel. In 2001, we expanded our sales force to approximately 50 sales representatives, including approximately 20 full-time contract sales representatives who focused on the dermatology market. In 2002, to support the launch of AVINZA, we redirected these contract sales representatives to call on high-prescribing pain specialists. Also in 2002, we hired approximately another 30 representatives to call on pain specialists, bringing the total number of representatives selling only AVINZA to approximately 50. In 2003, we expanded our specialty pain sales force to approximately 70 representatives. In addition, more than 700 Organon sales representatives began promoting AVINZA as a result of the co-promotion agreement we established in early 2003. During 2004, 36 additional Ligand specialty sales representatives were hired to promote AVINZA to top-decile, primary-care physicians. In November of 2004, an AVINZA sales force restructuring was implemented to improve sales call coverage and effectiveness (see “AVINZA Co-Promotion Agreement with Organon”). At the end of 2004, we had approximately 25 sales representatives promoting our in-line oncology products. At August 31, 2005, we had approximately 130 U.S. sales territories.
     Internationally, through marketing and distribution agreements with Elan, Ferrer International and Sigma Tau (rights transferred from Alfa Wassermann in October 2005), we have established marketing and distribution capabilities in Europe, as well as Central and South America. In February 2004, Elan and Medeus Pharma Limited (now “Zeneus”) announced that Zeneus had acquired Elan’s European sales and marketing business, and that the acquisition included the marketing and distribution rights to certain Ligand products in Europe.
     In the second half of 2004, we entered into fee-for-service agreements (or distribution service agreements) for each of our products, other than Panretin, with the majority of our wholesaler customers. In exchange for a set fee, the wholesalers have agreed to provide us with certain information regarding product stocking and out-movement; agreed to maintain inventory quantities within specified minimum and maximum levels; inventory handling, stocking and management services; and certain other services surrounding the administration of returns and chargebacks. In connection with implementation of the fee-for-service agreements, we no longer offer these wholesalers promotional discounts or incentives and as a result, we expect a net improvement in product gross margins as volumes grow. Additionally, we believe these arrangements will provide lower variability in wholesaler inventory levels and improved management of inventories within and between individual wholesaler distribution centers that we believe will result in a lower level of product returns compared to prior periods.
     For the year ended December 31, 2004, shipments to three wholesale distributors each accounted for more than 10% of total shipments and in the aggregate represented 77% of total shipments. These were AmerisourceBergen Corporation, Cardinal Health, Inc., and McKesson Corporation.
     Our practices with respect to working capital items are similar to comparable companies in the industry. We accept the return of pharmaceuticals that have reached their expiration date. Our policy for returns allows customers, primarily wholesale distributors, to return our oncology products three months prior to and six months after expiration. For ONTAK, customers are generally allowed to return product in exchange for replacement ONTAK vials. Our policy for returns of AVINZA allows customers to return the product six months prior to and six months after expiration.
     Substantially all of our revenues are attributable to customers in the United States; likewise, substantially all of our long-lived assets are located in the United States.
     For further discussion of these items, see below under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Research and Development Expenses
     Research and development expenses were $65.2 million, $66.7 million and $59.1 million in fiscal 2004, 2003 and 2002, respectively, of which approximately 88%, 84% and 75%, respectively, we sponsored, and the remainder of which was funded pursuant to collaborative research and development arrangements.
Competition
     Some of the drugs we are developing will compete with existing therapies. In addition, a number of companies are pursuing the development of novel pharmaceuticals that target the same diseases we are targeting. A number of pharmaceutical and biotechnology companies are pursuing IR-related approaches to drug discovery and development. Furthermore, academic institutions, government agencies, and other public and private organizations conducting research may seek patent protection with respect to potentially competing products or technologies and may establish collaborative arrangements with our competitors.
     Our marketed products also face competition. The principal products competing with our products targeted at the cutaneous t-cell lymphoma market are Supergen/Abbott’s Nipent and interferon, which is marketed by a number of companies, including Schering-Plough’s Intron A. Products that compete with AVINZA include Purdue Pharma L.P.’s OxyContin and MS Contin and potentially Palladone (launched in early 2005 and subsequently withdrawn from the market), Janssen Pharmaceutica Products, L.P.’s Duragesic, aai Pharma’s Oramorph SR, Alpharma’s Kadian, and generic sustained release morphine sulfate, oxycodone and fentanyl. Many of our existing or potential competitors, particularly large drug companies, have greater financial, technical and human resources than us and may be better equipped to develop, manufacture and market products. Many of these companies also have extensive experience in preclinical testing and human clinical trials, obtaining FDA and other regulatory approvals and manufacturing and marketing pharmaceutical products.
     Our competitive position also depends upon our ability to attract and retain qualified personnel, obtain patent protection or otherwise develop proprietary products or processes, and secure sufficient capital resources for the often substantial period between technological conception and commercial sales. For a discussion of the risks associated with competition, see “Risks and Uncertainties.”
Government Regulation
     The manufacturing and marketing of our products, our ongoing research and development activities, and products being developed by our collaborative partners are subject to regulation for safety and efficacy by numerous governmental authorities in the United States and other countries. In the United States, pharmaceuticals are subject to rigorous regulation by federal and various state authorities, including the FDA. The Federal Food, Drug and Cosmetic Act and the Public Health Service Act govern the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of our products. There are often comparable regulations that apply at the state level. Product development and approval within this regulatory framework takes a number of years and involves the expenditure of substantial resources.
     The steps required before a pharmaceutical agent may be marketed in the United States include (1) preclinical laboratory tests, (2) the submission to the FDA of an IND, which must become effective before human clinical trials may commence, (3) adequate and well-controlled human clinical trials to establish the safety and efficacy of the drug, (4) the submission of a NDA to the FDA and (5) the FDA approval of the NDA prior to any commercial sale or shipment of the drug. A company must pay a one-time user fee for NDA submissions, and annually pay user fees for each approved product and manufacturing establishment. In addition to obtaining FDA approval for each product, each domestic drug-manufacturing establishment must be registered with the FDA and, in California, with the Food and Drug Branch of California. Domestic manufacturing establishments are subject to pre-approval inspections by the FDA prior to marketing approval, then to biennial inspections, and must comply with current Good Manufacturing Practices (cGMP). To supply products for use in the United States, foreign manufacturing establishments must comply with cGMP and are subject to periodic inspection by the FDA or by regulatory authorities in such countries under reciprocal agreements with the FDA.

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     For both currently marketed and future products, failure to comply with applicable regulatory requirements after obtaining regulatory approval can, among other things, result in the suspension of regulatory approval, as well as possible civil and criminal sanctions. In addition, changes in existing regulations could have a material adverse effect to us.
     For marketing outside the United States before FDA approval to market, we must submit an export permit application to the FDA. We also are subject to foreign regulatory requirements governing human clinical trials and marketing approval for drugs. The requirements relating to the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country and there can be no assurance that we or any of our partners will meet and sustain any such requirements.
     We are also increasingly subject to regulation by the states. A number of states now regulate, for example, pharmaceutical marketing practices and the reporting of marketing activities, controlled substances such as our AVINZA product, clinical trials and general commercial practices. We have developed and are developing a number of policies and procedures to ensure our compliance with these state laws, in addition to the federal regulations described above. Significant resources are now required on an ongoing basis to ensure such compliance. For a discussion of the risks associated with government regulations, see “Risks and Uncertainties.”
Patents and Proprietary Rights
     We believe that patents and other proprietary rights are important to our business. Our policy is to file patent applications to protect technology, inventions and improvements to our inventions that are considered important to the development of our business. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position.
     As of August 31, 2005, we have filed or participated as licensee in the filing of approximately 65 currently pending patent applications in the United States relating to our technology, as well as foreign counterparts of certain of these applications in many countries. In addition, we own or have licensed rights covered by approximately 377 patents issued or applications, granted or allowed worldwide, including United States patents and foreign counterparts to United States patents. Except for a few patents and applications which are not material to our commercial success, these patents and applications will expire between 2005 and 2021. Our marketed products are expected to have patent protection in the United States and Europe that does not expire until between 2011 and 2017. Subject to compliance with the terms of the respective agreements, our rights under our licenses with our exclusive licensors extend for the life of the patents covering such developments. For a discussion of the risks associated with patent and proprietary rights, see “Risks and Uncertainties.”
     In December 2004, the United States Patent and Trademark Office declared an interference proceeding at our request between a patent application owned by Ligand claiming bexarotene (the active ingredient in our Targretin products) and related technology and an issued patent owned jointly by SRI International and The Burnham Institute. The patent owned jointly by SRI International and The Burnham Institute was exclusively licensed to Ligand in return for a royalty and other terms. In March 2005, we reached a settlement agreement with SRI and Burnham wherein SRI and Burnham agreed to concede priority of the bexarotene claims to Ligand and assign its patent and related rights to Ligand. In return, we will continue to pay to SRI and Burnham a royalty on Bexarotene at a lower rate and would pay the same royalty on any future products that may be covered by the related patents assigned to Ligand. The royalty would be payable for the relevant patent terms, including any additional patent term to which our patent application for bexarotene would be entitled.
Human Resources
     As of August 31, 2005, we had 519 full-time employees, of whom 238 were involved directly in scientific research and development activities. Of these employees, approximately 70 hold Ph.D. or M.D. degrees.

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Risks and Uncertainties
     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.
Risks Related to the Restatement
The restatement of our consolidated financial statements has had a material adverse impact on us, including increased costs, the increased possibility of legal or administrative proceedings, delisting from the NASDAQ National Market, and a default under our factoring arrangement.
We determined that our consolidated financial statements for the years ended December 31, 2002 and 2003, and as of and for the quarters of 2003, and for the first three quarters of 2004, as described in more detail in Note 2 to the Consolidated Financial Statements should be restated. As a result of these events, we have become subject to a number of additional risks and uncertainties, including:
  §   We have incurred substantial unanticipated costs for accounting and legal fees in 2005 in connection with the restatement. Although the restatement is complete, we expect to continue to incur such costs as noted below.
 
  §   We have been named in a number of lawsuits that began in August 2004 and an additional lawsuit filed in October 2005 claiming to be class actions and shareholder derivative actions. As a result of our restatement the plaintiffs in these lawsuits may make additional claims, expand existing claims and/or expand the time periods covered by the complaints. Other plaintiffs may bring additional actions with other claims, based on the restatement. If such events occur, we may incur additional substantial defense costs regardless of their outcome. Likewise, such events might cause a diversion of our management’s time and attention. If we do not prevail in any such actions, we could be required to pay substantial damages or settlement costs.
 
  §   The Securities and Exchange Commission (SEC) has instituted a formal investigation of the Company’s consolidated financial statements. This investigation will likely divert more of our management’s time and attention and cause us to incur substantial costs. Such investigations can also lead to fines or injunctions or orders with respect to future activities, as well as further substantial costs and diversion of management time and attention.
 
  §   In October 2005, a lawsuit was filed in the Court of Chancery in the State of Delaware by Third Point Offshore Fund, Ltd. requesting the Court to order us to hold an annual meeting for the election of directors within 60 days of an order by the Court. We agreed to settle this matter with Third Point and to schedule the annual meeting for January 31, 2006. Third Point has indicated that it will solicit proxies to elect at least three directors at that meeting. We may incur substantial costs in connection with the annual meeting regardless of the outcome. Likewise, any proxy contest might cause a diversion of our management’s time and attention.
 
  §   The need to reconsider our accounting treatment and the restatement of our consolidated financial statements caused us to be late in filing our required reports on Form 10-K for December 31, 2004 and Forms 10-Q for the quarters ended March 31, 2005 and June 30, 2005, respectively, which caused us to be delisted from NASDAQ National Market. See “Our common stock was delisted from the NASDAQ National Market which may reduce the price of our common stock and the levels of liquidity available to our stockholders and cause confusion among investors” for additional discussion regarding the NASDAQ delisting.
 
  §   The Company has entered into a long term factoring arrangement under which eligible accounts receivable are sold without recourse to a finance company. The agreement requires that the Company’s consolidated financial statements be provided within 120 days after year end. A waiver of the financial reporting covenant has been granted through December 31, 2005. Our inability to maintain the waivers of the financial reporting covenant could impact our ability to continue factoring our receivables. Our inability to

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      obtain adequate working capital through the factoring arrangement could adversely affect our business and our liquidity.
Material weaknesses or deficiencies in our internal control over financial reporting could harm stockholder and business confidence on our financial reporting, our ability to obtain financing and other aspects of our business.
     Maintaining an effective system of internal control over financial reporting is necessary for us to provide reliable financial reports. In November 2005, we restated our consolidated financial statements for the years ended 2002 and 2003, and the 2003 quarterly periods and first three quarters of 2004. We also identified and reported a number of material weaknesses in our internal control over financial reporting, as described in Item 9A of our Annual Report on Form 10-K for the period ended December 31, 2004.
     As a result of these material weaknesses, management’s assessment concluded that our internal controls over financial reporting are ineffective. Some of the identified material weaknesses have not been fully addressed. It is also possible that additional material weaknesses will be identified in the future. Until we remediate the remaining material weaknesses we have the risk of another restatement.
     The material weaknesses in our internal control over financial reporting related to the lack of controls and procedures to ensure that revenues are recognized in accordance with generally accepted accounting principles, the lack of controls and procedures to prevent shipping of short-dated products, the lack of adequate manpower and insufficient qualified accounting personnel to identify and resolve complex accounting issues, the lack of adequate record keeping and documentation of past transactional accounting decisions, the lack of controls over accruals and cut-offs, and the lack of controls surrounding financial reporting and close procedures.
     Because we have concluded that our internal control over financial reporting is not effective and our independent registered public accountants issued an adverse opinion on the effectiveness of our internal controls, and to the extent we identify future weaknesses or deficiencies, there could be material misstatements in our consolidated financial statements and we could fail to meet our financial reporting obligations. As a result, our ability to obtain additional financing, or obtain additional financing on favorable terms, could be materially and adversely affected, which, in turn, could materially and adversely affect our business, our financial condition and the market value of our securities. In addition, perceptions of us could also be adversely affected among customers, lenders, investors, securities analysts and others. Current material weaknesses or any future weaknesses or deficiencies could also hurt confidence in our business and consolidated financial statements and our ability to do business with these groups.
Our revenue recognition policy has changed to the sell-through method which is currently not used by most companies in the pharmaceutical industry which will make it more difficult to compare our results to the results of our competitors.
     Because our revenue recognition policy has changed to the sell-through method which reflects products sold through the distribution channel, we do not recognize revenue for the domestic product shipments of AVINZA, ONTAK, Targretin capsules and Targretin gel. Under our previous method of accounting, product sales were recognized at time of shipment.
     Under the sell-through revenue recognition method, future product sales and gross margins may be affected by the timing of certain gross to net sales adjustments including the cost of certain services provided by wholesalers under distribution service agreements, and the impact of price increases. Cost of products sold and therefore gross margins for our products may also be further impacted by changes in the timing of revenue recognition. Additionally, our revenue recognition models incorporate a significant amount of third party data from our wholesalers and IMS. Such data is subject to estimates and as such, any changes or corrections to these estimates identified in later periods, such as changes or corrections occurring as a result of natural disasters or other disruptions, including Hurricane Katrina, could affect the revenue that we report in future periods.
     As a result of our change in revenue recognition policy and the fact that the sell-through method is not widely used by our competitors, it may be difficult for potential and current stockholders to assess our financial results and compare these results to others in our industry. This may have an adverse effect on our stock price.

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     Primarily due to the change to the sell-through method, net product sales decreased by $12.8 million, $8.1 million, and $9.2 million for the quarters ended September 30, 2004, June 30, 2004, and March 31, 2004, respectively. Net product sales decreased by $25.5 million, $13.4 million, $12.8 million, and $7.5 million for the quarters ended December 31, 2003, September 30, 2003, June 30, 2003 and March 31, 2003, respectively. For the years ended December 31, 2003 and 2002, net product sales were reduced by $59.2 million and $24.2 million, respectively. At December 31, 2004, 2003, and 2002, the current portion of net deferred revenue totaled $152.5 million, $105.7 million, and $48.6 million (unaudited), respectively. See Management’s Discussion and Analysis, “Effects of the Sell-Through Method.”
Our new revenue recognition models under the sell-through method are extremely complex and depend upon the accuracy and consistency of third party data as well as dependence upon key finance and accounting personnel to maintain and implement the controls surrounding such models.
     We have developed revenue recognition models under the sell-through method that are unique to the Company’s business and therefore are highly complex and not widely used in the pharmaceutical industry. The revenue recognition models incorporate a significant amount of third party data from our wholesalers and IMS. To effectively maintain the revenue recognition models, we depend to a considerable degree upon the timely and accurate reporting to us of such data from these third parties and our key accounting and finance personnel to accurately interpolate such data into the models. If the third party data is not calculated on a consistent basis and reported to us on an accurate or timely basis or we lose any of our key accounting and finance personnel, the accuracy of our consolidated financial statements could be materially affected. This could cause future delays in our earnings announcements, regulatory filings with the SEC, and potential delays in relisting or delisting with the NASDAQ.
Our common stock was delisted from the NASDAQ National Market which may reduce the price of our common stock and the levels of liquidity available to our stockholders and cause confusion among investors.
     Our common stock was delisted from the NASDAQ National Market on September 7, 2005. Unless and until the Company’s common stock is relisted on NASDAQ, its common stock is expected to be quoted on the Pink Sheets. The quotation of our common stock on the Pink Sheets may reduce the price of our common stock and the levels of liquidity available to our stockholders. In addition, the quotation of our common stock on the Pink Sheets may materially adversely affect our access to the capital markets, and any limitation on liquidity or reduction in the price of our common stock could materially adversely affect our ability to raise capital through alternative financing sources on terms acceptable to us or at all. Stocks that are quoted on the Pink Sheets are no longer eligible for margin loans, and a company quoted on the Pink Sheets cannot avail itself of federal preemption of state securities or “blue sky” laws, which adds substantial compliance costs to securities issuances, including pursuant to employee option plans, stock purchase plans and private or public offerings of securities. Our delisting from the NASDAQ National Market and quotation on the Pink Sheets may also result in other negative implications, including the potential loss of confidence by suppliers, customers and employees, the loss of institutional investor interest and fewer business development opportunities.
     While we intend to apply to have our common stock relisted on the NASDAQ National Market when we regain compliance with the listing standards, we may not be successful in that effort. Even if we are successful in getting our common stock relisted on NASDAQ, the relisting may cause confusion among investors who have become accustomed to our being quoted on the Pink Sheets as they seek to determine our stock price or trade in our stock.
Risks Related to Us and Our Business
Our small number of products and our dependence on partners and other third parties means our results are vulnerable to setbacks with respect to any one product.
     We currently have only five products approved for marketing and a handful of other products/indications that have made significant progress through development. Because these numbers are small, especially the number of marketed products, any significant setback with respect to any one of them could significantly impair our operating results and/or reduce the market prices for our securities. Setbacks could include problems with shipping, distribution, manufacturing, product safety, marketing, government licenses and approvals, intellectual property rights and physician or patient acceptance of the product, as well as higher than expected total rebates, returns or discounts.

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     In particular, AVINZA our pain product, now accounts for a majority of our product revenues and we expect AVINZA revenues will continue to grow over the next several years. Thus any setback with respect to AVINZA could significantly impact our financial results and our share price. AVINZA was licensed from Elan Corporation which is currently its sole manufacturer. We have contracted with Cardinal to provide additional manufacturing capacity and second source back-up, however we expect Elan will be a significant supplier over the next several years. Any problems with Elan’s or Cardinal’s manufacturing operations or capacity could reduce sales of AVINZA, as could any licensing or other contract disputes with these suppliers.
     Similarly, our co-promotion partner executes a large part of the marketing and sales efforts for AVINZA and those efforts may be affected by our partner’s organization, operations, activities and events both related and unrelated to AVINZA. Our co-promotion efforts have encountered and continue to encounter a number of difficulties, uncertainties and challenges, including sales force reorganizations and lower than expected sales call and prescription volumes, which have hurt and could continue to hurt AVINZA sales growth. The negative impact on the product’s sales growth in turn has caused and may continue to cause our revenues and earnings to be disappointing. Any failure to fully optimize this co-promotion arrangement and the AVINZA brand, by either partner, could also cause AVINZA sales and our financial results to be disappointing and hurt our stock price. Any disputes with our co-promotion partner over these or other issues could harm the promotion and sales of AVINZA and could result in substantial costs to us.
     AVINZA is a relatively new product and therefore the predictability of its commercial results is relatively low. Higher than expected discounts (especially PBM/GPO rebates and Medicaid rebates, which can be substantial), returns and chargebacks and/or slower than expected market penetration could reduce sales. Other setbacks that AVINZA could face in the sustained-release opioid market include product safety and abuse issues, regulatory action, intellectual property disputes and the inability to obtain sufficient quotas of morphine from the Drug Enforcement Agency (DEA) to support our production requirements.
     In particular, with respect to regulatory action and product safety issues, the FDA recently requested that we expand the warnings on the AVINZA label to alert doctors and patients to the dangers of using AVINZA with alcohol. We are in the process of making appropriate changes to the label. The FDA also requested clinical studies to investigate the risks associated with taking AVINZA with alcohol. We are in discussions with the FDA regarding the design of those studies. These additional warnings, studies and any further regulatory action could have significant adverse affects on AVINZA sales.
Our product development and commercialization involves a number of uncertainties, and we may never generate sufficient revenues from the sale of products to become profitable.
     We were founded in 1987. We have incurred significant losses since our inception. At December 31, 2004, our accumulated deficit was approximately $794.7 million. We began receiving revenues from the sale of pharmaceutical products in 1999. We achieved quarterly net income for the first time in our corporate history during the fourth quarter of fiscal 2004, which was primarily the result of receiving approximately $31.3 million from the sale of royalty rights to Royalty Pharma. However, we expect to incur net losses in future quarters. To consistently be profitable, we must successfully develop, clinically test, market and sell our products. Even if we consistently achieve profitability, we cannot predict the level of that profitability or whether we will be able to sustain profitability. We expect that our operating results will fluctuate from period to period as a result of differences in when we incur expenses and receive revenues from product sales, collaborative arrangements and other sources. Some of these fluctuations may be significant.
     Most of our products in development will require extensive additional development, including preclinical testing and human studies, as well as regulatory approvals, before we can market them. We cannot predict if or when any of the products we are developing or those being developed with our partners will be approved for marketing. For example, lasofoxifene (Oporia), a partner product being developed by Pfizer recently received a “non-approvable” decision from the FDA and trials of our market product Targretin failed to meet endpoints in Phase III trials in

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which we were studying its use in non small cell lung cancer. There are many reasons that we or our collaborative partners may fail in our efforts to develop our other potential products, including the possibility that:
Ø   preclinical testing or human studies may show that our potential products are ineffective or cause harmful side effects;
 
Ø   the products may fail to receive necessary regulatory approvals from the FDA or foreign authorities in a timely manner, or at all;
 
Ø   the products, if approved, may not be produced in commercial quantities or at reasonable costs;
 
Ø   the products, once approved, may not achieve commercial acceptance;
 
Ø   regulatory or governmental authorities may apply restrictions to our products, which could adversely affect their commercial success; or
 
Ø   the proprietary rights of other parties may prevent us or our partners from marketing the products.
Any product development failures for these or other reasons, whether with our products or our partners’ products, may reduce our expected revenues, profits, and stock price.
Third-party reimbursement and health care reform policies may reduce our future sales.
     Sales of prescription drugs depend significantly on access to the formularies, or lists of approved prescription drugs, of third-party payers such as government and private insurance plans, as well as the availability of reimbursement to the consumer from these third party payers. These third party payers frequently require drug companies to provide predetermined discounts from list prices, and they are increasingly challenging the prices charged for medical products and services. Our current and potential products may not be considered cost-effective, may not be added to formularies and reimbursement to the consumer may not be available or sufficient to allow us to sell our products on a competitive basis. For example, we have current and recurring discussions with insurers regarding formulary access, discounts and reimbursement rates for our drugs, including AVINZA. We may not be able to negotiate favorable reimbursement rates and formulary status for our products or may have to pay significant discounts to obtain favorable rates and access. Only one of our products, ONTAK, is currently eligible to be reimbursed by Medicare (reimbursement for Targretin is being provided to a small group of patients by Medicare through December 2005 as part of the Medicare Replacement Drug Demonstration Project). Recently enacted changes by Medicare to the hospital outpatient payment reimbursement system may adversely affect reimbursement rates for ONTAK. Beginning in 2004 we have also experienced a significant increase in ONTAK units that are sold through Disproportionate Share Hospitals or DSHs. These hospitals are part of the federal government’s procurement system and thus receive significantly higher rebates than non-government purchasers of our products. As a result, our net revenues for ONTAK could be substantially reduced if this trend continues.
     In addition, the efforts of governments and third-party payers to contain or reduce the cost of health care will continue to affect the business and financial condition of drug companies such as us. A number of legislative and regulatory proposals to change the health care system have been discussed in recent years, including price caps and controls for pharmaceuticals. These proposals could reduce and/or cap the prices for our products or reduce government reimbursement rates for products such as ONTAK. In addition, an increasing emphasis on managed care in the United States has and will continue to increase pressure on drug pricing. We cannot predict whether legislative or regulatory proposals will be adopted or what effect those proposals or managed care efforts may have on our business. The announcement and/or adoption of such proposals or efforts could adversely affect our profit margins and business.
We are building marketing and sales capabilities in the United States and Europe which is an expensive and time-consuming process and may increase our operating losses.
     Developing the sales force to market and sell products is a difficult, expensive and time-consuming process. We have developed a US sales force of approximately 140 people. We also rely on third-party distributors to distribute our products. The distributors are responsible for providing many marketing support services, including customer service, order entry, shipping and billing and customer reimbursement assistance. In Europe, we currently rely on other companies to distribute and market our products. We have entered into agreements for the marketing and distribution of our products in territories such as the United Kingdom, Germany, France, Spain, Portugal, Greece,

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Italy and Central and South America and have established a subsidiary, Ligand Pharmaceuticals International, Inc., with a branch in London, England, to coordinate our European marketing and operations. Our reliance on these third parties means our results may suffer if any of them are unsuccessful or fail to perform as expected. We may not be able to continue to expand our sales and marketing capabilities sufficiently to successfully commercialize our products in the territories where they receive marketing approval. With respect to our co-promotion or licensing arrangements, for example our co-promotion agreement for AVINZA, any revenues we receive will depend substantially on the marketing and sales efforts of others, which may or may not be successful.
The cash flows from our product shipments may significantly fluctuate each period based on the nature of our products.
     Excluding AVINZA, our products are small-volume specialty pharmaceutical products that address the needs of cancer patients in relatively small niche markets with substantial geographical fluctuations in demand. To ensure patient access to our drugs, we maintain broad distribution capabilities with inventories held at approximately 150 locations throughout the United States. The purchasing and stocking patterns of our wholesaler customers for all our products are influenced by a number of factors that vary from product to product, including but not limited to overall level of demand, periodic promotions, required minimum shipping quantities and wholesaler competitive initiatives. As a result, the overall level of product in the distribution channel may average from two to six months’ worth of projected inventory usage. Although we have distribution services contracts in place to maintain stable inventories at our major wholesalers, if any of them were to substantially reduce the inventory they carry in a given period, e.g. due to circumstances beyond their reasonable control, or contract termination or expiration, our shipments and cash flow for that period could be substantially lower than historical levels.
     In the second half of 2004, we entered into new fee-for-service or distributor services agreements for each of our products with the majority of our wholesaler customers. Under these agreements, in exchange for a set fee, the wholesalers have agreed to provide us with certain services. Concurrent with the implementation of these agreements we will no longer routinely offer these wholesalers promotional discounts or incentives. The agreements typically have a one-year initial term and are renewable.
Our drug development programs will require substantial additional future funding which could hurt our operational and financial condition.
     Our drug development programs require substantial additional capital to successfully complete them, arising from costs to:
Ø   conduct research, preclinical testing and human studies;
 
Ø   establish pilot scale and commercial scale manufacturing processes and facilities; and
 
Ø   establish and develop quality control, regulatory, marketing, sales and administrative capabilities to support these programs.
 
    Our future operating and capital needs will depend on many factors, including:
 
Ø   the pace of scientific progress in our research and development programs and the magnitude of these programs;
 
Ø   the scope and results of preclinical testing and human studies;
 
Ø   the time and costs involved in obtaining regulatory approvals;
 
Ø   the time and costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims;
 
Ø   competing technological and market developments;
 
Ø   our ability to establish additional collaborations;
 
Ø   changes in our existing collaborations;
 
Ø   the cost of manufacturing scale-up; and
 
Ø   the effectiveness of our commercialization activities.
     We currently estimate our research and development expenditures over the next 3 years to range between $200 million and $275 million. However, we base our outlook regarding the need for funds on many uncertain variables. Such uncertainties include regulatory approvals, the timing of events outside our direct control such as product

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launches by partners and the success of such product launches, negotiations with potential strategic partners and other factors. Any of these uncertain events can significantly change our cash requirements as they determine such one-time events as the receipt of major milestones and other payments.
     While we expect to fund our research and development activities from cash generated from internal operations to the extent possible, if we are unable to do so we may need to complete additional equity or debt financings or seek other external means of financing. If additional funds are required to support our operations and we are unable to obtain them on terms favorable to us, we may be required to cease or reduce further development or commercialization of our products, to sell some or all of our technology or assets or to merge with another entity.
We may require additional money to run our business and may be required to raise this money on terms which are not favorable or which reduce our stock price.
     We have incurred losses since our inception and may not generate positive cash flow to fund our operations for one or more years. As a result, we may need to complete additional equity or debt financings to fund our operations. Our inability to obtain additional financing could adversely affect our business. Financings may not be available at all or on favorable terms. In addition, these financings, if completed, still may not meet our capital needs and could result in substantial dilution to our stockholders. For instance, in April 2002 and September 2003 we issued an aggregate of 7.7 million shares of our common stock in a private placement. In addition, in November 2002 we issued in a private placement $155.3 million in aggregate principal amount of our 6% Convertible Subordinated Notes due 2007, which could be converted into 25,149,025 shares of our common stock.
     If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our research or drug development programs, or our marketing and sales initiatives. Alternatively, we may be forced to attempt to continue development by entering into arrangements with collaborative partners or others that require us to relinquish some or all of our rights to technologies or drug candidates that we would not otherwise relinquish.
Our products face significant regulatory hurdles prior to marketing which could delay or prevent sales.
     Before we obtain the approvals necessary to sell any of our potential products, we must show through preclinical studies and human testing that each product is safe and effective. We and our partners have a number of products moving toward or currently in clinical trials, the most significant of which are our Phase III trials for Targretin capsules in NSCLC, lasofoxifene which is under NDA review and two products in Phase III trials by one of our partners involving bazedoxifene. Failure to show any product’s safety and effectiveness would delay or prevent regulatory approval of the product and could adversely affect our business. The clinical trials process is complex and uncertain. 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, which could be expensive and time-consuming, and failure to successfully conduct those trials could jeopardize continued commercialization.
     In particular, we announced top-line data, or a summary of significant findings from our Phase III trials for Targretin capsules in NSCLC in late March of 2005. The data analysis showed that the trials did not meet their endpoints of improved overall survival and projected two-year survival. However, in both trials, additional subset analysis completed after the initial intent to treat results are being analyzed. We have been evaluating data from current and prior Phase II studies to see if they show a similar correlation between hypertriglyceridemia and increased survival. The data will further shape our future plans for Targretin. If further studies are justified they will be conducted on our own or with a partner or cooperative group. These analyses may not be favorable and may not be completed or demonstrate any hypothesis or endpoint. If these analyses or subsequent data fails to show safety or effectiveness, our stock price could be harmed. In addition, subsequent data may be inconclusive or mixed and could be delayed. The FDA may not approve Targretin for this new indication, or may delay approval, even if the data appears to be favorable. Any of these events could depress our stock price.
     The rate at which we complete our clinical trials depends on many factors, including our ability to obtain adequate supplies of the products to be tested and patient enrollment. Patient enrollment is a function of many

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factors, including the size of the patient population, the proximity of patients to clinical sites and the eligibility criteria for the trial. For example, each of our Phase III Targretin clinical trials involved approximately 600 patients and required significant time and investment to complete enrollments. Delays in patient enrollment for our other 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 the collaborations. As a result, these collaborators may conduct these programs more slowly or in a different manner than we had expected. 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.
We face substantial competition which may limit our revenues.
     Some of the drugs that we are developing and marketing will compete with existing treatments. In addition, several companies are developing new drugs that target the same diseases that we are targeting and are taking IR-related and STAT-related approaches to drug development. The principal products competing with our products targeted at the cutaneous t-cell lymphoma market are Supergen/Abbott’s Nipent and interferon, which is marketed by a number of companies, including Schering-Plough’s Intron A. Products that compete with AVINZA include Purdue Pharma L.P.’s OxyContin and MS Contin and potentially Palladone (launched in early 2005 and subsequently withdrawn from the market), Janssen Pharmaceutica Products, L.P.’s Duragesic, aai Pharma’s Oramorph SR, Alpharma’s Kadian, and generic sustained release morphine sulfate, oxycodone and fentanyl. New generic, A/B substitutable or other competitive products may also come to market and compete with our products, reducing our market share and revenues. Many of our existing or potential competitors, particularly large drug companies, have greater financial, technical and human resources than us and may be better equipped to develop, manufacture and market products. Many of these companies also have extensive experience in preclinical testing and human clinical trials, obtaining FDA and other regulatory approvals and manufacturing and marketing pharmaceutical products. In addition, academic institutions, governmental agencies and other public and private research organizations are developing products that may compete with the products we are developing. These institutions are becoming more aware of the commercial value of their findings and are seeking patent protection and licensing arrangements to collect payments for the use of their technologies. These institutions also may market competitive products on their own or through joint ventures and will compete with us in recruiting highly qualified scientific personnel.
We rely heavily on collaborative relationships and termination of any of these programs could reduce the financial resources available to us, including research funding and milestone payments.
     Our strategy for developing and commercializing many of our potential products, including products aimed at larger markets, includes entering into collaborations with corporate partners, licensors, licensees and others. These collaborations provide us with funding and research and development resources for potential products for the treatment or control of metabolic diseases, hematopoiesis, women’s health disorders, inflammation, cardiovascular disease, cancer and skin disease, and osteoporosis. These agreements also give our collaborative partners significant discretion when deciding whether or not to pursue any development program. Our collaborations may not continue or be successful.
     In addition, our collaborators may develop drugs, either alone or with others, that compete with the types of drugs they currently are developing with us. This would result in less support and increased competition for our programs. If products are approved for marketing under our collaborative programs, any revenues we receive will depend on the manufacturing, marketing and sales efforts of our collaborators, who generally retain commercialization rights under the collaborative agreements. Our current collaborators also generally have the right to terminate their collaborations 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, our product development under these agreements will be delayed or terminated.
     We may have disputes in the future with our collaborators, including disputes concerning which of us owns the rights to any technology developed. For instance, we were involved in litigation with Pfizer, which we settled in April 1996, concerning our right to milestones and royalties based on the development and commercialization of droloxifene. These and other possible disagreements between us and our collaborators could delay our ability and the ability of our collaborators to achieve milestones or our receipt of other payments. In addition, any

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disagreements could delay, interrupt or terminate the collaborative research, development and commercialization of certain potential products, 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.
Some of our key technologies have not been used to produce marketed products and may not be capable of producing such products.
     To date, we have dedicated most of our resources to the research and development of potential drugs based upon our expertise in our IR technology. Even though there are marketed drugs that act through IRs, some aspects of our IR technologies have not been used to produce marketed products. Much remains to be learned about the function of IRs. If we are unable to apply our IR and STAT technologies to the development of our potential products, we may not be successful in discovering or developing new products.
Challenges to or failure to secure patents and other proprietary rights may significantly hurt our business.
     Our success will depend on our ability and the ability of our licensors to obtain and maintain patents and proprietary rights for our potential products and to avoid infringing the proprietary rights of others, 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. 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.
     Our patent position, like that of many pharmaceutical companies, is uncertain and involves complex legal and technical questions for 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, they 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. Further, the manufacture, use or sale of our products may infringe the patent rights of others.
     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 dominate those licensed to us. In addition, we may not be aware of all patents or patent applications that may impact our ability to make, use or sell any of our potential products. For example, US patent applications may be kept confidential while pending in the Patent and Trademark Office and patent applications filed in foreign countries are often first published six months or more after filing. 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. While we routinely receive communications or have conversations with the owners of other patents, none of these third parties have directly threatened an action or claim against us. If other companies obtain patents with conflicting claims, we may be required to obtain licenses to those patents or to develop or obtain alternative technology. We may not be able to obtain any such licenses on acceptable terms, or at all. Any failure to obtain such licenses could delay or prevent us from pursuing the development or commercialization of our potential products.
     We have had and will continue to have discussions with our current and potential collaborators regarding the scope and validity of our patents and other proprietary rights. If a collaborator 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 collaborators to terminate their agreements where contractually permitted. Such a determination could also 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 litigation results, a court may find our patents or those of our licensors invalid or may find that we have infringed on a competitor’s rights. If any of our competitors have filed patent applications in the United States which claim technology we also have invented, the

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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.
     Hoffmann-La Roche Inc. has received a US patent, has made patent filings and has issued patents in foreign countries that relate to our Panretin gel products. While we were unsuccessful in having certain claims of the US patent awarded to Ligand in interference proceedings, we continue to believe that any relevant claims in these Hoffman-La Roche patents in relevant jurisdictions are invalid and that our current commercial activities and plans relating to Panretin are not covered by these Hoffman-La Roche patents in the US or elsewhere. In addition, we have our own portfolio of issued and pending patents in this area which cover our commercial activities, as well as other uses of 9-cis retinoic acid, in the US, Europe and elsewhere. However, if the claims in these Hoffman-La Roche patents are not invalid and/or unenforceable, they might block the use of Panretin gel in specified cancers, not currently under active development or commercialization by us.
     Novartis AG has filed an opposition to our European patent that covers the principal active ingredient of our ONTAK drug. We have received a favorable preliminary opinion from the European Patent Office, however this is not a final determination and Novartis has filed a response to the preliminary opinion that argues our patent is invalid. If the opposition is successful, we could lose our ONTAK patent protection in Europe which could substantially reduce our future ONTAK sales in that region. We could also incur substantial costs in asserting our rights in this opposition proceeding, as well as in other possible future proceedings in the United States.
     We also rely on unpatented trade secrets and know-how to protect and maintain our competitive position. We require our employees, consultants, collaborators 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.
Reliance on third-party manufacturers to supply our products risks supply interruption or contamination and difficulty controlling costs.
     We currently have no manufacturing facilities, and we rely on others for clinical or commercial production of our marketed and potential products. In addition, some raw materials necessary for the commercial manufacturing of our products are custom and must be obtained from a specific sole source. Elan manufactures AVINZA for us, Cambrex manufactures ONTAK active pharmaceutical ingredient for us, Raylo manufactures Targretin active pharmaceutical ingredient, and Cardinal Health manufactures Targretin capsules for us. We also recently entered into contracts with Cardinal Health to manufacture and package AVINZA and with Hollister-Stier for the filling and finishing of ONTAK. Each of these recent contracts calls for manufacturing and packaging the product at a new facility. Qualification and regulatory approval for these facilities are required prior to starting commercial manufacturing and was recently received in 2005 for both facilities. Any delays or failures of the manufacturing or packaging process could cause inventory problems or product shortages.
     To be successful, we will need to ensure continuity of the manufacture of our products, either directly or through others, in commercial quantities, in compliance with regulatory requirements at acceptable cost and in sufficient quantities to meet product growth demands. Any extended or unplanned manufacturing shutdowns, shortfalls or delays could be expensive and could result in inventory and product shortages. If we are unable to reliably manufacture our products our revenues could be adversely affected. In addition, if we are unable to supply products in development, our ability to conduct preclinical testing and human clinical trials will be adversely affected. This in turn could also delay our submission of products for regulatory approval and our initiation of new development programs. In addition, although other companies have manufactured drugs acting through IRs and STATs on a commercial scale, we may not be able to translate our core technologies or other technologies into drugs that can be manufactured at costs or in quantities to make marketable products.
     The manufacturing process also may be susceptible to contamination, which could cause the affected manufacturing facility to close until the contamination is identified and fixed. In addition, problems with equipment failure or operator error also could cause delays in filling our customers’ orders.

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Our business exposes us to product liability risks or our products may need to be recalled, and we may not have sufficient insurance to cover any claims.
     Our business exposes us to potential product liability risks. Our products also may need to be recalled to address regulatory issues. A successful product liability claim or series of claims brought against us could result in payment of significant amounts of money and divert management’s attention from running the business. Some of the compounds we are investigating may be harmful to humans. For example, retinoids as a class are known to contain compounds which can cause birth defects. We may not be able to maintain our insurance on acceptable terms, or our insurance may not provide adequate protection in the case of a product liability claim. To the extent that product liability insurance, if available, does not cover potential claims, we will be required to self-insure the risks associated with such claims. We believe that we carry reasonably adequate insurance for product liability claims.
We use hazardous materials which requires us to incur substantial costs to comply with environmental regulations.
     In connection with our research and development activities, we handle hazardous materials, chemicals and various radioactive compounds. To properly dispose of these hazardous materials in compliance with environmental regulations, we are required to contract with third parties at substantial cost to us. Our annual cost of compliance with these regulations is approximately $0.7 million. We cannot completely eliminate the risk of accidental contamination or injury from the handling and disposing of hazardous materials, whether by us or by our third-party contractors. In the event of any accident, we could be held liable for any damages that result, which could be significant. We believe that we carry reasonably adequate insurance for toxic tort claims.
Future sales of our securities may depress the price of our securities.
     Sales of substantial amounts of our securities in the public market could seriously harm prevailing market prices for our securities. These sales might make it difficult or impossible for us to sell additional securities when we need to raise capital.
You may not receive a return on your securities other than through the sale of your securities.
     We have not paid any cash dividends on our common stock to date. We intend to retain any earnings to support the expansion of our business, and we do not anticipate paying cash dividends on any of our securities in the foreseeable future.
Our shareholder rights plan and charter documents may hinder or prevent change of control transactions.
     Our shareholder rights plan and provisions contained in our certificate of incorporation and bylaws may discourage transactions involving an actual or potential change in our ownership. In addition, our board of directors may issue shares of preferred stock without any further action by you. Such issuances may have the effect of delaying or preventing a change in our ownership. If changes in our ownership are discouraged, delayed or prevented, it would be more difficult for our current board of directors to be removed and replaced, even if you or our other stockholders believe that such actions are in the best interests of us and our stockholders.
Item 2. Properties
     We currently lease and occupy office and laboratory facilities in San Diego, California. These include a 52,800 square foot facility leased through July 2015 and an 82,500 square foot facility which we own through our consolidated subsidiary, Nexus. We believe these facilities will be adequate to meet our near-term space requirements.
Item 3. Legal Proceedings
     Seragen, Inc., our subsidiary, and Ligand, were named parties to Sergio M. Oliver, et al. v. Boston University, et al., a putative shareholder class action filed on December 17, 1998 in the Court of Chancery in the State of Delaware in and for New Castle County, C.A. No. 16570NC, by Sergio M. Oliver and others against Boston University and

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others, including Seragen, its subsidiary Seragen Technology, Inc. and former officers and directors of Seragen. The complaint, as amended, alleged that Ligand aided and abetted purported breaches of fiduciary duty by the Seragen related defendants in connection with the acquisition of Seragen by Ligand and made certain misrepresentations in related proxy materials and seeks compensatory and punitive damages of an unspecified amount. On July 25, 2000, the Delaware Chancery Court granted in part and denied in part defendants’ motions to dismiss. Seragen, Ligand, Seragen Technology, Inc. and our acquisition subsidiary, Knight Acquisition Corporation, were dismissed from the action. Claims of breach of fiduciary duty remain against the remaining defendants, including the former officers and directors of Seragen. The hearing on the plaintiffs’ motion for class certification took place on February 26, 2001. The court certified a class consisting of shareholders as of the date of the acquisition and on the date of the proxy sent to ratify an earlier business unit sale by Seragen. On January 20, 2005, the Delaware Chancery Court granted in part and denied in part the defendants’ motion for summary judgment. The Court denied plaintiffs’ motion for summary judgment in its entirety. Trial was scheduled for February 7, 2005. Prior to trial, several of the Seragen director-defendants reached a settlement with the plaintiffs. The trial in this action then went forward as to the remaining defendants and concluded on February 18, 2005. The timing of a decision by the Court and the outcome are unknown. While Ligand and its subsidiary Seragen have been dismissed from the action, such dismissal is subject to a possible subsequent appeal upon any judgment in the action against the remaining parties, as well as possible indemnification obligations with respect to certain defendants.
     On December 11, 2001, a lawsuit was filed in the United States District Court for the District of Massachusetts against Ligand by the Trustees of Boston University and other former stakeholders of Seragen. The suit was subsequently transferred to federal district court in Delaware. The complaint alleges breach of contract, breach of the implied covenants of good faith and fair dealing and unfair and deceptive trade practices based on, among other things, allegations that Ligand wrongfully withheld approximately $2.1 million in consideration due the plaintiffs under the Seragen acquisition agreement. This amount had been previously accrued for in the Company’s consolidated financial statements in 1998. The complaint seeks payment of the withheld consideration and treble damages. Ligand filed a motion to dismiss the unfair and deceptive trade practices claim. The Court subsequently granted Ligand’s motion to dismiss the unfair and deceptive trade practices claim (i.e. the treble damages claim), in April 2003. In November 2003, the Court granted Boston University’s motion for summary judgment, and entered judgment for Boston University. In January 2004, the district court issued an amended judgment awarding interest of approximately $0.7 million to the plaintiffs in addition to the approximately $2.1 million withheld. In view of the judgment, the Company restated its consolidated financial statements to record a charge of $0.7 million to “Selling, general and administrative” expense in the fourth quarter of 2003. The Company continues to believe that the plaintiff’s claims are without merit and has appealed the judgment in this case as well as the award of interest and the calculation of damages. The appeal has been fully briefed and was argued in June 2005, and the parties are waiting for the court’s decision. The likelihood of success on appeal is unknown.
     Beginning in August 2004, several purported class action stockholder lawsuits were filed in the United States District Court for the Southern District of California against the Company and certain of its directors and officers. The actions were brought on behalf of purchasers of the Company’s common stock during several time periods, the longest of which runs from July 28, 2003 through August 2, 2004. The complaints generally allege that the Company violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission by making false and misleading statements, or concealing information about the Company’s business, forecasts and financial performance, in particular statements and information related to drug development issues and AVINZA inventory levels. These lawsuits have been consolidated and lead plaintiffs appointed. A consolidated complaint was filed by the plaintiffs in March 2005. On September 27, 2005, the court granted the Company’s motion to dismiss the consolidated complaint, with leave for plaintiffs to file an amended complaint within 30 days. No trial date has been set.
     Beginning on or about August 13, 2004, several derivative actions were filed on behalf of the Company by individual stockholders in the Superior Court of California. The complaints name the Company’s directors and certain of its officers as defendants and name the Company as a nominal defendant. The complaints are based on the same facts and circumstances as the purported class actions discussed in the previous paragraph and generally allege breach of fiduciary duties, abuse of control, waste and mismanagement, insider trading and unjust enrichment. These actions are in discovery. The court has set a trial date of May 26, 2006.

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     In October 2005, a shareholder derivative action was filed on behalf of the Company in the United States District Court for the Southern District of California. The complaint names the Company’s directors and certain of its officers as defendants and the Company as a nominal defendant. The action was brought by an individual stockholder. The complaint generally alleges that the defendants falsified Ligand’s publicly reported financial results throughout 2002 and 2003 and the first three quarters of 2004 by improperly recognizing revenue on product sales. The complaint generally alleges breach of fiduciary duty by all defendants and requests disgorgement, e.g., under Section 304 of the Sarbanes-Oxley Act of 2002. No trial date has been set.
     The Company believes that all of the above actions are without merit and intends to vigorously defend against each of such lawsuits. Due to the uncertainty of the ultimate outcome of these matters, the impact on future financial results is not subject to reasonable estimates.
     In October 2005, a lawsuit was filed in the Court of Chancery in the State of Delaware by Third Point Offshore Fund, Ltd. requesting the Court to order Ligand to hold an annual meeting for the election of directors within 60 days of an order by the Court. Ligand’s annual meeting has been delayed as a result of the previously announced restatement. The complaint requested the Court to set a time and place and record date for such annual meeting and establish the quorum for such meeting as the shares present at the meeting, notwithstanding any relevant provisions of Ligand’s certificate of incorporation or bylaws. The complaint also sought payment of plaintiff’s costs and attorney’s fees. Ligand agreed on November 11, 2005 to settle this lawsuit and schedule the annual meeting for January 31, 2006. The record date will be set by the Board of Directors and will be between December 5 and December 15, 2005. No special quorum requirement will be established and each party will be responsible for its own costs and fees. Third Point has indicated that it will solicit proxies to elect at least three directors at the annual meeting.
     In connection with the restatement, the SEC instituted a formal investigation concerning the Company’s consolidated financial statements. These matters were previously the subject of an informal SEC inquiry. Ligand has been cooperating fully with the SEC and will continue to do so in order to bring the investigation to a conclusion as promptly as possible.
     In addition, the Company is subject to various lawsuits and claims with respect to matters arising out of the normal course of business. Due to the uncertainty of the ultimate outcome of these matters, the impact on future financial results is not subject to reasonable estimates.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders in the fourth quarter ended December 31, 2004.

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PART II
Item 5. Market for Registrant’s Common Stock, Related Stockholder Matters, and Issuer Purchases of Equity Securities
(a) Market Information
     Prior to September 7, 2005, our common stock was traded on the NASDAQ National Market tier of the NASDAQ Stock Market under the symbols “LGND” and “LGNDE.” Our common stock was delisted from the NASDAQ National Market on September 7, 2005 and currently is quoted on the Pink Sheets under the symbol “LGND.”
     The following table sets forth the high and low intraday sales prices for our common stock on the NASDAQ National Market for the periods indicated:
                 
    Price Range  
    High     Low  
Year Ended December 31, 2004:
               
1st Quarter
  $ 20.94     $ 13.19  
2nd Quarter
    24.91       15.82  
3rd Quarter
    17.38       7.41  
4th Quarter
    12.97       8.26  
 
               
Year Ended December 31, 2003:
               
1st Quarter
    6.90       3.69  
2nd Quarter
    16.59       6.25  
3rd Quarter
    15.90       9.90  
4th Quarter
    15.75       11.35  
     As of November 11, 2005, the closing price of our common stock on the Pink Sheets was $ 9.00.
(b) Holders
     As of August 31, 2005, there were approximately 1,807 holders of record of the common stock.
(c) Dividends
     We have never declared or paid any cash dividends on our capital stock and do not intend to pay any cash dividends in the foreseeable future. We currently intend to retain our earnings, if any, to finance future growth.
Item 6. Selected Consolidated Financial Data
     The following selected historical consolidated financial and other data are qualified by reference to, and should be read in conjunction with, our consolidated financial statements and the related notes thereto appearing elsewhere herein and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our selected statement of operations data set forth below for each of the five years ended December 31, 2004, 2003, 2002, 2001, and 2000, and the balance sheet data as of December 31, 2004, 2003, 2002, 2001, and 2000, are derived from our consolidated financial statements. Balance sheet data as of December 31, 2003, 2002, 2001, and 2000, and statements of operations data for the years then ended have been restated with respect to the matters described in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K and in Note 2 to our accompanying consolidated financial statements. We have not amended our previously filed annual reports on Form 10-K or quarterly reports on Form 10-Q for the periods affected by the restatement. The information that has been previously filed or otherwise reported for these periods is superseded by the information in this Annual Report on Form 10-K. As such, the consolidated financial statements and related financial information contained in such previously filed reports should no longer be relied upon.

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    Year Ended December 31,  
    2004     2003     2002     2001     2000  
            (Restated)     (Restated)     (Restated)     (Restated)  
                            (Unaudited)     (Unaudited)  
    (in thousands, except share and loss per share data)  
Consolidated Statement of Operations Data:
                                       
Product sales (1)
  $ 120,335     $ 55,324     $ 30,326     $ 32,038     $ 18,818  
Sale of royalty rights, net (2)
    31,342       11,786       17,600              
Collaborative research and development and other revenues
    11,835       14,008       23,843       30,718       25,200  
Cost of products sold (1)
    39,804       26,557       14,738       11,582       8,355  
Research and development expenses
    65,204       66,678       59,060       49,427       49,903  
Selling, general and administrative expenses
    65,798       52,540       41,825       35,072       34,370  
Co-promotion expense (3)
    30,077       9,360                    
Loss from operations
    (37,371 )     (74,017 )     (43,854 )     (33,325 )     (48,610 )
Loss before cumulative effect of changes in accounting principles
    (45,141 )     (94,466 )     (52,257 )     (53,305 )     (62,005 )
Cumulative effect on prior years of changing method of revenue recognition (4)
                            (13,099 )
Cumulative effect of changing method of accounting for variable interest entity (5)
          (2,005 )                  
Net loss
    (45,141 )     (96,471 )     (52,257 )     (53,305 )     (75,104 )
 
                                       
Basic and diluted per share amounts:
                                       
Loss before cumulative effect of changes in accounting principles
  $ (0.61 )   $ (1.33 )   $ (0.76 )   $ (0.90 )   $ (1.11 )
Cumulative effect on prior years of changing method of revenue recognition (4)
                            (0.24 )
Cumulative effect of changing method of accounting for variable interest entity (5)
          (0.03 )                  
 
                             
Net loss
  $ (0.61 )   $ (1.36 )   $ (0.76 )   $ (0.90 )   $ (1.35 )
 
                             
Weighted average number of common shares
    73,692,987       70,685,234       69,118,976       59,413,270       55,664,921  
 
                             
 
                                       
Pro forma amounts assuming the changed method of accounting for variable interest entity is applied retroactively (5):
                                       
Net loss
          $ (94,352 )   $ (52,456 )   $ (53,600 )   $ (75,561 )
 
                             
Basic and diluted net loss per share
          $ (1.34 )   $ (0.76 )   $ (0.90 )   $ (1.36 )
 
                             
                                         
    December 31,  
    2004     2003     2002     2001     2000  
            (Restated)     (Restated)     (Restated)     (Restated)  
                    (Unaudited)     (Unaudited)     (Unaudited)  
    (in thousands)  
Consolidated Balance Sheet Data:
                                       
Cash, cash equivalents, short-term investments and restricted investments
  $ 114,870     $ 100,690     $ 74,894     $ 40,058     $ 25,097  
Working capital (deficit) (6)
    (43,888 )     (16,930 )     18,370       2,375       8,372  
Total assets
    332,466       314,046       287,709       126,898       117,484  
Current portion of deferred revenue, net
    152,528       105,719       48,609       27,152       13,713  
Long-term obligations (excludes long-term portion of deferred revenues, net)
    174,214       173,851       162,329       138,837       133,575  
Long-term portion of deferred revenue, net
    4,512       3,448       3,595       4,164       5,727  
Common stock subject to conditional redemption/repurchase
    12,345       14,595       34,595       14,595       14,595  
Accumulated deficit
    (794,660 )     (749,519 )     (653,048 )     (600,791 )     (547,486 )
Total stockholders’ equity (deficit) (7)
    (75,317 )     (37,554 )     8,925       (86,849 )     (72,405 )
(footnotes on next page)

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(1)   We began selling ONTAK and Panretin gel in 1999 and Targretin capsules and Targretin gel in 2000. AVINZA was approved by the FDA in March 2002 and subsequently launched in the U.S. in June 2002.
 
(2)   Represents the sale of rights to royalties. See Note 11 (Royalty Agreements) of the Notes to Consolidated Financial Statements.
 
(3)   Represents expense related to our AVINZA co-promotion agreement with Organon Pharmaceuticals USA, Inc. entered into in February 2003. See Note 8 of the Notes to the Consolidated Financial Statements.
 
(4)   In 2000, we changed our policy for the recognition of revenue related to up-front fees in accordance with SAB 104.
 
(5)   In December 2003, we adopted FIN 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. Under FIN 46(R), we were required to consolidate the variable interest entity from which we leased our corporate headquarters. Accordingly, as of December 31, 2003, we consolidated assets with a carrying value of $13.6 million, debt of $12.5 million, and a non-controlling interest of $0.6 million. In connection with the adoption of FIN 46(R), we recorded a charge of $2.0 million as a cumulative effect of the accounting change on December 31, 2003. In April 2004, we acquired the portion of the variable interest entity that we did not previously own. The acquisition resulted in Ligand assuming the existing loan against the property and making a payment of approximately $0.6 million to the entity’s other shareholder. See Note 3 (Cumulative Effect of Accounting Change) of the Notes to Consolidated Financial Statements.
 
(6)   Working capital (deficit) includes deferred product revenue recorded under the sell-through revenue recognition method.
 
(7)   The cumulative effect of the restatement at January 1, 2000 was approximately $(13.2) million, which represents the effect of the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(1.0) million; royalties – $0.1 million; $(1.6) million regarding rent expense for annual rent increases; $(14.6) million regarding the reclassification from equity of the Company’s issuance of common stock subject to conditional redemption to Pfizer in accordance with EITF D-98; $3.4 million regarding the capitalization of the X-Ceptor purchase right in October 1999; and $0.5 million regarding the reversal of X-Ceptor warrant amortization.

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EFFECTS OF THE RESTATEMENT
The following tables reconcile the Company’s consolidated financial position and results of operations from the previously reported consolidated financial statements to the restated consolidated financial statements. Additionally, set forth below for each of the tables is an explanation of the restatement adjustments. Please refer to the discussion herein regarding further explanation of the restatement adjustments. Following the table presentation is a discussion regarding the significant changes to our quarterly results for the 2004 and 2003 periods. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Background of the Restatement – Quarterly Effects of the Restatement.”

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
(in thousands, except share and per share data)
                 
    For the Year Ended December 31,  
    2003     2002  
Net loss, as previously reported:
  $ (37,462 )   $ (32,596 )
 
               
Adjustments to net loss (increase) decrease:
               
Product sales:
               
Net product sales (a)
    (59,187 )     (24,160 )
Other (b)
    (121 )     (36 )
Sale of royalty rights, net (c)
    (714 )     (675 )
Cost of products sold:
               
Product cost (d)
    151       2,549  
Royalties (d)
    4,910       3,019  
Research and development:
               
Reclassification (e)
    55        
Clinical trial (f)
    918       (1,107 )
X-Ceptor warrant amortization (g)
          692  
Patent expense accrual (h)
          345  
Other (b)
    28       (183 )
Selling, general and administrative:
               
Reclassification (e)
    (55 )      
Rent (i)
    (111 )     (158 )
Seragen litigation (j)
    (739 )      
Other (b)
    26       11  
Interest (b)
    (172 )      
Other, net:
               
X-Ceptor purchase right (k)
    (3,990 )      
Income tax expense (l)
    56       44  
Other (b)
    (8 )     42  
Income tax expense (l)
    (56 )     (44 )
 
           
 
               
Net loss, as restated
  $ (96,471 )   $ (52,257 )
 
           
 
               
Per Share Data
               
As previously reported:
               
Basic and diluted net loss per share
  $ (0.53 )   $ (0.47 )
Weighted average number of common shares
    70,685,234       69,118,976  
As restated:
               
Basic and diluted net loss per share
  $ (1.36 )   $ (0.76 )
Weighted average number of common shares
    70,685,234       69,118,976  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following:
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the deferral of a portion of the sale of royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties.
 
(e)   To reclassify expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(f)   To correct clinical trial expense.
 
(g)   To reverse X-Ceptor warrant amortization.
 
(h)   To correct patent expense.
 
(i)   To adjust rent expense for contractual annual rent increase which is recognized over the lease term on a straight-line basis.
 
(j)   To reflect accrued interest for the Seragen acquisition litigation.
 
(k)   To reflect the write-off of the X-Ceptor purchase right in March 2003.
 
(l)   To reclassify income taxes related to international operations.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
(in thousands, except share and per share data)
(unaudited)
                         
    2004 Quarterly Periods  
    March 31,     June 30,     September 30,  
Net loss, as previously reported:
  $ (13,139 )   $ (14,216 )   $ (6,789 )
 
                       
Adjustments to net loss (increase) decrease:
                       
Product sales:
                       
Net product sales (a)
    (9,245 )     (8,097 )     (12,842 )
Other (b)
    48       (89 )     50  
Sale of royalty rights, net (c)
                67  
Cost of products sold:
                       
Product cost (d)
    886       214       163  
Royalties (d)
    392       (6 )     1,029  
Research and development:
                       
Reclassification (e)
    742       1,454       1,221  
Salk-buyout (f)
    (1,120 )            
Patent expense (g)
    (238 )            
Other (b)
    (49 )     154       12  
Selling, general and administrative:
                       
Reclassification (e)
    (742 )     (1,454 )     (1,221 )
Legal expense (h)
    373              
Other (b)
    136       (37 )     (200 )
Interest:
                       
Factoring arrangement (i)
                (238 )
Other (b)
    44       12       12  
Other, net:
                       
Factoring arrangement (i)
                238  
Income taxes (j)
    16       18       3  
Income tax expense (j)
    (16 )     (18 )     (3 )
 
                 
 
                       
Net loss, as restated
  $ (21,912 )   $ (22,065 )   $ (18,498 )
 
                 
 
                       
Per Share Data
                       
As previously reported:
                       
Basic and diluted net loss per share
  $ (0.18 )   $ (0.19 )   $ (0.09 )
Weighted average number of common shares
    73,299,281       73,754,146       73,845,613  
As restated:
                       
Basic and diluted net loss per share
  $ (0.30 )   $ (0.30 )   $ (0.25 )
Weighted average number of common shares
    73,299,281       73,754,146       73,845,613  
Refer to the explanation of adjustments on the next page.

54


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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following:
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the recognition of revenue previously deferred in regard to the sale of royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties.
 
(e)   To reclassify expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(f)   To expense the payment to The Salk Institute to buy-out the Company’s royalty obligation on lasofoxifene in March 2004.
 
(g)   To correct patent expense.
 
(h)   To correct legal expense.
 
(i)   To reclassify interest and factoring expenses incurred under a factoring arrangement.
 
(j)   To reclassify income taxes related to international operations.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
(in thousands, except share and per share data)
(unaudited)
                                 
    2003 Quarterly Periods  
    March 31,     June 30,     September 30,     December 31,  
Net (loss) income, as previously reported:
  $ (20,320 )   $ (11,997 )   $ (11,087 )   $ 5,942  
 
                               
Adjustments to net (loss) (increase) decrease/ income increase (decrease):
                               
Product sales:
                               
Net product sales (a)
    (7,468 )     (12,835 )     (13,376 )     (25,508 )
Other (b)
    13       (181 )     13       34  
Sale of royalty rights, net (c)
                35       (749 )
Cost of products sold:
                               
Product cost (d)
    3       (437 )     (23 )     608  
Royalties (d)
    415       1,358       1,547       1,590  
Research and development:
                               
Reclassification (e)
          9       20       26  
Clinical trial expense (f)
          331       281       233  
Other (b)
    91       (125 )     (40 )     175  
Selling, general and administrative:
                               
Reclassification (e)
          (9 )     (20 )     (26 )
Seragen litigation (g)
                      (739 )
Other (b)
    74       11       (6 )     (164 )
Interest (b)
    (26 )     (81 )     (170 )     105  
Other, net:
                             
X-Ceptor purchase right (h)
    (3,990 )                  
Income tax expense (i)
    15       16       9       16  
Other (b)
    80             113       (201 )
Income tax expense (i)
    (15 )     (16 )     (9 )     (16 )
 
                       
 
                               
Net loss, as restated
  $ (31,128 )   $ (23,956 )   $ (22,713 )   $ (18,674 )
 
                       
 
                               
Per Share Data
                               
As previously reported:
                               
Basic and diluted net (loss) income per share
  $ (0.29 )   $ (0.17 )   $ (0.16 )   $ 0.08  
Weighted average number of common shares used in basic per share calculation
    70,238,438       69,275,323       70,100,280       73,098,427  
Weighted average number of common shares used in fully diluted per share calculation
                            99,684,427  
As restated:
                               
Basic and diluted net loss per share
  $ (0.44 )   $ (0.35 )   $ (0.32 )   $ (0.26 )
Weighted average number of common shares
    70,238,438       69,275,323       70,100,280       73,098,427  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following:
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the recognition/(deferral) regarding the sale of royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties.
 
(e)   To reclassify expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(f)   To correct clinical trial expense.
 
(g)   To reflect accrued interest for the Seragen acquisition litigation.
 
(h)   To reflect the write-off of the X-Ceptor purchase right in March 2003, which was previously deferred and recognized over the period from 1999 through June 2002.
 
(i)   To reclassify income taxes related to international operations.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(in thousands)
                                 
    December 31, 2003
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Year   Year   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 59,030                     $ 59,030  
Short-term investments
    40,004                       40,004  
Accounts receivable, net
    19,051     $ 247 (a)   $ (397 ) (a)(c)     18,901  
Inventories, net
    8,262       150 (a)     68 (a)     8,480  
Other current assets
    3,810       7,665 (a)(b)     4,886 (a)(b)     16,361  
 
                               
     
Total current assets
    130,157       8,062       4,557       142,776  
Restricted investments
    1,656                       1,656  
Property and equipment, net
    23,501                       23,501  
Acquired technology and product rights, net
    137,857       260 (a)(d)             138,117  
Other assets
    8,084       3,958 (a)(e)     (4,046 ) (a)(e)     7,996  
     
 
  $ 301,255     $ 12,280     $ 511     $ 314,046  
     
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 18,691     $ 913 (a)(f)   $ (763 ) (a)(f)   $ 18,841  
Accrued liabilities
    30,315       (2,182 ) (a)(g)     4,534 (a)(h)     32,667  
Current portion of deferred revenue, net
    2,564       43,926 (i)     59,229 (i)     105,719  
Current portion of equipment financing obligations
    2,184       253 (j)     (253 ) (j)     2,184  
Current portion of long-term debt
    295                       295  
     
Total current liabilities
    54,049       42,910       62,747       159,706  
Long-term debt
    167,408                       167,408  
Long-term portion of deferred revenue, net
    2,275       581 (k)     592 (k)     3,448  
Long-term portion of equipment financing obligations
    2,644       (253 ) (j)     253 (j)     2,644  
Other long-term liabilities
    4,151       (463 ) (l)     111 (l)     3,799  
 
                               
     
Total liabilities
    230,527       42,775       63,703       337,005  
     
 
                               
Common stock subject to conditional redemption/repurchase
            34,595 (m)     (20,000 ) (n)     14,595  
             
Stockholders’ equity (deficit):
                               
Common stock
    73       (3 ) (m)     2 (n)     72  
Additional paid-in capital
    727,410       (30,355 ) (a)(m)     15,815 (a)(n)     712,870  
Accumulated other comprehensive loss
    (66 )                     (66 )
Accumulated deficit
    (655,778 )     (34,732 )     (59,009 )     (749,519 )
 
                               
     
 
    71,639       (65,090 )     (43,192 )     (36,643 )
Treasury stock
    (911 )                     (911 )
 
                               
     
Total stockholders’ equity (deficit)
    70,728       (65,090 )     (43,192 )     (37,554 )
     
 
  $ 301,255     $ 12,280     $ 511     $ 314,046  
     
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   Cumulative effect of prior year adjustments includes $7,603 related to the change to the sell-through revenue recognition method (deferred royalties – $4,215; deferred cost of products sold – $3,388). Current year adjustments include $5,668 related to the change to the sell-through revenue recognition method (deferred royalties – $5,465; deferred cost of products sold – $203); correct prepaid clinical trial expense – $(254); reclassify Organon cost-sharing receivable balance to co-promotion liability – $(461).
 
(c)   To correct bad debt expense – $(205).
 
(d)   To correct accumulated amortization related to ONTAK acquired technology – $357.
 
(e)   To record the capitalization of the X-Ceptor Purchase Right in October 1999 – $3,990; to write-off the X-Ceptor Purchase Right in March 2003, which was previously recognized over the period from 1999 to June 2002 – $(3,990).
 
(f)   To correct clinical trial expense. Cumulative effect of prior year adjustments – $918; current year adjustments – $(918).
 
(g)   Includes $(1,089) related to the change to the sell-through revenue recognition method (product cost – $(1,491); royalties – $402); to correct accruals for bonus expense – $694; and property tax expense – $(316); reclassification of Seragen acquisition liability from other long-term liabilities – $2,700; reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $(4,133).
 
(h)   Includes $446 adjustment related to the change to the sell-through revenue recognition method (product cost – $(108); royalties $554); to correct accruals for bonus expense – $(424) and legal, trademark and patent expense — $230; to reclassify Organon cost-sharing receivable balance to co-promotion liability – $(461); to reflect accrued interest for the Seragen acquisition liability – $739; reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $4,133.
 
(i)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(j)   To reclassify equipment lease obligation from long-term to current obligation.
 
(k)   To reflect the deferral of a portion of the sale of the royalty rights to Royalty Pharma.
 
(l)   The cumulative effect of prior year adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis – $2,237; to reclassify the Seragen acquisition litigation to accrued liabilities – $(2,700). Current year adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis – $111.
 
(m)   In accordance with EITF D-98, to reclassify from equity the Company’s issuance of common stock to Pfizer – common stock – $(1); additional paid in capital $(14,594) and Elan shares – common stock $(2); additional paid in capital $(19,998); reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $4,133.
 
(n)   To reflect the repurchase and retirement of the Elan shares in February 2003 – $20,000 – common stock – $2; additional paid-in capital – $19,998; reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $(4,133).

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
                         
    Year Ended December 31, 2003  
    As                
    Previously             As  
    Reported     Adjustments   Restated  
     
Product sales
  $ 114,632     $ (59,308 ) (a)(b)   $ 55,324  
Sale of royalty rights, net
    12,500       (714 ) (c)     11,786  
Collaborative research and development and other revenues
    14,008               14,008  
 
                       
     
Total revenues
    141,140       (60,022 )     81,118  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    31,618       (5,061 ) (d)     26,557  
Research and development
    67,679       (1,001 ) (b)(e)(f)     66,678  
Selling, general and administrative
    51,661       879 (b)(f)(g)     52,540  
Co-promotion
    9,360               9,360  
 
                       
     
Total operating costs and expenses
    160,318       (5,183 )     155,135  
 
                       
     
Loss from operations
    (19,178 )     (54,839 )     (74,017 )
 
                       
Other income (expense):
                       
Interest income
    783               783  
Interest expense
    (10,970 )     (172 ) (b)     (11,142 )
Other, net
    (6,092 )     (3,942 ) (b)(h)(i)     (10,034 )
 
                       
     
Total other expense, net
    (16,279 )     (4,114 )     (20,393 )
     
 
                       
Loss before income taxes and cumulative effect of a change in accounting principle
    (35,457 )     (58,953 )     (94,410 )
Income tax expense
          (56 ) (i)     (56 )
     
 
                       
Loss before cumulative effect of a change in accounting principle
    (35,457 )     (59,009 )     (94,466 )
Cumulative effect of changing method of accounting for variable interest entity
    (2,005 )             (2,005 )
 
                       
     
Net loss
  $ (37,462 )   $ (59,009 )   $ (96,471 )
     
 
                       
Basic and diluted per share amounts:
                       
Loss before cumulative effect of a change in accounting principle
  $ (0.50 )           $ (1.33 )
Cumulative effect of changing method of accounting for variable interest entity
    (0.03 )             (0.03 )
 
                       
 
                   
Net loss
  $ (0.53 )           $ (1.36 )
 
                   
 
                       
Weighted average number of common shares
    70,685,234               70,685,234  
 
                       
Pro forma amounts assuming the changed method of accounting for variable interest entity is applied retroactively:
                       
Net loss
  $ (35,557 )           $ (94,352 )
 
                       
Basic and diluted net loss per share
  $ (0.50 )           $ (1.34 )
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(59,187).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the deferral of a portion of the sale of the royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties – product cost – $(151); royalties – $(4,910).
 
(e)   To correct clinical trial expense – $(918).
 
(f)   To reclassify $55 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(g)   To reflect interest expense for the Seragen acquisition liability – $739.
 
(h)   To reflect the write-off of the X-Ceptor Purchase Right in March 2003 – $3,990.
 
(i)   To reclassify income taxes related to international operations – $56.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    December 31, 2002
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Year   Year   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
 
Cash and cash equivalents
  $ 42,423     $       $ (1,600 )(a)   $ 40,823  
Short-term investments
    21,825               1,600 (a)     23,425  
Accounts receivable, net
    12,176       196 (b)     51 (b)     12,423  
Inventories, net
    4,841       596 (c)     (446 )(c)     4,991  
Other current assets
    7,308       1,456 (b)(d)     6,209 (b)(d)     14,973  
     
Total current assets
    88,573       2,248       5,814       96,635  
Restricted investments
    10,646                       10,646  
Property and equipment, net
    9,672       248 (e)     (248 )(e)     9,672  
Acquired technology and product rights, net
    148,546       357 (f)     (97 )(b)     148,806  
Other assets
    17,992       3,868 (b)(g)     90 (b)     21,950  
 
                               
     
 
  $ 275,429     $ 6,721     $ 5,559     $ 287,709  
     
Current liabilities:
                               
Accounts payable
  $ 11,979     $ 79 (b)   $ 834 (b)(h)   $ 12,892  
Accrued liabilities
    16,606       3,219 (b)(i)     (5,401 )(b)(i)     14,424  
Current portion of deferred revenue, net
    4,683       18,423 (j)     25,503 (j)     48,609  
Current portion of equipment financing obligations
    2,087               253 (k)     2,340  
Current portion of long-term debt
                           
 
                               
     
Total current liabilities
    35,355       21,721       21,189       78,265  
Long-term debt
    155,250                       155,250  
Long-term portion of deferred revenue, net
    3,014               581 (l)     3,595  
Long-term portion of equipment financing obligations
    4,095               (253 )(k)     3,842  
Other long-term liabilities
    3,700       (621 )(m)     158 (m)     3,237  
 
                               
     
Total liabilities
    201,414       21,100       21,675       244,189  
     
 
                               
Common stock subject to conditional redemption/repurchase
            14,595 (n)     20,000 (o)     34,595  
     
 
                               
Stockholders’ equity:
                               
Common stock
    72       (1 )(n)     (2 )(o)     69  
Additional paid-in capital
    693,213       (14,594 )(n)     (15,761 )(b)(o)     662,858  
Deferred warrant expense
          692 (p)     (692 )(p)      
Accumulated other comprehensive loss
    (43 )                     (43 )
Accumulated deficit
    (618,316 )     (15,071 )(q)     (19,661 )     (653,048 )
 
                               
     
 
    74,926       (28,974 )     (36,116 )     9,836  
Treasury stock
    (911 )                     (911 )
 
                               
     
Total stockholders’ equity
    74,015       (28,974 )     (36,116 )     8,925  
 
                               
     
 
  $ 275,429     $ 6,721     $ 5,559     $ 287,709  
     
     Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reclassify cash to short-term investments.
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reverse replacement reserve.
 
(d)   Cumulative effect of prior year adjustments includes $1,576 related to the change to the sell-through revenue recognition method (deferred royalties — $1,055; deferred cost of products sold — $521). Current year adjustments include $6,027 related to the change to the sell-through revenue recognition method (deferred royalties — $3,160; deferred cost of products sold — $2,867).
 
(e)   To accrue for fixed asset additions at December 31, 2001 — $248.
 
(f)   To correct accumulated amortization expense related to ONTAK acquired technology.
 
(g)   To record the capitalization of the X-Ceptor Purchase Right in October 1999 — $3,990.
 
(h)   To correct clinical trial expense — $1,168 and fixed asset additions — $(248).
 
(i)   Cumulative effect of prior year adjustments includes $90 related to the change to the sell-through revenue recognition method (product cost — $(268); royalties — $358); to correct accruals for vendor expenses — $321, bonus expense — $236, property tax expense - $(364); reclassification of Seragen acquisition liability from other long-term liabilities - - $2,700. Current year adjustments include $(1,179) related to the change to the sell-through revenue recognition method (product cost — $(1,223); royalties — $44); correct accruals for vendor expenses — $(321), bonus expense — $458, legal, trademark and patent expense — $(263); reclassification of the Elan shares from accrued liabilities to additional paid-in capital — $(4,133).
 
(j)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(k)   To reclassify equipment lease obligation from long term to current obligation.
 
(l)   To reflect the deferral of a portion of the sale of the royalty rights to Royalty Pharma.
 
(m)   The cumulative effect of prior year adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis — $2,079, to reclassify the Seragen acquisition liability to accrued liabilities $(2,700). Current year adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis - $158.
 
(n)   To reclassify from equity the Company’s issuance of common stock to Pfizer in accordance with EITF D-98 — $(14,595) — common stock — $(1); additional paid in capital - $(14,594).
 
(o)   To reclassify from equity the Elan shares in accordance with EITF D-98 — $(20,000) - common stock — $(2); additional paid-in capital — $(19,998); reclassification of the Elan shares from accrued liabilities to additional paid-in capital — $4,133.
 
(p)   To write off deferred warrant amortization in connection with the capitalization of the X-Ceptor Purchase Right.
 
(q)   To reflect the cumulative effect, as of January 1, 2002, of the restatement for years prior to 2000 — $(2,033) — product sales — $(1,015), rent expense — $(1,614), royalties - $59, reversal of X-Ceptor warrant amortization — $530, other — $7; 2000 — $(2,728) - product sales — $(4,092), rent expense — $(255), royalties — $(235); reversal of X-Ceptor warrant amortization — $1,384, amortization of acquired technology — $357, other — $113; 2001 — $(10,310) — product sales — $(13,585), rent expense — $(209), royalties — $1,368, reversal of X-Ceptor warrant amortization — $1,384, other — $732.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
                         
    Year Ended December 31, 2002  
    As                
    Previously             As  
    Reported     Adjustments     Restated  
     
Product sales
  $ 54,522     $ (24,196 )(a)(b)   $ 30,326  
Sale of royalty rights, net
    18,275       (675 )(c)     17,600  
Collaborative research and development and other revenues
    23,843               23,843  
 
                       
     
Total revenues
    96,640       (24,871 )     71,769  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    20,306       (5,568 )(b)(d)     14,738  
Research and development
    58,807       253 (b)(e)     59,060  
Selling, general and administrative
    41,678       147 (b)     41,825  
 
                       
     
Total operating costs and expenses
    120,791       (5,168 )     115,623  
 
                       
     
Loss from operations
    (24,151 )     (19,703 )     (43,854 )
 
                       
Other income (expense):
                       
Interest income
    1,086               1,086  
Interest expense
    (6,295 )             (6,295 )
Debt conversion expense
    (2,015 )             (2,015 )
Other, net
    (1,221 )     86 (b)(f)     (1,135 )
 
                       
     
Total other expense, net
    (8,445 )     86       (8,359 )
     
Loss before income taxes
    (32,596 )     (19,617 )     (52,213 )
 
                       
Income tax expense
            (44 )(f)     (44 )
 
                       
     
Net loss
  $ (32,596 )   $ (19,661 )   $ (52,257 )
     
 
                       
Basic and diluted per share amounts:
                       
Net loss
  $ (0.47 )           $ (0.76 )
 
                   
 
                       
Weighted average number of common shares
    69,118,976               69,118,976  
 
                       
Pro forma amounts assuming the changed method of accounting for variable interest entity is applied retroactively:
                       
Net loss
  $ (32,795 )           $ (52,456 )
 
                       
Basic and diluted net loss per share
  $ (0.47 )           $ (0.76 )
     Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method — net product sales — $(24,160).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the deferral of a portion of the sale of the royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties — product cost — $(2,549); royalties — $(3,116).
 
(e)   To correct clinical trial expense — $1,107; to reverse X-Ceptor warrant amortization - $(692); to correct patent expense — $(345).
 
(f)   To reclassify income taxes related to international operations — $44.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    March 31, 2004  
            Cumulative              
    As     Effect of     Current        
    Previously     Prior Period     Quarter     As  
    Reported     Adjustments     Adjustments     Restated  
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 65,558                     $ 65,558  
Short-term investments
    31,625                       31,625  
Accounts receivable, net
    14,185     $ (150 )(a)   $ 37 (a)     14,072  
Inventories, net
    9,770       218 (a)     (121 )(a)     9,867  
Other current assets
    3,764       12,551 (a)(b)     1,273 (a)(b)     17,588  
     
Total current assets
    124,902       12,619       1,189       138,710  
 
                               
Restricted investments
    1,656                       1,656  
Property and equipment, net
    23,620                       23,620  
Acquired technology and product rights, net
    135,189       260 (a)(c)             135,449  
Other assets
    8,822       (88 )(a)     (1,120 )(d)     7,614  
     
 
  $ 294,189     $ 12,791     $ 69     $ 307,049  
     
 
                               
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 16,866     $ 150 (a)   $ (149 )(a)   $ 16,867  
Accrued liabilities
    35,304       2,352 (a)(e)     (2,286 )(a)(e)     35,370  
Current portion of deferred revenue, net
    2,346       103,155 (f)     10,657 (f)     116,158  
Current portion of equipment financing obligations
    2,439                       2,439  
Current portion of long-term debt
    303                       303  
     
Total current liabilities
    57,258       105,657       8,222       171,137  
     
 
                               
Long-term debt
    167,328                       167,328  
Long-term portion of deferred revenue, net
    2,198       1,173 (g)             3,371  
Long-term portion of equipment financing obligations
    3,518                       3,518  
Other long-term liabilities
    3,516       (352 )(h)     620 (h)     3,784  
     
Total liabilities
    233,818       106,478       8,842       349,138  
     
 
                               
Common stock subject to conditional redemption
            14,595 (i)             14,595  
 
                           
Stockholders’ equity (deficit):
                               
Common stock
    74       (1 )(i)             73  
Additional paid-in capital
    730,178       (14,540 )(a)(i)             715,638  
Accumulated other comprehensive loss
    (53 )                     (53 )
Accumulated deficit
    (668,917 )     (93,741 )     (8,773 )     (771,431 )
 
                               
     
 
    61,282       (108,282 )     (8,773 )     (55,773 )
Treasury stock
    (911 )                     (911 )
 
                               
     
Total stockholders’ equity (deficit)
    60,371       (108,282 )     (8,773 )     (56,684 )
     
 
  $ 294,189     $ 12,791     $ 69     $ 307,049  
     
     Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   Cumulative effect of prior period adjustments includes $13,271 related to the change to the sell-through revenue recognition method (deferred royalties — $9,680; deferred cost of products sold — $3,591); to reclassify Organon cost sharing receivable balance to co-promotion liability — $(461). Current quarter adjustments include $786 related to the change to the sell-through revenue recognition method (deferred royalties — $(100); deferred cost of products sold — $886); to reclassify Organon cost-sharing receivable balance to co-promotion liability — $461; to correct prepaid clinical trial expense - $(192);.
 
(c)   To correct accumulated amortization expense related to ONTAK acquired technology - $357.
 
(d)   To expense the payment to The Salk Institute to buy-out the Company’s royalty obligation on lasofoxifene in March 2004.
 
(e)   Cumulative effect of prior period adjustments includes $(643) related to the change to the sell-through revenue recognition method (product cost — $(1,599); royalties — $956); to reclassify Organon cost-sharing receivable balance to co-promotion liability — $(461); to correct accruals for bonus expense — $270 and property tax expense — $(277); to reclassify Seragen acquisition liability from other long-term liabilities — $2,700; to accrue interest for the Seragen acquisition liability — $739. Current quarter adjustments include $(2,055) related to the change to the sell-through revenue recognition method (product cost - $(1,563); royalties — $(492)); to reclassify Organon cost-sharing receivable balance to co-promotion liability — $461; to reclassify from other long term liabilities the payment of a portion of the Seragen acquisition liability — $(600).
 
(f)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(g)   To reflect the deferral of a portion of the sales of royalty rights to Royalty Pharma.
 
(h)   The cumulative effect of prior period adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis — $2,348; to reclassify the Seragen acquisition liability to accrued liabilities — $(2,700). Current quarter adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis — $20; to reclassify to accrued liabilities the payment of a portion of the Seragen acquisition liability — $600.
 
(i)   To reclassify from equity the Company’s issuance of common stock subject to conditional redemption to Pfizer, in connection with the Pfizer settlement agreement in accordance with EITF D-98 — $(14,595) — common stock — $(1), additional paid in capital — $(14,594).

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended March 31, 2004  
    As                
    Previously             As  
    Reported     Adjustments     Restated  
     
Product sales
  $ 34,136     $ (9,197 )(a)(b)   $ 24,939  
Collaborative research and development and other revenues
    2,476               2,476  
 
                       
     
Total revenues
    36,612       (9,197 )     27,415  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    8,823       (1,278 )(c)     7,545  
Research and development
    16,852       665 (b)(d)(e)     17,517  
Selling, general and administrative
    14,472       233 (b)(d)(f)     14,705  
Co-promotion
    6,731               6,731  
 
                       
     
Total operating costs and expenses
    46,878       (380 )     46,498  
 
                       
Loss from operations
    (10,266 )     (8,817 )     (19,083 )
 
                       
Other income (expense):
                       
Interest income
    231               231  
Interest expense
    (3,091 )     44 (b)     (3,047 )
Other, net
    (13 )     16 (g)     3  
 
                       
     
Total other expense, net
    (2,873 )     60       (2,813 )
     
 
                       
Loss before income taxes
    (13,139 )     (8,757 )     (21,896 )
 
                       
Income tax expense
            (16 )(g)     (16 )
 
                       
     
Net loss
  $ (13,139 )   $ (8,773 )   $ (21,912 )
     
 
                       
Basic and diluted per share amounts:
                       
Net loss
  $ (0.18 )           $ (0.30 )
 
                   
 
                       
Weighted average number of common shares
    73,299,281               73,299,281  
     Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method — net product sales — $(9,245).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties — product cost — $(886); royalties — $(392).
 
(d)   To reclassify $742 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(e)   To expense $1,120 payment to The Salk Institute to buy-out the Company’s royalty obligation on lasofoxifene in March 2004; to reflect patent expense in the proper accounting period — $238.
 
(f)   To reflect legal expense in the proper accounting period — $(373).
 
(g)   To reclassify income taxes related to international operations — $16.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    June 30, 2004
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Period   Quarter   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 41,920                     $ 41,920  
Short-term investments
    43,958                       43,958  
Accounts receivable, net
    17,936     $ (113 )(a)   $ (49 )(a)     17,774  
Inventories, net
    11,752       97 (a)     118 (a)     11,967  
Other current assets
    3,245       13,824 (a)(b)     (601 )(a)(b)     16,468  
 
                               
     
Total current assets
    118,811       13,808       (532 )     132,087  
 
                               
Restricted investments
    1,656                       1,656  
Property and equipment, net
    23,910                       23,910  
Acquired technology and product rights, net
    132,520       260 (a)(c)             132,780  
Other assets
    8,420       (1,208 )(a)(d)             7,212  
     
 
  $ 285,317     $ 12,860     $ (532 )   $ 297,645  
     
 
                               
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 20,225     $ 1 (a)   $       $ 20,226  
Accrued liabilities
    36,108       66 (a)(e)     (364 )(a)(e)     35,810  
Current portion of deferred revenue, net
    2,381       113,812 (f)     7,661 (f)     123,854  
Current portion of equipment financing obligations
    2,453                       2,453  
Current portion of long-term debt
    303                       303  
     
Total current liabilities
    61,470       113,879       7,297       182,646  
Long-term debt
    167,256                       167,256  
Long-term portion of deferred revenue, net
    2,120       1,173 (g)             3,293  
Long-term portion of equipment financing obligations
    3,547                       3,547  
Other long-term liabilities
    2,925       268 (h)     20 (h)     3,213  
     
Total liabilities
    237,318       115,320       7,317       359,955  
     
 
                               
Common stock subject to conditional redemption
            14,595 (i)             14,595  
 
                               
Stockholders’ equity (deficit):
                               
Common stock
    74       (1 )(i)             73  
Additional paid-in capital
    732,096       (14,540 )(a)(i)             717,556  
Accumulated other comprehensive loss
    (127 )                     (127 )
Accumulated deficit
    (683,133 )     (102,514 )     (7,849 )     (793,496 )
 
                               
     
 
    48,910       (117,055 )     (7,849 )     (75,994 )
Treasury stock
    (911 )                     (911 )
     
Total stockholders’ equity (deficit):
    47,999       (117,055 )     (7,849 )     (76,905 )
 
                               
     
 
  $ 285,317     $ 12,860     $ (532 )   $ 297,645  
     
     Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   Cumulative effect of prior period adjustments includes $14,057 related to the change to the sell-through revenue recognition method (deferred royalties — $9,580; deferred cost of products sold — $4,477). Current quarter adjustments include $(781) related to the change to the sell-through revenue recognition method (deferred royalties — $(876); deferred cost of products sold — $95).
 
(c)   To correct accumulated amortization expense related to ONTAK acquired technology - $357.
 
(d)   To expense the effect of The Salk Institute payment to buy-out the Company’s royalty obligation on lasofoxifene — $(1,120).
 
(e)   Cumulative effect of prior period adjustments includes $(2,698) related to the change to the sell-through revenue recognition method (product cost — $(3,162); royalties — $464); to correct property tax expense — $(260); to reclassify Seragen acquisition liability from other long-term liabilities — $2,100; accrual of interest on the Seragen acquisition liability — $739. Current quarter adjustments include $(358) related to the change to the sell-through revenue recognition method (product cost — $510; royalties — $(868)).
 
(f)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(g)   To reflect the deferral of a portion of the sales of royalty rights to Royalty Pharma.
 
(h)   The cumulative effect of prior period adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis — $2,368; to reclassify the Seragen acquisition liability to accrued liabilities — $(2,100). Current quarter adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis — $20.
 
(i)   To reclassify from equity the Company’s issuance of common stock subject to conditional redemption to Pfizer, in connection with the Pfizer settlement agreement in accordance with EITF D-98 — $(14,595) — common stock — $(1), additional paid-in capital — $(14,594).

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended June 30, 2004  
    As                
    Previously             As  
    Reported     Adjustments     Restated  
     
Product sales
  $ 37,485     $ (8,186 )(a)(b)   $ 29,299  
Collaborative research and development and other revenues
    2,975               2,975  
 
                       
     
Total revenues
    40,460       (8,186 )     32,274  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    9,926       (208 )(c)     9,718  
Research and development
    18,174       (1,608 )(b)(d)     16,566  
Selling, general and administrative
    16,625       1,491 (b)(d)     18,116  
Co-promotion
    7,000               7,000  
 
                       
     
Total operating costs and expenses
    51,725       (325 )     51,400  
 
                       
     
Loss from operations
    (11,265 )     (7,861 )     (19,126 )
Other income (expense):
                       
Interest income
    208               208  
Interest expense
    (3,140 )     12 (b)     (3,128 )
Other, net
    (19 )     18 (e)     (1 )
 
                       
     
Total other expense, net
    (2,951 )     30       (2,921 )
 
                       
Loss before income taxes
    (14,216 )     (7,831 )     (22,047 )
 
                       
Income tax expense
            (18 )(e)     (18 )
 
                       
     
Net loss
  $ (14,216 )   $ (7,849 )   $ (22,065 )
     
 
                       
Basic and diluted per share amounts:
                       
 
                       
Net loss
  $ (0.19 )           $ (0.30 )
 
                   
 
                       
Weighted average number of common shares
    73,754,146               73,754,146  
     Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method — net product sales — $(8,097).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties — product sales — $(214); royalties — $6.
 
(d)   To reclassify $1,454 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(e)   To reclassify income taxes related to international operations — $18.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    September 30, 2004
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Period   Quarter   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 46,020                     $ 46,020  
Short-term investments
    34,387                       34,387  
Accounts receivable, net
    30,583     $ (162 )(a)   $ 36 (a)     30,457  
Inventories, net
    11,355       215 (b)     21 (a)     11,591  
Other current assets
    2,985       13,223 (a)(c)     2,729 (a)(c)     18,937  
 
                               
     
Total current assets
    125,330       13,276       2,786       141,392  
Restricted investments
    1,656                       1,656  
Property and equipment, net
    23,844                       23,844  
Acquired technology and product rights, net
    129,852       260 (a)(d)             130,112  
Other assets
    7,977       (1,208 )(a)(e)             6,769  
     
 
  $ 288,659     $ 12,328     $ 2,786     $ 303,773  
     
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 16,719     $ 1 (a)   $ 68 (a)   $ 16,788  
Accrued liabilities
    49,527       (298 )(a)(f)     (3,308 )(a)(f)     45,921  
Current portion of deferred revenue, net
    2,352       121,473 (g)     17,720 (g)     141,545  
Current portion of equipment financing obligations
    2,617                       2,617  
Current portion of long-term debt
    314                       314  
 
                               
     
Total current liabilities
    71,529       121,176       14,480       207,185  
 
                               
Long-term debt
    167,171                       167,171  
Long-term portion of deferred revenue, net
    2,043       1,173 (h)             3,216  
Long-term portion of equipment financing obligations
    4,087                       4,087  
Other long-term liabilities
    2,870       288 (i)     15 (i)     3,173  
     
Total liabilities
    247,700       122,637       14,495       384,832  
     
 
                               
Common stock subject to conditional redemption
            14,595 (j)     (2,250 )(k)     12,345  
             
 
                               
Stockholders’ equity (deficit):
                               
Common stock
    74       (1 )(j)             73  
Additional paid-in capital
    731,841       (14,540 )(a)(j)     2,250 (k)     719,551  
Accumulated other comprehensive loss
    (123 )                     (123 )
Accumulated deficit
    (689,922 )     (110,363 )     (11,709 )     (811,994 )
 
                               
     
 
    41,870       (124,904 )     (9,459 )     (92,493 )
Treasury stock
    (911 )                     (911 )
 
                               
     
Total stockholders’ equity (deficit)
    40,959       (124,904 )     (9,459 )     (93,404 )
 
                               
     
 
  $ 288,659     $ 12,328     $ 2,786     $ 303,773  
     
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   To reverse replacement reserve.
 
(c)   Cumulative effect of prior period adjustments includes $13,276 related to the change to the sell-through revenue recognition method (deferred royalties — $8,704; deferred cost of products sold — $4,572). Current quarter adjustments include $2,654 related to the change to the sell-through revenue recognition method (deferred royalties — $2,486; deferred cost of products sold — $168).
 
(d)   To correct accumulated amortization expense related to ONTAK acquired technology - $357.
 
(e)   To expense the payment to The Salk Institute to buy-out the Company’s royalty obligation on lasofoxifene — $(1,120).
 
(f)   Cumulative effect of prior period adjustments includes $(3,056) related to the change to the sell-through revenue recognition method (product cost — $(2,652); royalties - $(404)); to correct bonus expense — $(201); to reclassify Seragen acquisition liability from other long-term liabilities — $2,100; to accrue interest on Seragen acquisition liability — $739. Current quarter adjustments include $(3,349) related to the change to the sell-through revenue recognition method (product cost — $(4,806); royalties — $1,457).
 
(g)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(h)   To reflect the deferral of a portion of the sale of royalty rights to Royalty Pharma.
 
(i)   The cumulative effect of prior period adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis — $2,388; to reclassify the Seragen acquisition liability to accrued liabilities — $(2,100). Current quarter adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis — $15.
 
(j)   To reclassify from equity the Company’s issuance of common stock subject to conditional redemption to Pfizer, in connection with the Pfizer settlement agreement in accordance with EITF D-98 — $(14,595) — common stock — $(1), additional paid-in capital — $(14,594).
 
(k)   To reflect Pfizer’s redemption of shares in connection with the achievement of a milestone in accordance with the Pfizer settlement agreement.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended September 30, 2004  
    As                
    Previously             As  
    Reported     Adjustments     Restated  
     
Product sales
  $ 44,726     $ (12,792 )(a)(b)   $ 31,934  
Sale of royalty rights, net
            67 (c)     67  
Collaborative research and development and other revenues
    4,771               4,771  
 
                       
     
Total revenues
    49,497       (12,725 )     36,772  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    11,011       (1,192 ) (d)     9,819  
Research and development
    17,980       (1,233 ) (b)(e)     16,747  
Selling, general and administrative
    15,890       1,421 (b)(e)     17,311  
Co-promotion
    8,501               8,501  
 
                       
     
Total operating costs and expenses
    53,382       (1,004 )     52,378  
 
                       
     
Loss from operations
    (3,885 )     (11,721 )     (15,606 )
 
                       
Other income (expense):
                       
Interest income
    255               255  
Interest expense
    (2,919 )     (226 ) (b)(f)     (3,145 )
Other, net
    (240 )     241 (b)(f)(g)     1  
 
                       
     
Total other expense, net
    (2,904 )     15       (2,889 )
 
                       
Loss before income taxes
    (6,789 )     (11,706 )     (18,495 )
 
                       
Income tax expense
            (3 ) (g)     (3 )
 
                       
     
Net loss
  $ (6,789 )   $ (11,709 )   $ (18,498 )
     
 
                       
Basic and diluted per share amounts:
                       
Net loss
  $ (0.09 )           $ (0.25 )
 
                   
 
                       
Weighted average number of common shares
    73,845,613               73,845,613  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(12,842).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the recognition of revenue previously deferred in regard to the sale of royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties – product cost – $(163), royalties – $(1,029).
 
(e)   To reclassify $1,221 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(f)   To reclassify $238 of interest and factoring expenses incurred under a factoring arrangement from other, net to interest expense.
 
(g)   To reclassify income taxes related to international operations – $3.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    March 31, 2003
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Period   Quarter   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 12,979                     $ 12,979  
Short-term investments
    21,004                       21,004  
Accounts receivable, net
    17,086     $ 247 (a)   $ 13 (a)     17,346  
Inventories, net
    5,395       150 (a)     (18 )(a)     5,527  
Other current assets
    6,547       7,665 (a)(b)     (280 )(a)(b)     13,932  
 
     
Total current assets
    63,011       8,062       (285 )     70,788  
Restricted investments
    10,741                       10,741  
Property and equipment, net
    9,229                       9,229  
Acquired technology and product rights, net
    145,862       260 (a)(c)             146,122  
Other assets
    12,333       3,958 (a)(d)     (3,958 )(a)(d)     12,333  
     
 
  $ 241,176     $ 12,280     $ (4,243 )   $ 249,213  
     
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 13,441     $ 913 (a)(e)   $ (314 )(a)(e)   $ 14,040  
Accrued liabilities
    17,640       (2,182 )(a)(f)     3,386 (a)(f)     18,844  
Current portion of deferred revenue, net
    4,637       43,926 (g)     7,594 (g)     56,157  
Current portion of equipment financing obligations
    2,105       253 (h)     15 (h)     2,373  
 
     
Total current liabilities
    37,823       42,910       10,681       91,414  
 
                               
Long-term debt
    155,250                       155,250  
Long-term portion of deferred revenue, net
    2,709       581 (i)             3,290  
Long-term portion of equipment financing obligations
    3,707       (253 )(h)     (15 )(h)     3,439  
Other long-term liabilities
    3,664       (463 )(j)     32 (j)     3,233  
 
     
Total liabilities
    203,153       42,775       10,698       256,626  
     
 
                               
Common stock subject to conditional redemption/repurchase
            34,595 (k)     (20,000 )(l)     14,595  
 
                               
Stockholders’ equity (deficit):
                               
Common stock
    70       (3 )(k)     2 (l)     69  
Additional paid-in capital
    677,561       (30,355 )(a)(k)     15,865 (l)     663,071  
Accumulated other comprehensive loss
    (61 )                     (61 )
Accumulated deficit
    (638,636 )     (34,732 )     (10,808 )     (684,176 )
     
 
    38,934       (65,090 )     5,059       (21,097 )
Treasury stock
    (911 )                     (911 )
     
Total stockholders’ equity (deficit)
    38,023       (65,090 )     5,059       (22,008 )
 
                               
     
 
  $ 241,176     $ 12,280     $ (4,243 )   $ 249,213  
     
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   Cumulative effect of prior period adjustments includes $7,603 related to the change to the sell-through revenue recognition method (deferred royalties – $4,215; deferred cost of products sold – $3,388). Current quarter adjustments include $118 related to the change to the sell-through revenue recognition method (deferred royalties – $98; deferred cost of products sold – $20); to correct prepaid clinical trial expense – $(352).
 
(c)   To correct accumulated amortization expense related to ONTAK acquired technology – $357.
 
(d)   To record the capitalization of the X-Ceptor Purchase Right in October 1999 – $3,990; to write-off the X-Ceptor Purchase Right in March 2003, which was previously recognized for the period from 1999 to June 2002 – $(3,990).
 
(e)   To correct clinical trial expense – cumulative effect of prior period adjustments – $918; current quarter adjustments – $(367).
 
(f)   Cumulative effect of prior period adjustments include $(1,089) related to the change to the sell-through revenue recognition method (product cost – $(1,491); royalties – $402); to correct accruals for bonus expense – $694, and property tax expense – $(316); to reclassify Seragen acquisition liability from other long-term liabilities – $2,700; reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $(4,133). Current quarter adjustments include $(444) related to the change to the sell-through revenue recognition method (product cost – $(126); royalties – $(318)); reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $4,133.
 
(g)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(h)   To reclassify equipment lease obligations from long-term to current obligations.
 
(i)   To reflect the deferral of a portion of the sales of royalty rights to Royalty Pharma.
 
(j)   The cumulative effect of prior period adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases amortized over the lease term on a straight line basis – $2,237; to reclassify the Seragen acquisition liability to accrued liabilities – $(2,700). Current quarter adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis – $32.
 
(k)   In accordance with EITF D-98, to reclassify from equity the Company’s issuance of common stock to Pfizer – common stock – $(1); additional paid in capital $(14,594); and Elan shares – common stock $(2); additional paid in capital $(19,998); reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $4,133.
 
(l)   To reflect the repurchase and retirement of the Elan shares in February 2003 – $20,000 – common stock – $2; additional paid-in capital – $19,998; reclassification of the Elan shares from accrued liabilities to additional paid-in capital – $(4,133).

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended March 31, 2003  
    As                
    Previously             As  
    Reported     Adjustments     Restated  
     
Product sales
  $ 18,928     $ (7,455 ) (a)(b)   $ 11,473  
Collaborative research and development and other revenues
    4,195               4,195  
 
                       
     
Total revenues
    23,123       (7,455 )     15,668  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    6,620       (418 ) (c)     6,202  
Research and development
    16,640       (91 ) (b)     16,549  
Selling, general and administrative
    12,426       (74 ) (b)     12,352  
 
                       
     
Total operating costs and expenses
    35,686       (583 )     35,103  
 
                       
     
Loss from operations
    (12,563 )     (6,872 )     (19,435 )
 
                       
Other income (expense):
                       
Interest income
    243               243  
Interest expense
    (2,682 )     (26 ) (b)     (2,708 )
Other, net
    (5,318 )     (3,895 ) (b)(d)(e)     (9,213 )
 
                       
     
Total other expense, net
    (7,757 )     (3,921 )     (11,678 )
 
                       
Loss before income taxes
    (20,320 )     (10,793 )     (31,113 )
 
                       
Income tax expense
            (15 ) (e)     (15 )
 
                       
     
Net loss
  $ (20,320 )   $ (10,808 )   $ (31,128 )
     
 
                       
Basic and diluted per share amounts:
                       
Net loss
  $ (0.29 )           $ (0.44 )
 
                   
 
                       
Weighted average number of common shares
    70,238,438               70,238,438  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(7,468).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties – product cost – $(3); royalties – $(415).
 
(d)   To reflect the write off of the X-Ceptor Purchase Right in March 2003 – $3,990.
 
(e)   To reclassify income taxes related to international operations – $15.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    June 30, 2003    
     
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Period   Quarter   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 24,248                     $ 24,248  
Short-term investments
    17,595                       17,595  
Accounts receivable, net
    7,689     $ 260 (a)   $ (221 )(a)     7,728  
Inventories, net
    4,806       132 (a)     93 (a)     5,031  
Other current assets
    2,635       7,385 (a)(b)     1,390 (a)(b)     11,410  
 
     
Total current assets
    56,973       7,777       1,262       66,012  
Restricted investments
    6,204                       6,204  
Property and equipment, net
    8,843                       8,843  
Acquired technology and product rights, net
    143,194       260 (a)(c)             143,454  
Other assets
    11,718                       11,718  
 
     
 
  $ 226,932     $ 8,037     $ 1,262     $ 236,231  
     
 
                               
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 10,819     $ 599 (a)(d)   $ (185 ) (a)   $ 11,233  
Accrued liabilities
    18,319       1,204 (a)(e)     (26 ) (a)(e)     19,497  
Current portion of deferred revenue, net
    4,126       51,520 (f)     13,400 (f)     69,046  
Current portion of equipment financing obligations
    1,890       268 (g)     224 (g)     2,382  
 
     
Total current liabilities
    35,154       53,591       13,413       102,158  
Long-term debt
    155,250                       155,250  
Long-term portion of deferred revenue, net
    2,430       581 (h)             3,011  
Long-term portion of equipment financing obligations
    3,403       (268 ) (g)     (224 ) (g)     2,911  
Other long-term liabilities
    3,638       (431 ) (i)     32 (i)     3,239  
 
     
Total liabilities
    199,875       53,473       13,221       266,569  
     
Common stock subject to conditional redemption
            14,595 (j)             14,595  
 
                               
Stockholders’ equity (deficit):
                               
Common stock
    70       (1 ) (j)             69  
Additional paid-in capital
    678,577       (14,490 ) (a)(j)             664,087  
Accumulated other comprehensive loss
    (46 )                     (46 )
Accumulated deficit
    (650,633 )     (45,540 )     (11,959 )     (708,132 )
 
     
 
    27,968       (60,031 )     (11,959 )     (44,022 )
Treasury stock
    (911 )                     (911 )
     
Total stockholders’ equity (deficit)
    27,057       (60,031 )     (11,959 )     (44,933 )
 
     
 
  $ 226,932     $ 8,037     $ 1,262     $ 236,231  
     
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   Cumulative effect of prior period adjustments includes $7,721 related to the change to the sell-through revenue recognition method (deferred royalties – $4,313; deferred cost of products sold – $3,408); to correct prepaid clinical trial expense – $(290). Current quarter adjustments include $1,416 related to the change to the sell-through revenue recognition method (deferred royalties – $1,818; deferred cost of products sold – $(402)).
 
(c)   To correct accumulated amortization expense related to ONTAK acquired technology – $357.
 
(d)   To correct clinical trial expense – $551.
 
(e)   Cumulative effect of prior period adjustments includes $(1,533) related to the change to the sell-through revenue recognition method (product cost – $(1,617); royalties – $84); to correct accruals for bonus expense – $588, property tax expense – $(361), and legal, trademark and patent expense –$(240); to reclassify Seragen acquisition liability from long-term to current – $2,700. Current quarter adjustments includes $(105) related to the change to the sell-through revenue recognition method (product cost – $(565); royalties – $460).
 
(f)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(g)   To reclassify equipment financing obligations from long-term to current obligations.
 
(h)   To reflect the deferral of a portion of the sales of royalty rights to Royalty Pharma.
 
(i)   The cumulative effect of prior period adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis – $2,269; to reclassify the Seragen acquisition liability to accrued liabilities – $(2,700). Current quarter adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis – $32.
 
(j)   To reclassify from equity the Company’s issuance of common stock subject to conditional redemption to Pfizer, in connection with the Pfizer settlement agreement in accordance with EITF D-98 – $(14,595) – common stock – $(1); additional paid in capital – $(14,594).

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended June 30, 2003  
    As                
    Previously             As  
    Reported     Adjustments     Restated  
     
Product sales
  $ 25,187     $ (13,016 )(a)(b)   $ 12,171  
Collaborative research and development and other revenues
    3,939               3,939  
 
                       
     
Total revenues
    29,126       (13,016 )     16,110  
 
Operating costs and expenses:
                       
Cost of products sold
    7,766       (921 ) (c)     6,845  
Research and development
    16,859       (215 ) (b)(d)(e)     16,644  
Selling, general and administrative
    13,571       (2 ) (b)(d)     13,569  
 
                       
     
Total operating costs and expenses
    38,196       (1,138 )     37,058  
 
                       
     
Loss from operations
    (9,070 )     (11,878 )     (20,948 )
 
                       
Other income (expense):
                       
Interest income
    140               140  
Interest expense
    (2,688 )     (81 ) (b)     (2,769 )
Other, net
    (379 )     16 (f)     (363 )
 
                       
     
Total other expense, net
    (2,927 )     (65 )     (2,992 )
 
                       
Loss before income taxes
    (11,997 )     (11,943 )     (23,940 )
 
                       
Income tax expense
            (16 ) (f)     (16 )
 
                       
     
Net loss
  $ (11,997 )   $ (11,959 )   $ (23,956 )
     
 
                       
Basic and diluted per share amounts:
                       
Net loss
  $ (0.17 )           $ (0.35 )
 
                   
 
                       
Weighted average number of common shares
    69,275,323               69,275,323  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(12,835).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties – product cost – $437; royalties – $(1,358).
 
(d)   To reclassify $9 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(e)   To correct clinical trial expense – $(331).
 
(f)   To reclassify income taxes related to international operations – $16.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED BALANCE SHEET
(unaudited) (in thousands)
                                 
    September 30, 2003
            Cumulative        
    As   Effect of   Current    
    Previously   Prior Period   Quarter   As
    Reported   Adjustments   Adjustments   Restated
     
ASSETS
                               
Current assets:
                               
Cash and cash equivalents
  $ 73,002                     $ 73,002  
Short-term investments
    13,744                       13,744  
Accounts receivable, net
    9,923     $ 39 (a)   $ (42 ) (a)     9,920  
Inventories, net
    6,005       225 (a)     (119 ) (a)     6,111  
Other current assets
    3,188       8,775 (a)(b)     1,684 (a)(b)     13,647  
 
                               
     
Total current assets
    105,862       9,039       1,523       116,424  
Restricted investments
    6,203                       6,203  
Property and equipment, net
    9,072                       9,072  
Acquired technology and product rights, net
    140,526       260 (a)(c)             140,786  
Other assets
    11,134                       11,134  
 
     
 
  $ 272,797     $ 9,299     $ 1,523     $ 283,619  
     
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                               
Current liabilities:
                               
Accounts payable
  $ 17,261     $ 414 (a)(d)   $ (141 ) (a)   $ 17,534  
Accrued liabilities
    23,228       1,178 (a)(e)     (829 ) (a)(e)     23,577  
Current portion of deferred revenue, net
    3,502       64,920 (f)     14,092 (f)     82,514  
Current portion of equipment financing obligations
    2,299       492 (g)     (492 ) (g)     2,299  
 
                               
     
Total current liabilities
    46,290       67,004       12,630       125,924  
Long-term debt
    155,250                       155,250  
Long-term portion of deferred revenue, net
    2,352       581 (h)             2,933  
Long-term portion of equipment financing obligations
    2,682       (492 ) (g)     492 (g)     2,682  
Other long-term liabilities
    3,627       (399 ) (i)     27 (i)     3,255  
 
                               
     
Total liabilities
    210,201       66,694       13,149       290,044  
     
 
                               
Common stock subject to conditional redemption
            14,595 (j)             14,595  
 
                               
 
                               
Stockholders’ equity (deficit):
                               
Common stock
    73       (1 ) (j)             72  
Additional paid-in capital
    725,244       (14,490 ) (a)(j)             710,754  
Accumulated other comprehensive loss
    (90 )                     (90 )
Accumulated deficit
    (661,720 )     (57,499 )     (11,626 )     (730,845 )
 
     
 
    63,507       (71,990 )     (11,626 )     (20,109 )
Treasury stock
    (911 )                     (911 )
     
Total stockholders’ equity (deficit)
    62,596       (71,990 )     (11,626 )     (21,020 )
 
     
 
  $ 272,797     $ 9,299     $ 1,523     $ 283,619  
     
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect other adjustments and reclassifications.
 
(b)   Cumulative effect of prior period adjustments includes $9,137 related to the change to the sell-through revenue recognition method (deferred royalties – $6,131; deferred cost of products sold – $3,006); to correct prepaid clinical trial expense – $(234). Current quarter adjustments include $1,501 related to the change to the sell-through revenue recognition method (deferred royalties – $1,525; deferred cost of products sold – $(24)).
 
(c)   To correct accumulated amortization expense related to ONTAK acquired technology – $357.
 
(d)   To correct clinical trial expense – $276.
 
(e)   Cumulative effect of prior period adjustments includes $(1,638) related to the change to the sell-through revenue recognition method (product cost – $(2,182); royalties – $544); to correct accruals for bonus expense – $482, and property tax expense –$(340); to reclassify Seragen acquisition liability from long-term to current – $2,700. Current quarter adjustments include $(903) related to the change to the sell-through revenue recognition method (product cost – $(881); royalties – $(22)).
 
(f)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method.
 
(g)   To reclassify equipment financing obligations from long-term to current obligations.
 
(h)   To reflect the deferral of a portion of the sales of royalty rights to Royalty Pharma.
 
(i)   The cumulative effect of prior period adjustments reflects the effect of the adjustment to rent expense for contractual annual rent increases recognized over the lease term on a straight line basis – $2,301; to reclassify the Seragen acquisition liability to accrued liabilities – $(2,700). Current quarter adjustment reflects the adjustment to rent expense for contractual annual rent increase recognized over the lease term on a straight line basis – $27.
 
(j)   To reclassify from equity the Company’s issuance of common stock subject to conditional redemption to Pfizer, in connection with the Pfizer settlement agreement in accordance with EITF D-98 – $(14,595) – common stock – $(1), additional paid in capital – $(14,594).

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended September 30, 2003  
    As                
    Previously             As  
    Reported     Adjustments   Restated  
     
Product sales
  $ 28,123     $ (13,363 )(a)(b)   $ 14,760  
Sale of royalty rights, net
            35 (c)     35  
Collaborative research and development and other revenues
    3,160               3,160  
 
                       
     
Total revenues
    31,283       (13,328 )     17,955  
 
                       
Operating costs and expenses:
                       
Cost of products sold
    8,565       (1,524 )(d)     7,041  
Research and development
    17,696       (261 )(b)(e)(f)     17,435  
Selling, general and administrative
    13,216       26 (b)(e)     13,242  
 
                       
     
Total operating costs and expenses
    39,477       (1,759 )     37,718  
 
                       
     
Loss from operations
    (8,194 )     (11,569 )     (19,763 )
 
                       
Other income (expense):
                       
Interest income
    136               136  
Interest expense
    (2,653 )     (170 )(b)     (2,823 )
Other, net
    (376 )     122 (b)(g)     (254 )
 
                       
     
Total other expense, net
    (2,893 )     (48 )     (2,941 )
 
                       
Loss before income taxes
    (11,087 )     (11,617 )     (22,704 )
 
Income tax expense
            (9 )(g)     (9 )
 
                       
     
Net loss
  $ (11,087 )   $ (11,626 )   $ (22,713 )
     
 
                       
Basic and diluted per share amounts:
                       
Net loss
  $ (0.16 )           $ (0.32 )
 
                   
 
                       
Weighted average number of common shares
    70,100,280               70,100,280  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(13,376).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the recognition of revenue previously deferred in regard to the sales of royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties – product cost – $23, royalties – $(1,547).
 
(e)   To reclassify $20 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense.
 
(f)   To correct clinical trial expense – $(281).
 
(g)   To reclassify income taxes related to international operations – $9.

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LIGAND PHARMACEUTICALS INCORPORATED
EFFECTS OF THE RESTATEMENT
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
                         
    Three Months Ended December 31, 2003  
    As                
    Previously             As  
    Reported     Adjustments   Restated  
     
Product sales
  $ 42,394     $ (25,474 ) (a)(b)   $ 16,920  
Sale of royalty rights, net
    12,500       (749 ) (c)     11,751  
Collaborative research and development and other revenues
    2,714               2,714  
     
Total revenues
    57,608       (26,223 )     31,385  
Operating costs and expenses:
                       
Cost of products sold
    8,667       (2,198 ) (d)     6,469  
Research and development
    16,484       (434 ) (b)(e)     16,050  
Selling, general and administrative
    12,448       929 (b)(f)(g)     13,377  
Co-promotion
    9,360               9,360  
     
Total operating costs and expenses
    46,959       (1,703 )     45,256  
 
                       
     
Income (loss) from operations
    10,649       (24,520 )     (13,871 )
Other income (expense):
                       
Interest income
    264               264  
Interest expense
    (2,947 )     105 (b)     (2,842 )
Other, net
    (19 )     (185 ) (b)(h)     (204 )
     
Total other expense, net
    (2,702 )     (80 )     (2,782 )
 
                       
Income (loss) before income taxes and cumulative effect of a change in accounting principle
    7,947       (24,600 )     (16,653 )
 
                       
Income tax expense
          (16 ) (h)     (16 )
 
                       
     
Income (loss) before cumulative effect of a change in accounting principle
    7,947       (24,616 )     (16,669 )
     
 
                       
Cumulative effect of changing method of accounting for variable interest entity
    (2,005 )             (2,005 )
     
Net income (loss)
  $ 5,942     $ (24,616 )   $ (18,674 )
     
Basic per share amounts:
                       
Income (loss) before cumulative effect of a change in accounting principle
  $ 0.11             $ (0.23 )
 
                       
Cumulative effect of changing method of accounting for variable interest entity
    (0.03 )             (0.03 )
 
                       
 
                   
Net income (loss)
  $ 0.08             $ (0.26 )
 
                   
Weighted average number of common shares for basic net income (loss) per share
    73,098,427               73,098,427  
 
                       
Diluted per share amounts:
                       
Income (loss) before cumulative effect of a change in accounting principle
  $ 0.10             $ (0.23 )
Cumulative effect of changing method of accounting for variable interest entity
    (0.02 )             (0.03 )
 
                   
Net income (loss)
  $ 0.08             $ (0.26 )
 
                   
Weighted average number of common shares for diluted net income (loss) per share
    99,684,427               73,098,427  
Refer to the explanation of adjustments on the next page.

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EFFECTS OF THE RESTATEMENT
The adjustments relate to the following (in thousands):
 
(a)   To reflect the change in the revenue recognition method from the sell-in method to the sell-through method – net product sales – $(25,508).
 
(b)   To reflect other adjustments and reclassifications.
 
(c)   To reflect the deferral of a portion of the sales of royalty rights to Royalty Pharma.
 
(d)   To reflect the effect of the sell-through revenue recognition method on cost of products sold and royalties – product cost – $(608), royalties – $(1,590).
 
(e)   To reclassify $26 of expenses incurred for the technology transfer and validation effort related to the second source of supply for AVINZA from research and development expense to selling, general and administrative expense; to correct patent expense – $(233).
 
(f)   To reflect accrual of interest on Seragen acquisition liability – $739.
 
(g)   To reflect legal expense in the proper accounting period – $308.
 
(h)   To reclassify income taxes related to international operations – $16.

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Item 7. 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 Item 1 – Business at “Risks and Uncertainties.” This outlook represents our current judgment on the future direction of our business. These statements include those related to management’s trend analyses and expectations, Organon discussions; product and corporate partner pipeline; litigation, the annual stockholders’ meeting, the SEC enforcement investigation, compliance with the NASDAQ Listing Qualifications Panel requirements and the potential relisting of the Company’s securities, and material weaknesses and remediation. Actual events or results may differ materially from Ligand’s expectations. For example, there can be no assurance of that the Company’s subsequent processes and initiatives such as compliance with NASDAQ Listing Qualifications Panel requirements will be completed or when, that the Company will achieve relisting by the NASDAQ Stock Market and if so, when relisting will occur, that the Company’s currently ongoing or future litigation (including private litigation and the SEC investigation) will not have an adverse effect on the Company, that the Company will be able to successfully conclude discussions with Organon, that corporate or partner pipeline products will gain approval or success in the market, that the Company will remediate any identified material weaknesses, that the sell-through revenue recognition models will not require adjustment and not result in a subsequent restatement. In addition, the Company’s financial results and stock price may suffer as a result of the previously announced restatement and delisting action by NASDAQ or as a result of any failure to remediate material weaknesses and its relationships with its vendors, stockholders or other creditors may suffer. Such risks and uncertainties could cause actual results to differ materially from any future performance suggested. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date of this annual report. This caution is made under the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 as amended.
     Our trademarks, trade names and service marks referenced herein include Ligand, AVINZA, ONTAK, Panretin and Targretin. Each other trademark, trade name or service mark appearing in this annual report belongs to its owner.
Background of the Restatement
     On March 17, 2005, the Company announced that in connection with the preparation of its consolidated financial statements for 2004 and the audit of those consolidated financial statements, the Audit Committee of the Board of Directors would conduct a review, with the assistance of management, of the Company’s revenue recognition policies and accounting for product sales, including its estimates of product returns under SFAS 48 and SAB 104. The review included the Company’s revenue recognition policies and practices for current and past periods as well as the Company’s internal control over financial reporting as it related to those items. The Company also reviewed the accounting and classification of its sales of royalty rights in its consolidated statements of operations. The Audit Committee retained Dorsey & Whitney LLP as independent counsel. The Audit Committee and independent counsel subsequently retained PricewaterhouseCoopers as their independent accounting consultants to assist in the review. In addition, the Company, through its counsel, Latham & Watkins LLP, retained FTI Ten Eyck to provide an independent accounting perspective in connection with the accounting issues under review.
     On May 20, 2005, the Company announced that the Audit Committee had completed its accounting review and that the Company would restate its consolidated financial statements as of December 31, 2003 and for the years ended December 31, 2003 and 2002, and as of and for the first three quarters of 2004 and for the quarters of 2003. The Audit Committee and management independently reviewed the Company’s revenue recognition practices and policies for product sales for 2003 and 2002 and each of the three quarters in the period ended September 30, 2004. These reviews focused on whether the Company had properly recognized revenue on product shipments to distributors under SFAS 48 and SAB 104. Based on these reviews, the Company determined that it had not met all of the criteria under SFAS 48 and SAB 104 to recognize revenue upon shipment. As a result of this error, the Company determined to restate its financial results and to report financial results under the sell-through revenue recognition method for the domestic product shipments of AVINZA, ONTAK, Targretin capsules and Targretin gel. The Company also announced that it was continuing its work to review the accounting and classification of its sales of royalty rights in its consolidated statements of operations and that the Audit Committee review found no evidence of improper or fraudulent actions or practices by any member of management or that management acted in bad faith in adopting and administering the Company’s historical revenue recognition policies.

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     Subsequent to the Company’s announcement that it would restate its consolidated financial statements, the Company’s previous auditors declined to be re-engaged to audit the restatement. As a result, the Audit Committee engaged BDO Seidman, LLP (“BDO”), the Company’s current independent registered public accounting firm, to re-audit the consolidated financial statements for the fiscal years ended December 31, 2003 and 2002. During the course of the re-audits other errors were identified that affect the restated consolidated financial statements.
     In connection with the restatement, the SEC instituted a formal investigation concerning the Company’s consolidated financial statements. These matters were previously the subject of an informal SEC inquiry. Ligand has been cooperating fully with the SEC and will continue to do so in order to bring the investigation to a conclusion as promptly as possible.
The Restatement and Other Related Matters
     Set forth below is a summary of the significant determinations regarding the restatement and additional matters addressed in the course of the restatement.
     Revenue Recognition. The restatement corrects the recognition of revenue for transactions involving each of the Company’s products that did not satisfy all of the conditions for revenue recognition contained in SFAS 48 and SAB 104. The Company’s products impacted by this restatement are the domestic product shipments of AVINZA, ONTAK, Targretin Capsules, and Targretin Gel. Specifically, although the Company believed it had met each of the criteria for recognizing revenue upon shipment of each of its products, management subsequently determined that based upon SFAS 48 and SAB 104 it did not have the ability to make reasonable estimates of future returns because there was (i) a lack of sufficient visibility into the wholesaler and retail distribution channels; (ii) an absence of historical experience with similar products; (iii) increasing levels of inventory in the wholesale and retail distribution channels as a result of increasing demand of the Company’s new products among other factors; and (iv) a concentration of a few large distributors. As a result, the Company could not make reliable and reasonable estimates of returns which precluded it from recognizing revenue at the time of product shipment, and therefore such transactions must be restated using the sell-through method. The restatement of product revenue under the sell-through method requires the correction of other accounts whose balances are largely based upon the prior accounting policy. Such accounts include gross to net sales adjustments and cost of goods (products) sold. Gross to net sales adjustments include allowances for returns, rebates, chargebacks, discounts, and promotions, among others. Cost of product sold includes manufacturing costs and royalties.
     The restatement did not affect the revenue recognition of Panretin or the Company’s international product sales. For Panretin, our wholesalers only stock minimal amounts of product, if any. As such, wholesaler orders are considered to approximate end-customer demand for the product. For international sales, our products are sold to third-part distributors. For these sales, we believe that the Company has met the SFAS 48 and SAB 104 criteria for recognizing revenue.
     Specific models were developed for: AVINZA, including a separate model for each dosage strength (a retail-stocked product for which the sell-through revenue recognition event is prescriptions as reported by a third party data provider, IMS Health Incorporated, or IMS); Targretin capsules and gel (for which revenue recognition is based on wholesaler out-movement as reported by IMS); and ONTAK (for which revenue recognition is based on wholesaler out-movement as reported to the Company by its wholesalers as the product is generally not stocked in pharmacies). Separate models were also required for each of the adjustments associated with the gross to net sales adjustments and cost of goods sold. The Company also developed separate demand reconciliations for each product to assess the reasonableness of the third party information described above which was used in the restatement and will be used on a going-forward basis.
     Under the sell-through method used in the restatement and to be used on a going-forward basis, the Company does not recognize revenue upon shipment of product to the wholesaler. For these shipments, the Company invoices the wholesaler, records deferred revenue at gross invoice sales price less estimated cash discounts and, for ONTAK, end-customer returns, and classifies the inventory held by the wholesaler as “deferred cost of goods sold” within “other current assets.” Additionally, for royalties paid to technology partners based on product shipments to wholesalers, the Company records the cost of such royalties as “deferred royalty expense” within “other current

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assets.” Royalties paid to technology partners are deferred as the Company has the right to offset royalties paid for product that are later returned against subsequent royalty obligations. Royalties for which the Company does not have the ability to offset (for example, at the end of the contracted royalty period) are expensed in the period the royalty obligation becomes due. The Company recognizes revenue when inventory is “sold through” (as discussed below), on a first-in first-out (FIFO) basis. Sell-through for AVINZA is considered to be at the prescription level or at the time of end user consumption for non-retail prescriptions. Thus, changes in wholesaler or retail pharmacy inventories of AVINZA do not affect the Company’s product revenues, but will be reflected on the balance sheet as a change to deferred product revenue. Sell-through for ONTAK, Targretin capsules, and Targretin gel is considered to be at the time the product moves from the wholesaler to the wholesaler’s customer. Changes in wholesaler inventories for all the Company’s products, including product that the wholesaler returns to the Company for credit, do not affect product revenues but will be reflected as a change in deferred product revenue.
     The Company’s revenue recognition is subject to the inherent limitations of estimates that rely on third-party data, as certain-third party information is itself in the form of estimates. Accordingly, the Company’s sales and revenue recognition under the sell-through method reflect the Company’s estimates of actual product sold through the distribution channel. The estimates by third parties include inventory levels and customer sell-through information the Company obtains from wholesalers which currently account for a large percentage of the market demand for its products. The Company also uses third-party market research data to make estimates where time lags prevent the use of actual data. Certain third-party data and estimates are validated against the Company’s internal product movement information. To assess the reasonableness of third-party demand (i.e. sell-through) information, the Company prepares separate demand reconciliations based on inventory in the distribution channel. Differences identified through these demand reconciliations outside an acceptable range will be recognized as an adjustment to the third-party reported demand in the period those differences are identified. This adjustment mechanism is designed to identify and correct for any material variances between reported and actual demand over time and other potential anomalies such as inventory shrinkage at wholesalers or retail pharmacies.
     As a result of the Company’s adoption of the sell-through method, it recorded reductions to net product sales in the amounts of $12.8 million, $8.1 million and $9.2 million for the quarters ended September 30, 2004, June 30, 2004 and March 31, 2004, respectively, and $25.5 million, $13.4 million, $12.8 million, and $7.5 million for the quarters ended December 31, 2003, September 30, 2003, June 30, 2003, and March 31, 2003, respectively. Additionally, for the years ended December 31, 2003 and 2002, the Company recorded a corresponding reduction to net product sales in the amounts of $59.2 million and $24.2 million, respectively. These amounts do not include other adjustments also affected by the change to the sell-through method such as cost of products sold and royalties. Revenue which has been deferred will be recognized as the product sells through in future periods as discussed above.
Effects of the Sell-Through Method on Consolidated Financial Statements
     Under the sell-through revenue recognition method, product sales and gross margins for 2004, 2003 and 2002 are affected by the timing of gross to net sales adjustments including wholesaler promotional discounts, the cost of certain services provided by wholesalers under distribution service agreements, and the impact of price increases. Additionally, cost of products sold and therefore gross margins for the Company’s products are further impacted by the changes in the timing of revenue recognition and certain related changes in accounting as a result of the change to the sell-through revenue recognition method. The more significant impacts are summarized below:
    Impact of changed sales volumes - a significant amount of cost of products sold is comprised of “fixed costs” including amortization of acquired technology and product rights that result in lower margins at lower sales levels.
 
    Returns - as discussed above, when product is shipped into the wholesale channel, inventory held by the wholesaler (and subsequently held by retail pharmacies in the case of AVINZA) is classified as “deferred cost of product sold” which is included in “Other current assets.” At the time of shipment, the Company makes an estimate of units that may be returned and records a reserve for those units against the “deferred cost of goods sold” account. Upon an announced price increase, the Company revalues its estimate of deferred product revenue to be returned to recognize the potential higher credit a wholesaler may take upon product return determined as the difference between the new and the initial wholesaler acquisition cost.

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      The impact of this reserve revaluation is likewise reflected as a charge to the Company’s statement of operations in the period the Company announces such price increase.
 
    Change to AVINZA product cost – in November 2002, the Company and Elan Corporation agreed to amend the terms of the AVINZA license and supply agreement. Under the terms of the amended agreement, Elan’s adjusted royalty and supply price of AVINZA is approximately 10% of the product’s net sales, compared to approximately 30-35% in the prior agreement. As noted above, product shipped to the wholesaler is recorded as “deferred cost of goods sold” and subsequently recognized as cost of sales when the product sells-through. In the restated revenue, the majority of product manufactured by Elan in 2002 at the higher contractual cost of production, sold-through and was recognized as cost of sales in 2003. Accordingly, AVINZA gross margins for 2003 under sell-through revenue recognition reflect this higher product cost compared to the previously reported 2003 margins under the sell-in revenue recognition method. If future sales volume increases and future return levels and product mix are similar to the Company’s experience in 2004, the Company expects that its gross margin levels overall will increase and stabilize over time. Gross margin on all product sales for 2004, 2003, and 2002 was 67%, 52%, and 51%, respectively.
 
    Royalties – under the sell-through method, royalties paid based on unit shipments to wholesalers are deferred and recognized as royalty expense as those units are sold-through and recognized as revenue.
     Sale of Royalty Rights. In March 2002, the Company entered into an agreement with Royalty Pharma AG (“Royalty Pharma”) to sell a portion of its rights to future royalties from the net sales of three (SERM) products now in late stage development with two of the Company’s collaborative partners, Pfizer Inc. and American Home Products Corporation, now known as Wyeth, in addition to the right, but not the obligation, to acquire additional percentages of the SERM products’ net sales on future dates by giving the Company notice. When the Company entered into the agreement with Royalty Pharma and upon each subsequent exercise of its options to acquire additional percentages of royalty payments to the Company, the Company recognized the consideration paid to it by Royalty Pharma as revenue. Cumulative payments totaling $63.3 million were received from Royalty Pharma from 2002 through 2004 for the sale of royalty rights from the net sales of the SERM products.
     The Company determined that, while the current accounting classification is appropriate, a portion of the revenue recognized under the Royalty Pharma agreement should have been deferred since Pfizer and Wyeth each had the right to offset a portion of future royalty payments for, and to the extent of, amounts previously paid to the Company for certain developmental milestones. Approximately $0.6 million of revenue was deferred in each of 2003 and 2002 related to the offset rights by the Company’s collaborative partners, Pfizer and Wyeth. The amounts associated with the offset rights against future royalty payments will be recognized as revenue upon receipt of future royalties from the respective partners or upon determination that no such future royalties will be forthcoming. Additionally, the Company determined to defer a portion of such revenue as it relates to the value of the option rights sold to Royalty Pharma until Royalty Pharma exercised such options or upon the expiration of the options. The value of Royalty Pharma options outstanding at the end of 2002 which was recognized in 2003 was approximately $0.1 million. The value of options outstanding at the end of 2003 which was recognized in 2004 was approximately $0.2 million. As of December 31, 2004, all of the option revenue deferred during fiscal 2002 and 2003 has been recognized. Accordingly, for the years ended December 31, 2003 and 2002, the Company has restated revenue from the sale of royalty rights under the Royalty Pharma agreement, which reduced royalty revenue by approximately $0.7 million for each of the years ended December 31, 2003 and 2002.
Additional Matters Addressed in the Restatement
     Subsequent to May 20, 2005, the Company determined that it should also restate its consolidated financial statements as they relate to the following matters:
     Buy-Out of Salk Royalty Obligation. In March 2004, the Company paid The Salk Institute $1.12 million in connection with the Company’s exercise of an option to buy out milestone payments, other payment-sharing obligations and royalty payments due on future sales of lasofoxifene, a product under development by Pfizer for which a NDA was expected to be filed in 2004. At the time of the Company’s exercise of its buyout right, the payment was accounted for as a prepaid royalty asset to be amortized on a straight-line basis over the period for

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which the Company had a contractual right to the lasofoxifene royalties. This payment was included in “other assets” on the Company’s consolidated balance sheet at September 30, 2004, June 30, 2004, and March 31, 2004. Pfizer filed the NDA for lasofoxifene with the United States Food and Drug Administration in the third quarter of 2004. Because the NDA had not been filed at the time the Company exercised its buyout right, the Company determined in the course of the restatement that the payment should have been expensed. Accordingly, the Company corrected such error and recognized the Salk payment as development expense for the quarter ended March 31, 2004 and the year ended December 31, 2004.
     X-Ceptor Therapeutics, Inc. In June 1999, the Company invested $6.0 million in X-Ceptor Therapeutics, Inc. (“X- Ceptor”) through the acquisition of convertible preferred stock. Additionally, in October 1999, the Company issued warrants to X-Ceptor investors, founders and certain employees to purchase 950,000 shares of Ligand common stock with an exercise price of $10.00 per share and an expiration date of October 6, 2006. At the time of issuance, the warrants were recorded at their fair value of $4.20 per warrant or $4.0 million as deferred warrant expense within stockholders’ deficit and were amortized to operating expense through June 2002. The Company determined during the course of the restatement that the warrant issuance should have been capitalized as an asset rather than treated as a deferred expense within equity since the warrant issuance was deemed to be consideration for the right granted to the Company by X-Ceptor to acquire all of the outstanding stock of X-Ceptor (the “Purchase Right”). Accordingly, the Company recorded the Purchase Right as an other asset in the amount of $4.0 million. The effect of this change resulted in a decrease in expense for the year ended December 31, 2002 of $0.7 million. This asset was subsequently written off to “Other, net expense” in the quarter ended March 31, 2003, the period the Company determined that the Purchase Right would not be exercised.
     Pfizer Settlement Agreement and Elan Shares. In April 1996, the Company and Pfizer entered into a settlement agreement with respect to a lawsuit filed in December 1994 by the Company against Pfizer. In connection with a collaborative research agreement the Company entered into with Pfizer in 1991, Pfizer purchased shares of the Company’s common stock. Under the terms of the settlement agreement, at the option of either the Company or Pfizer, milestone and royalty payments owed to the Company can be satisfied by Pfizer by transferring to the Company shares of the Company’s common stock at an exchange ratio of $12.375 per share. At the time of the settlement, the Company accounted for the prior issuance of common stock to Pfizer as equity on its balance sheet.
     Additionally, in 1998, Elan International (Elan) agreed to exclusively license to the Company in the United States and Canada its proprietary product AVINZA. In connection with the November 2002 restructuring of the AVINZA license agreement with Elan, the Company agreed to repurchase approximately 2.2 million shares of the Company’s common stock held by an affiliate of Elan (the “Elan Shares”) for $9.00 a share. At the time of the November 2002 agreement, the shares were classified as equity on the Company’s balance sheet. The Elan Shares were repurchased and retired in February 2003.
     In conjunction with the restatement, the remaining common stock issued and outstanding to Pfizer following the settlement and the Elan Shares were reclassified as “common stock subject to conditional redemption/repurchase” (between liabilities and equity) in accordance with Emerging Issue Task Force Topic D-98, “Classification and Measurement of Redeemable Securities” (EITF D-98), which was issued in July 2001.
     EITF D-98 requires the security to be classified outside of permanent equity if there is a possibility of redemption of securities that is not solely within the control of the issuer. Since Pfizer has the option to settle with Company’s shares milestone and royalties payments owed to the Company and, as of December 31, 2002, the Company was required to repurchase the Elan shares, the Company determined that such factors indicated that the redemptions were not within the Company’s control, and accordingly, EITF D-98 was applicable to the treatment of the common stock issued to Pfizer and the Elan Shares. These adjustments totaling $34.6 million only had an effect on the balance sheet classification, not on the consolidated statements of operations. Of the total adjustments, $14.6 million related to the Pfizer shares and $20.0 million related to the Elan Shares.
     Seragen Litigation. On December 11, 2001, a lawsuit was filed in the United States District Court for the District of Massachusetts against the Company by the Trustees of Boston University and other former stakeholders of Seragen. The suit was subsequently transferred to federal district court in Delaware. The complaint alleges breach of contract, breach of the implied covenants of good faith and fair dealing and unfair and deceptive trade practices based on, among other things, allegations that the Company wrongfully withheld approximately $2.1

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million in consideration due the plaintiffs under the Seragen acquisition agreement. This amount had been previously accrued for in the Company’s consolidated financial statements in 1998. The complaint seeks payment of the withheld consideration and treble damages. The Company filed a motion to dismiss the unfair and deceptive trade practices claim. The Court subsequently granted the Company’s motion to dismiss the unfair and deceptive trade practices claim (i.e. the treble damages claim), in April 2003. In November 2003, the Court granted Boston University’s motion for summary judgment, and entered judgment for Boston University. In January 2004, the district court issued an amended judgment awarding interest of approximately $0.7 million to the plaintiffs in addition to the approximately $2.1 million withheld. The Court award of interest was previously not accrued. Though the Company has appealed the judgment in this case as well as the award of interest and the calculation of damages, in view of the judgment, the Company revised its consolidated financial statements in the fourth quarter of 2003 to record a charge of $0.7 million.
     Other. In conjunction with the restatement, the Company also made other adjustments and reclassifications to its accounting for various other errors, in various years, including, but not limited to: (1) a correction to the Company’s estimate of the accrual for clinical trials; (2) corrections to estimates of other accrued liabilities; (3) royalty payments made to technology partners; (4) straight-line recognition of rent expense for contractual annual rent increases; and (5) corrections to estimates of future obligations and bonuses to employees.
     For the quarters ended September 30, 2004, June 30, 2004, and March 31, 2004, the restatement increased the net loss by $11.7 million or $0.16 per share; $7.8 million or $0.11 per share; and $8.8 million or $0.12 per share, respectively. For the quarter ended December 31, 2003, the restatement decreased net income by $24.6 million or $0.34 per share and increased net loss for the quarters ended September 30, 2003, June 30, 2003, and March 31, 2003 by $11.6 million or $0.16 per share; $12.0 million or $0.18 per share; and $10.8 million or $0.15 per share, respectively. The restatement increased the net loss in 2003 by $59.0 million or $0.83 per share to $96.5 million or $1.36 per share. The restatement increased the net loss in 2002 by $19.7 million or $0.29 per share to $52.3 million or $0.76 per share. For periods prior to 2002, the restatement was effectuated through an aggregate adjustment as of January 1, 2002 of $15.1 million to the Company’s accumulated deficit. Additionally, for periods prior to 2002, restatement of the Pfizer settlement agreement was effectuated as of January 1, 2002 through a reduction of additional paid in capital and a corresponding increase to “common stock subject to conditional redemption/repurchase” (between liabilities and equity) of $14.6 million. The restatement regarding the Elan shares had no effect on periods prior to 2002 since it was effectuated as of November 2002 through a reduction of additional paid in capital and a corresponding increase to “common stock subject to conditional redemption/repurchase” of $20.0 million.
Quarterly Effects of the Restatement
     Set forth below is a discussion of the significant changes to our quarterly 2004, 2003 and 2002 consolidated financial statements as a result of the restatement. The effects of the restatement are discussed elsewhere in this discussion under the captions “The Restatement and Other Related Matters.” Unless otherwise indicated in this “Quarterly Effects of the Restatement” section below, the trends and known uncertainties discussed in “Restated Results of Operations” as they relate to the annual periods are applicable to the quarterly 2004, 2003 and 2002 periods.
     Changes to our previously reported quarterly earnings primarily reflect the effects of our change to the sell-through method of revenue recognition for the domestic product shipments of AVINZA, ONTAK, Targretin capsules and Targretin gel. The Company’s previous revenue recognition method recognized net product sales upon shipment of product to the wholesalers. The sell-through method does not recognize net product sales until the product is sold through the distribution channel. As a result, for each of the quarterly periods, net product sales were significantly reduced with related increases classified in the current portion of deferred revenue to be recognized in future periods, net of gross to net sales adjustments, as the product sells through the distribution channel. As a result, the current portion of deferred revenue significantly increased in the 2004, 2003, and 2002 quarterly periods.
     In addition to the change to the sell-through method of revenue recognition, the 2002 quarterly periods were also affected by the launch of AVINZA in the second quarter of 2002. Under the previous sell-in method of revenue recognition, AVINZA net sales for the quarters ended December 31, 2002, September 30, 2002, and June 30, 2002 totaled $2.0 million, $6.1 million, and $4.1 million, respectively. Under the restated sell-through method of revenue

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recognition, total 2002 AVINZA net product sales were $1.1 million. As such, the reduction in 2002 AVINZA net product sales resulted in an increase in deferred product revenue to be recognized in future periods as the product sells through the distribution channel.
     The restatement did not affect the revenue recognition of Panretin or the Company’s international product sales. For Panretin, our wholesalers only stock minimal amounts of product, if any. As such, wholesaler orders are considered to approximate end-customer demand for the product. For international sales, our products are sold to third-party distributors, for which we have had minimal returns. For these sales, we believe that the Company has met the SFAS 48 and SAB 104 criteria for recognizing revenue.
     Under the sell-through revenue recognition method, product sales and gross margins for the quarterly periods in 2004 and 2003 periods were also affected by the timing of certain gross to net sales adjustments including wholesaler promotional discounts, the cost of certain services provided by wholesalers under distribution service agreements, and the impact of price increases. Additionally, cost of products sold and therefore gross margins for the Company’s products were further impacted by the changes in the timing of revenue recognition and certain related changes in accounting as a result of the change to the sell-through revenue recognition method. As discussed elsewhere in this discussion under the caption “Effects of the Sell-Through Method on Consolidated Financial Statements,” the more significant impacts were related to the impact of changed sales volumes and wholesaler returns. Under the sell-through method, gross margin was approximately 70%, 67%, and 69% for the first, second and third quarters of 2004, respectively. Under the Company’s previous method, gross margin was 74%, 74%, and 75%, for the first, second, and third quarters of 2004, respectively.
     For the 2003 quarterly periods, cost of products sold and gross margin were not only impacted by changed sales volumes and wholesaler returns but also significantly impacted by the change to AVINZA product cost as it relates to the Elan agreement as described under the caption “Effects of the Sell-Through Method on Consolidated Financial Statements – Change to AVINZA product cost” in this discussion. Under the sell-through method, gross margin was approximately 46%, 44%, 52% and 62% for the first, second, third, and fourth quarters of 2003, respectively. Under the Company’s previous method, gross margin was 65%, 69%, 70%, and 80%, for the first, second, third, and fourth quarters of 2003, respectively.
     In regard to the change in product gross profit margin under the sell-through method, though there is no assurance, the Company expects that its product gross margin levels will increase and stabilize over time, if future sales volume increase and future return levels and product mix are similar to the Company’s experience in 2004.
     The change to research and development expense in the first quarter of 2004 reflects the payment of $1.12 million to The Salk Institute and reclassification of certain costs incurred in connection with identifying and validating a second source for AVINZA and a new fill-finish site for ONTAK to selling, general and administrative expense. The reduction in research and development expense in the second and third quarters of 2004 primarily also reflects the reclassification of certain costs incurred in connection with identifying and validating a second source for AVINZA and a new fill-finish site for ONTAK to selling, general and administrative expense. Research and development expense for the 2003 quarterly periods remained relatively constant.
     Because the Company previously recognized revenue under a different revenue recognition model, it paid product royalties based on the former revenue recognition policy. Following the restatement, certain royalties have likewise been reduced for those periods.
     Other, net expense in the first quarter of 2003 reflects the $9.0 million write-off in March 2003 of X-Ceptor Purchase Right comprised of the initial value of the right, $4.0 million, and $5.0 million paid to X-Ceptor in 2002 to extend the Purchase Right. Selling, general and administrative expense for the fourth quarter of 2003 reflects a $0.7 million accrual of interest for a legal judgment against the Company related to ongoing litigation with Boston University resulting from amounts withheld from Boston University in connection with the Company’s 1998 acquisition of Seragen. We continue to believe that the plaintiff’s claims are without merit and have appealed the judgment in this case as well as the award of interest and the calculation of damages. The appeal has been fully briefed and was argued in June 2005 and the parties are awaiting the court’s decision.
     The restatement also had a significant impact on certain balance sheet accounts as further discussed below:

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     Accrued liabilities – The previous revenue recognition method included an allowance for sale returns in accrued liabilities. Under the sell-through method, except for end-customer returns of ONTAK and returns of Panretin, returns are no longer included as accrued liabilities since the revenue is not recognized until the product is sold through the distribution channel. As a result, accrued liabilities significantly decreased for the 2004 and 2003 quarterly periods.
     Common Stock Subject to Conditional Redemption/Repurchase – In connection with the Pfizer Settlement agreement and the repurchase of the Elan shares, as discussed under the caption “Additional Matters Addressed in the Restatement,” in this discussion, the common stock issued and outstanding to Pfizer and the Elan shares were reclassified as common stock subject to conditional redemption/repurchase (between liabilities and equity) in accordance with EITF D-98. Common stock subject to conditional redemption decreased in the third quarter of 2004 as a result the Company’s redemption of 181,818 shares held by Pfizer. Likewise, in the first quarter of 2003, common stock subject to conditional redemption/repurchase decreased by $20.0 million, as a result of the Company’s repurchase and retirement of the Elan shares in February 2003.
Overview
     We discover, develop and market drugs that address patients’ critical unmet medical needs in the areas of cancer, pain, men’s and women’s health or hormone-related health issues, skin diseases, osteoporosis, blood disorders and metabolic, cardiovascular and inflammatory diseases. Our drug discovery and development programs are based on our proprietary gene transcription technology, primarily related to Intracellular Receptors, also known as IRs, a type of sensor or switch inside cells that turns genes on and off, and Signal Transducers and Activators of Transcription, also known as STATs, which are another type of gene switch.
     We currently market five products in the United States: AVINZA, for the relief of chronic, moderate to severe pain; ONTAK, for the treatment of patients with persistent or recurrent cutaneous T-cell lymphoma (or CTCL); Targretin capsules, for the treatment of CTCL in patients who are refractory to at least one prior systemic therapy; Targretin gel, for the topical treatment of cutaneous lesions in patients with early stage CTCL; and Panretin gel, for the treatment of Kaposi’s sarcoma in AIDS patients. In Europe, we have marketing authorizations for Panretin gel and Targretin capsules and are currently marketing these products under arrangements with local distributors. In April 2003, we withdrew our ONZAR (ONTAK in the U.S.) marketing authorization application in Europe for our first generation product. It was our assessment that the cost of the additional clinical and technical information requested by the European Agency for the Evaluation of Medicinal Products (EMEA) for the first generation product would be better spent on acceleration of the second generation ONTAK formulation development. We expect to resubmit the ONZAR application with the second generation product in 2006 or early 2007.
     In February 2003, we entered into an agreement for the co-promotion of AVINZA with Organon Pharmaceuticals USA Inc. (Organon). Under the terms of the agreement, Organon committed to a specified minimum number of primary and secondary product calls delivered to certain high prescribing physicians and hospitals beginning in March 2003. Organon’s compensation is structured as a percentage of net sales, based on the Company’s standard accounting principles and generally accepted accounting principles (GAAP), which pays Organon for their efforts and also provides Organon an economic incentive for performance and results. In exchange, we pay Organon a percentage of AVINZA net sales based on the following schedule:
     
    % of Incremental Net Sales
Annual Net Sales of AVINZA   Paid to Organon by Ligand
$0-35 million (2003 only)   0% (2003 only)
$0-150 million   30%
$150-300 million   40%
$300-425 million   50%
> $425 million   45%
     Through the announcement of the restatement, we calculated and paid Organon’s compensation according to our prior application of GAAP and our prior standard accounting principles. The restatement corrects the recognition of revenue for transactions involving AVINZA that did not satisfy all of the conditions for revenue

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recognition contained in SFAS 48 and SAB 104. Shipments made to wholesalers for AVINZA did not meet the revenue recognition criteria under GAAP and such transactions were restated using the sell-through method as opposed to the sell-in method previously used.
     Under the sell-through method used in the restatement and to be used on a going-forward basis, we do not recognize revenue upon shipment of AVINZA to the wholesaler. As a result, we believe that we have overpaid Organon under the terms of the agreement by approximately $18.6 million through December 31, 2004. We have notified Organon regarding the overpayment and our intention to apply such overpayment to future amounts due under the co-promotion agreement calculated under GAAP and our standard accounting principles. Organon has expressed its disagreement with this position and we are currently in discussions with Organon. While the discussions continue, the payments made and under discussion are reflected in our 2004 and 2003 consolidated financial statements as co-promotion expense, $9.2 million in 2004 and $9.4 million in 2003, respectively. Therefore, the consolidated financial statements included herein do not recognize the overpayment pending resolution of the matter. Until this matter is resolved, we will continue to account for co-promotion expense based on net sales determined using the sell-in method.
     Additionally, both companies agreed to share equally all costs for AVINZA advertising and promotion, medical affairs and clinical trials. Each company is responsible for its own sales force costs and other expenses. The initial term of the co-promotion agreement is 10 years. Organon has the option any time prior to January 1, 2008 to extend the agreement to 2017 by making a $75.0 million payment to us. Either party may terminate the agreement in the event that net sales of AVINZA during 2007 are less than a specified level. Further, either party may terminate the agreement upon material breach of the other party, including a failure of the other party to meet at least 95% of its minimum sales calls obligations or to use its commercially reasonable efforts to market and promote AVINZA in accordance with the mutually agreed marketing plan, which includes the number, targeting and frequency of sales calls.
     We are currently involved in the research phase of a research and development collaboration with TAP Pharmaceutical Products Inc. (or TAP). Collaborations in the development phase are being pursued by Eli Lilly and Company, GlaxoSmithKline, Organon, Pfizer, TAP and Wyeth. We receive funding during the research phase of the arrangements and milestone and royalty payments as products are developed and marketed by our corporate partners. In addition, in connection with some of these collaborations, we received non-refundable up-front payments.
     We have been unprofitable since our inception on an annual basis. We achieved quarterly net income of $17.3 million during the fourth quarter of fiscal 2004, which was primarily the result of recognizing approximately $31.3 million from the sale of royalty rights to Royalty Pharma. However, we expect to incur net losses in future quarters. To consistently be profitable, we must successfully develop, clinically test, market and sell our products. Even if we consistently achieve profitability, we cannot predict the level of that profitability or whether we will be able to sustain profitability. We expect that our operating results will fluctuate from period to period as a result of differences in the timing of revenues earned from product sales, expenses incurred, collaborative arrangements and other sources. Some of these fluctuations may be significant.
Recent Developments
Sales Force Activity/Realignment
     In March 2004, Ligand and Organon announced plans to increase sales calls in 2004 to primary care physicians through increased call activity by Organon’s primary care sales force and by Ligand hiring an additional 36 representatives calling on top decile primary care physicians in a mirrored activity to Organon’s. The companies also announced plans for 2004 for increased calls to long-term care and hospice market segments through the Organon sales and LTC/hospice infrastructure. Although these initiatives were in place during the second, third and fourth quarters of 2004, the sales call expansion and prescription increases anticipated were slower than expected.
     As part of an overall larger sales force realignment in Organon, a comprehensive territory rebalancing and AVINZA sales force restructuring was implemented in November 2004. This restructuring created approximately 370 AVINZA primary care territories with an estimated 60 AVINZA primary care physicians in each, eliminated the

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specialty sales force and placed specialty physicians into the hospital sales force call universe, and solidified a hospital sales force of 110 representatives. The primary care sales force was essentially focused on AVINZA and the hospital sales force called on specialists with AVINZA in position one.
     While the increased focus of the primary care representatives and the territory rebalancing of physicians was intended to be positive and increase sales call productivity over time, the immediate and near term effects including sales force turnover appear to have impacted the quantity and quality of expected sales calls in 2004 and continuing into 2005. In addition, the Organon reorganization impacted the infrastructure and personnel available to execute the long-term care and hospice initiatives in the second half of 2004. The Organon reorganization and rebalancing, and the Ligand primary care sales force expansion are expected to improve sales call productivity in primary care over time, however, reacceleration of prescription demand and market share gains have not yet responded in the expected timeframes or in the expected quantities. This remains one of the key challenges of the co-promotion partners going forward.
Restructuring of ONTAK Royalty
     In November 2004, Ligand and Eli Lilly and Company (Lilly) agreed to amend their ONTAK royalty agreement to add options in 2005 that if exercised would restructure our royalty obligations on net sales of ONTAK. Under the revised agreement, we and Lilly each obtained two options. Our options, exercisable in January 2005 and April 2005, provided for the buy down of a portion of our ONTAK royalty obligation on net sales in the United States for total consideration of $33.0 million. Lilly also had two options exercisable in July 2005 and October 2005 to trigger the same royalty buy-downs for total consideration of up to $37.0 million dependent on whether we have exercised one or both of our options.
     Our first option, providing for a one-time payment of $20.0 million to Lilly in exchange for the elimination of our ONTAK royalty obligations in 2005 and a reduced reverse-tiered royalty scale on ONTAK sales in the U.S. thereafter, was exercised in January 2005. The second option, exercised in April 2005, provided for a one-time payment of $13.0 million to Lilly in exchange for the elimination of royalties on ONTAK net sales in the U.S. in 2006 and a reduced reverse-tiered royalty thereafter. Beginning in 2007 and throughout the remaining ONTAK patent life (2014), we will pay no royalties to Lilly on U.S. sales up to $38.0 million. Thereafter, Ligand would pay royalties to Lilly at a rate of 20% on net U.S. sales between $38.0 million and $50.0 million; at a rate of 15% on net U.S. sales between $50.0 million and $72.0 million; and at a rate of 10% on net U.S. sales in excess of $72.0 million.
Targretin Capsules Development Programs
     In March 2005, we announced that the final data analysis for Targretin capsules in NSCLC showed that the trials did not meet their endpoints of improved overall survival and projected two year survival. We are continuing to analyze the data and apply it to the continued development of Targretin capsules in NSCLC. Failure to demonstrate the product’s safety and effectiveness would delay or prevent regulatory approval of the product and could adversely affect our business as well as our stock price. See “Risk Factors – Our products face significant regulatory hurdles prior to marketing which could delay or prevent sales.”
Additional Manufacturing Sources
     In 2004, we entered into contracts with Cardinal Health to provide a second source for AVINZA, and with Hollister-Stier to fill and finish ONTAK. In July 2005, we announced that the FDA approved the Hollister-Stier facility for fill/finish of ONTAK. In August 2005, the FDA approved the production of AVINZA at the Cardinal Health facility which provides a second source of supply, thus diversifying the AVINZA supply chain and increasing production capacity.

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Restated Results of Operations
     Total revenues for 2004 increased to $163.5 million compared to $81.1 million in 2003 and $71.8 million in 2002. Loss before the cumulative effect of a change in accounting principle was $45.1 million ($ 0.61 per share) in 2004, compared to $94.5 million ($1.33 per share) in 2003 and $52.3 million ($0.76 per share) in 2002. Net loss for 2004 was $45.1 million ($0.61 per share), compared to $96.5 million ($1.36 per share) in 2003 and $52.3 million ($0.76 per share) in 2002. As more fully described in Note 3 of the notes to consolidated financial statements, results for 2003 reflect the implementation of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, as revised December 2003, which required us to consolidate the entity from which we leased one of our corporate office buildings under a synthetic lease arrangement. The effect on 2003 results, recorded as a cumulative effect of a change in accounting principle, increased net loss by $2.0 million or $0.03 per share.
Product Sales
     Our product sales for any individual period can be influenced by a number of factors including changes in demand for a particular product, competitive products, the level and nature of promotional activity, the timing of announced price increases, and the level of prescriptions subject to rebates and chargebacks. According to IMS data, AVINZA ended 2004 with a market share of prescriptions in the sustained-release opioid market of 3.9% compared to 1.4% at the end of 2003. Quarterly prescription market share for the three months ended December 31, 2004 was 4.3% compared to 2.7% for the three months ended December 31, 2003. We expect that AVINZA prescription market share will continue to increase as a result of a more balanced and focused sales and marketing activity compared to 2004. We also continue to expect that demand for and sales of ONTAK will be positively impacted as further data is obtained from ongoing expanded-use clinical trials and the initiation of new expanded-use trials but negatively impacted by continuing reimbursement trends resulting from changes to the Centers for Medicare and Medicaid Services reimbursement rates. The level and timing of any such increases, however, are influenced by a number of factors outside our control, including the accrual of patients and overall progress of clinical trials that are managed by third parties.
     Excluding AVINZA, our products are small-volume specialty pharmaceutical products that address the needs of cancer patients in relatively small niche markets with substantial geographical fluctuations in demand. To ensure patient access to our drugs, we maintain broad distribution capabilities with inventories held at approximately 150 locations throughout the United States. The purchasing and stocking patterns of our wholesaler customers for all our products are influenced by a number of factors that vary from product to product. These factors include, but are not limited to, overall level of demand, periodic promotions, required minimum shipping quantities and wholesaler competitive initiatives. If any or all of our major wholesalers decide to reduce the inventory they carry in a given period (subject to the terms of our fee-for-service agreements discussed below), our shipments and cash flow for that period could be substantially lower than historical levels.
     In the third and fourth quarters of 2004, we entered into one-year fee-for-service agreements (or distribution service agreements) for each of our products with the majority of our wholesaler customers. The principal fee-for-service agreements were subsequently renewed during the third quarter of 2005. In exchange for a set fee, the wholesalers have agreed to provide us with certain information regarding product stocking and out-movement; agreed to maintain inventory quantities within specified minimum and maximum levels; inventory handling, stocking and management services; and certain other services surrounding the administration of returns and chargebacks. In connection with implementation of the fee-for-service agreements, we no longer offer these wholesalers promotional discounts or incentives and as a result, we expect a net improvement in product gross margins as volumes grow. Additionally, we believe these arrangements will provide lower variability in wholesaler inventory levels and improved management of inventories within and between individual wholesaler distribution centers that we believe will result in a lower level of product returns compared to prior periods.
     Certain of our products are included on the formularies (or lists of approved and reimbursable drugs) of many states’ health care plans, as well as the formulary for certain Federal government agencies. In order to be placed on these formularies, we generally sign contracts which provide discounts to the purchaser off the then-current list price and limit how much of an annual price increase we can implement on sales to these groups. As a result, the discounts off list price for these groups can be significant for products where we have implemented list price

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increases. We monitor the portion of our sales subject to these discounts, and accrue for the cost of these discounts at the time of the recognition of product sales. We believe that by being included on these formularies, we will gain better physician acceptance, which will then result in greater overall usage of our products. If the relative percentage of our sales subject to these discounts increases materially in any period, our sales and gross margin could be substantially lower than historical levels.
     Our total net product sales for 2004 were $120.3 million, compared to $55.3 million in 2003 and $30.3 million in 2002. A comparison of sales by product is as follows (in thousands):
                         
    Year Ended December 31,  
    2004     2003     2002  
            (Restated)     (Restated)  
AVINZA
  $ 69,470     $ 16,482     $ 1,114  
ONTAK
    32,200       24,108       17,706  
Targretin capsules
    15,105       11,556       8,563  
Other
    3,560       3,178       2,943  
 
                 
Total product sales
  $ 120,335     $ 55,324     $ 30,326  
 
                 
AVINZA
     Sales of AVINZA were $69.5 million in 2004 compared to $16.5 million in 2003. This increase is due to higher prescriptions as a result of the increased level of marketing and sales activity under our co-promotion agreement with Organon, which started in March 2003, and the product’s success in achieving state Medicaid and commercial formulary status. Formulary access removes obstacles to physicians prescribing the product and facilitates patient access to the product through lower co-pays. Demand for AVINZA as measured by prescription levels (or patient consumption for channels with no prescription requirements) increased by 235.6% for 2004 compared to 2003, as reported by IMS Health. Sales in 2004 also benefited from a 9.9% price increase effective January 1, 2004 and a 9.0% price increase effective July 1, 2004. Since the start of co-promotion activities, AVINZA had been promoted by more than 700 sales representatives compared to approximately 50 representatives in 2003 prior to co-promotion. However, as a result of a recent sales force restructuring and rebalancing of the Organon AVINZA sales territories, as further discussed above under “Recent Developments”, and the expansion of Ligand’s sales force, four separate sales forces totaling approximately 600 representatives are anticipated to be deployed in 2005 to provide more than 800,000 focused sales calls per year to the primary care, specialist, and long-term care and hospice markets.
     AVINZA sales were negatively impacted during 2004 by a higher level of Medicaid rebates, which significantly increased in the fourth quarter of 2003, driven by increased prescriptions in states where AVINZA (1) obtained preferred formulary status relative to competing products and (2) came onto the state formulary but not in a preferred position. AVINZA sales during 2004 compared to 2003 were also impacted by a higher level of rebates under certain managed care contracts entered into in late 2003 and early 2004 with pharmacy benefit managers (PBMs), group purchasing organizations (GPOs) and health maintenance organizations (HMOs). Any changes to our estimates for Medicaid prescription activity or prescriptions written under our managed care contracts may have an impact on our rebate liability and a corresponding impact on AVINZA net product sales. For example, a 20% variance to our estimated Medicaid and managed care contract rebate accruals for AVINZA as of December 31, 2004 could result in adjustments to our Medicaid and managed care contract rebate accruals and net product sales of approximately $0.9 million and $0.3 million, respectively.
     Sales of AVINZA were $16.5 million in 2003 compared to $1.1 million in 2002. This increase is due to increasing prescriptions as a result of the increased level of marketing and sales activity under our co-promotion arrangement with Organon, and to 2003 being the first full year of AVINZA sales. Demand for AVINZA as measured by prescription levels (or patient consumption for channels with no prescription requirements) was 17 times greater for 2003 than for 2002, as reported by IMS Health.
ONTAK
     Sales of ONTAK were $32.2 million in 2004 compared to $24.1 million in 2003. Sales in 2004 were positively impacted by a 9% price increase effective January 1, 2004 and increasing use (impacted in part by expanded clinical

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data) in CTCL, CLL, and NHL. Demand for ONTAK as measured by shipments to end users as reported by our wholesalers increased by 28% for 2004 compared to 2003. Sales of ONTAK in 2004 were negatively impacted, however, by a continued increase in chargebacks and rebates due to changes in patient mix and evolving reimbursement rates. We expect that sales of ONTAK will be negatively impacted by changes to the Centers for Medicare and Medicaid Services reimbursement rates in 2005 but expect improved reimbursement rates moving into 2006. A 20% variance to our Medicaid rebate and estimated chargeback accruals for ONTAK as of December 31, 2004 could result in an adjustment to such accruals and net product sales of approximately $0.1 million.
     Sales of ONTAK were $24.1 million in 2003 compared to $17.7 million in 2002. This increase reflects price increases and increasing use (impacted in part by expanded clinical data) in CTCL, CLL, and NHL. Overall demand for ONTAK measured by unit shipments to end users increased 20% for 2003 compared to the prior year. Sales of ONTAK were negatively impacted, however, by increased chargebacks and rebates reflecting changes in our patient mix and reimbursement rates.
Targretin Capsules
     Sales of Targretin capsules were $15.1 million in 2004 compared to $11.6 million in 2003. This increase reflects a 7% price increase effective January 1, 2004 and the full period impact of a 15% price increase effective April 1, 2003. Additionally, demand for Targretin capsules as measured by product outmovement increased by 5.4% for 2004 compared to 2003, as reported by IMS Health.
     In June 2004, the Centers for Medicare and Medicaid Services (CMS) announced formal implementation of the Section 641 Demonstration Program under the Medicare Modernization Act of 2003 including reimbursement under Medicare for Targretin for patients with CTCL. As a result, we continue to expect improved patient access for Targretin in 2005.
     Sales of Targretin capsules were $11.6 million in 2003 compared to $8.6 million in 2002. This increase reflects a 15% price increase effective April 1, 2003. Additionally, demand for Targretin capsules as measured by product outmovement increased by 1.0% for 2003 compared to 2002, as reported by IMS Health.
Sale of Royalty Rights
     Revenue from the sale of royalty rights represents the sale to third parties of rights and options to acquire future royalties we may earn from the sale of products in development with our collaborative partners. In those instances where we have no continuing involvement in the research or development of these products, sales of royalty rights are recognized as revenue in the period the transaction is consummated or the options are exercised or expire. See Footnote 3 “Significant Accounting Policies” of Notes to Consolidated Financial Statements for further discussion of our revenue recognition policy with respect to sales of royalty rights.
     Sale of royalty rights recognized in 2004, 2003 and 2002 amounted to $31.3 million, $11.8 million, and $17.6 million, respectively, net of the deferral of offset rights of $1.4 million, $0.6 million and $0.6 million, respectively, and the recognition in 2004 and 2003 of $0.2 million and $0.1 million, respectively, of option value deferred in previous periods.
     In March 2002, we entered into an agreement with Royalty Pharma AG (“Royalty Pharma”), to sell a portion of our rights to future royalties from the net sales of three selective estrogen receptor modulator (SERM) products now in late stage development with two of our collaborative partners, Pfizer and Wyeth. The agreement provided for the initial sale of rights to 0.25% of such product net sales for $6.0 million and options to acquire up to an additional 1.00% of net sales for $50.0 million. Of the initial $6.0 million sale of rights, $0.2 million was attributed to the options and recorded as deferred revenue.
     In July and December of 2002, the agreement was amended to replace the existing options with new options providing for the rights to acquire an additional 1.3125% of net sales for $63.8 million. Royalty Pharma exercised each of the three available 2002 options, as amended, acquiring rights to 0.4375% of net sales for $12.3 million. The fair value estimated for the amended options, $0.2 million, was recorded as deferred revenue.

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     In October 2003, the existing royalty agreement was amended and Royalty Pharma exercised an option for $12.5 million in exchange for 0.7% of potential future sales of the three SERM products for 10 years. Under the revised agreement, Royalty Pharma had three additional options to purchase up to 1.3% of such product net sales for $39.0 million.
     In November 2004, Royalty Pharma agreed to purchase an additional 1.625% royalty on future sales of the SERM products for $32.5 million and cancel its remaining two options.
     Under the underlying royalty agreements, both Pfizer and Wyeth have the right to offset a portion of any future royalty payments owed to the Company. Accordingly, the Company deferred a portion of the revenue associated with each tranche of royalty right sold, including rights acquired upon the exercise of options, equal to the pro-rata share of the potential royalty offset. Such amounts associated with the offset rights against future royalty payments will be recognized as revenue upon receipt of future royalties from the respective partners.
Collaborative Research and Development and Other Revenue
     Collaborative research and development and other revenues for 2004 were $11.8 million, compared to $14.0 million for 2003 and $23.8 million for 2002. Collaborative research and development and other revenues include reimbursement for ongoing research activities, earned development milestones, and recognition of prior years’ up-front fees previously deferred in accordance with SAB 104. Revenue from distribution agreements includes recognition of up-front fees collected upon contract signing and deferred over the life of the distribution arrangement and milestones achieved under such agreements.
     A comparison of collaborative research and development and other revenues is as follows (in thousands):
                         
    Year Ended December 31,  
    2004     2003     2002  
Collaborative research and development
  $ 7,843     $ 10,887     $ 18,268  
Development milestones
    3,681       2,807       5,060  
Other
    311       314       515  
 
                 
 
  $ 11,835     $ 14,008     $ 23,843  
 
                 
     Collaborative Research and Development. The decrease in ongoing research activities reimbursement revenue in 2004 compared to 2003 is due to lower funding from our research arrangement with Lilly, which contributed $4.0 million to revenue in 2004 compared to $5.7 million in 2003. The research term of the Lilly collaboration was extended for an additional year effective November 2003 at a lower level of funding, through November 2004. Additionally, the decrease is due to the contractually agreed lower level of research activity and funding under our collaboration arrangement with TAP, which contributed $3.4 million to revenue in 2004 compared to $4.2 million in 2003. In December 2004, the TAP collaboration was extended for a second time, until June 2006.
     The decrease in ongoing research activities reimbursement revenue in 2003 compared to 2002 is due to lower funding from our research arrangement with Lilly, which contributed $5.7 million to revenue in 2003 compared to $8.2 million in 2002. Additionally, the decrease is due to the contractually agreed lower level of research activity and funding under our research arrangement with TAP, which contributed $4.2 million to revenue in 2003 compared to $5.0 million in 2002.
     Revenue from up-front fees, which is included in collaborative research and development, is recognized over the period during which we provide research services. Revenue from TAP up-front fees decreased to $0.4 million in 2004 from $1.0 million in 2003 and from $1.3 million in 2002. Revenue from Lilly up-front fees was $3.4 million in 2002 and none thereafter, due to the completion of the initial research term of the Lilly collaboration.
     Development Milestones. Development milestone revenue in 2004 includes net development milestones of $2.0 million from Pfizer as a result of Pfizer’s filing with the FDA of a new drug application for lasofoxifene, $0.8 million earned from TAP in connection with TAP’s selection of an additional selective androgen receptor modulator (SARM) as a second clinical candidate for development for the treatment of major androgen-related diseases, and $0.8 million earned from GlaxoSmithKline.

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     Development milestone revenue in 2003 represents $0.9 million earned from Wyeth, a $1.1 million milestone from Lilly, and a $0.8 million milestone from GlaxoSmithKline. Development milestone revenue in 2002 represents a $2.4 million milestone from Lilly, $0.6 million earned from Wyeth, and a $2.0 million milestone from GlaxoSmithKline.
Gross Margin
     Gross margin on product sales was 66.9% in 2004 compared to 52.0% in 2003 and 51.4% in 2002. The increase in the margin in 2004 compared to 2003 is primarily due to the relative increase of sales of AVINZA. AVINZA, which represented 58% of net product sales in 2004 compared to 30% in the prior year, has significantly higher margins than ONTAK for which we owed third party royalties of approximately 27% of ONTAK product sales. For both AVINZA and ONTAK we have capitalized license, royalty and technology rights recorded in connection with the acquisition of the rights to those products. AVINZA cost of product sold includes the amortization of license and royalty rights capitalized in connection with the restructuring of our AVINZA license and supply agreement in November 2002. The total amount of capitalized license and royalty rights, $114.4 million, is being amortized to cost of product sold on a straight-line basis over 15 years. The total amount of ONTAK acquired technology, $45.3 million, is also amortized to cost of product sold on a straight-line basis over 15 years. In accordance with SFAS 142, “Goodwill and Other Intangibles” (“SFAS 142”), these assets are amortized on a straight line basis since the pattern in which the economic benefits of the assets are consumed (or otherwise used up) cannot be reliably determined. At December 31, 2004, acquired technology and product rights net totaled $127.4 million.
     Gross margin in 2004 was also favorably impacted by price increases on our products which became effective January 1, 2004 and July 1, 2004 and a lower level of promotional discounts paid to the Company’s wholesaler customers. As discussed, under “Product Sales”, in the third and fourth quarters of 2004, we entered into distribution service agreements with the majority of our wholesaler customers. In connection with the implementation of these agreements, we no longer offer wholesalers promotional discounts or incentives.
     Lastly, the cost of AVINZA product sold in 2004 reflects the full-year impact of a reduction to the pricing of AVINZA purchases from Elan which occurred in prior periods. In November 2002, the Company and Elan agreed to amend the terms of the AVINZA license and supply agreement. Under the terms of the amended agreement, Elan’s adjusted royalty and supply price of AVINZA was reduced to approximately 10% of the product’s net sales, compared to approximately 30-35% in the prior agreement. Under the sell-through revenue recognition model, product shipped to the wholesaler is recorded as “deferred cost of goods sold” and subsequently recognized as cost of sales when it sells-through. Accordingly, the majority of product manufactured by Elan in 2002 at the higher contractual cost of production sold-through and was recognized as cost of sales in 2003. As a result, AVINZA gross margins for 2003 under sell-through revenue recognition reflect this higher product cost compared to cost of product sold in 2004.
     Gross margin in 2004 compared to 2003 was negatively impacted, however, by a higher proportionate level of AVINZA rebates and ONTAK chargebacks and rebates and the costs associated with our wholesaler distribution service agreements as further discussed under “Product Sales.” Additionally, gross margin in 2004 reflects a charge to royalty expense in the amount of $3.0 million, recorded in the fourth quarter of 2004, for deferred royalties at the end of the contracted royalty period for which we did not have offset rights. Under the sell-through revenue recognition method, royalties paid based on unit shipments to wholesalers are deferred and recognized as royalty expense as those units are sold through and recognized as revenue. Royalties paid to technology partners are deferred as we have the right to offset royalties paid for product that are later returned against subsequent royalty obligations. Royalties for which we do not have the right to offset, however, (for example, at the end of the contracted royalty period) are expensed in the period the royalty obligation becomes due.
     Gross margin on product sales was 52.0% in 2003 compared to 51.4% in 2002. The increase in the margin reflects a lower proportionate level of ONTAK sales in 2003. ONTAK has lower overall margins than our other oncology products due to a higher royalty rate owed to third party technology partners. Gross margins also improved in 2003 as a result of a higher absolute level of ONTAK sales which resulted in a higher base to absorb the fixed amortization of the ONTAK acquired technology. This increase was largely offset by a higher proportionate level of AVINZA sales in 2003 compared to 2002 when the product was launched. The cost of the

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majority of AVINZA products recognized in 2003 was manufactured in 2002 under the terms of the existing license and supply agreement with Elan, which provided for a cost of production of approximately 30-35% of the product’s net sales. This cost was significantly higher than the manufacturing cost of our other products.
     Overall, given the fixed level of amortization of the capitalized AVINZA license and royalty rights, we expect the AVINZA gross margin percentages in 2005 to continue to increase as sales of AVINZA increase.
Research and Development Expenses
     Research and development expenses were $65.2 million in 2004 compared to $66.7 million in 2003 and $59.1 million in 2002. The major components of research and development expenses are as follows (in thousands):
                         
    Year Ended December 31,  
    2004     2003     2002  
            (Restated)     (Restated)  
Research
                       
 
Research performed under collaboration agreements
  $ 7,853     $ 10,535     $ 14,906  
Internal research programs
    15,517       12,013       9,990  
 
                 
Total research
    23,370       22,548       24,896  
 
                 
 
                       
Development
                       
 
                       
New product development
    28,329       30,771       20,518  
Existing product support (1)
    13,505       13,359       13,646  
 
                 
Total development
    41,834       44,130       34,164  
 
                 
 
                       
Total research and development
  $ 65,204     $ 66,678     $ 59,060  
 
                 
 
(1)   Includes costs incurred to comply with post-marketing regulatory commitments.
     Overall, spending for research expenses remained relatively constant in 2004 compared to 2003, with increases in expenses for internal research programs offset by decreases in expenses for research performed under collaboration agreements. The decrease in expenses for research performed under collaboration agreements was due primarily to a lower contractual level of research funding under our agreement with TAP and a lower level of research funding agreed to with Lilly in connection with the November 2003 extension of our collaboration agreement through November 2004. The increase in internal research program expenses in 2004 compared to the 2003 period reflects an increased level of effort in the areas of thrombopoietin (TPO) agonists and peroxisome proliferation activated receptors (PPARs). The level of effort on selective androgen receptor modulators (SARMs) remained constant in 2004 as compared to 2003.
     Spending for development expenses decreased to $41.8 million in 2004 compared to $44.1 million in 2003 reflecting a lower level of expense for new product development. The decrease in expenses for new product development is due primarily to a reduced level of spending on Phase III clinical trials for Targretin capsules in NSCLC, which became fully enrolled in 2003. In March 2005, we announced that the final data analysis for Targretin capsules in NSCLC showed that the trials did not meet their primary endpoints of improved overall survival and projected two-year survival. We are continuing to analyze the data and apply it to the continued development of Targretin in NSCLC. As a result of these findings, we expect the overall spending on the NSCLC trials to further decrease in 2005. The decrease in 2004 as compared to 2003 is partially offset by a $1.1 million payment to The Salk Institute in March 2004 to buy out milestone payments, other payment sharing obligations and royalty payments due on future sales of lasofoxifine, a product under development by Pfizer. Pfizer filed an NDA for lasofoxifene with the FDA in August 2004.
     The overall increase in research and development expenses in 2003 compared to 2002 is primarily due to development funding of Phase III clinical trials for Targretin capsules in NSCLC. This increase was partially offset by a lower level of research funding agreed to with Lilly in connection with the two one-year extensions of our

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collaboration agreements through November 2004. This lower level of funding resulted in lower research expenses performed under collaboration agreements by approximately $4.4 million in 2003 compared to 2002.
     We expect overall development expenses to be the same or lower in 2005 due to lower expenses for the completed NSCLC Phase III trials as discussed above, partially offset by higher expense for AVINZA clinical trials and development of our thrombopoietin oral mimic (TPO) compound.

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     A summary of our significant internal research and development programs is as follows:
         
Program   Disease/Indication   Development Phase
AVINZA
  Chronic, moderate-to-severe pain   Marketed in U.S.
 
      Phase IV
 
       
ONTAK
  CTCL   Marketed in U.S., Phase IV
 
  Chronic lymphocytic leukemia   Phase II
 
  Peripheral T-cell lymphoma   Phase II
 
  B-cell Non-Hodgkin’s lymphoma   Phase II
 
  NSCLC third line   Phase II
 
       
Targretin capsules
  CTCL   Marketed in U.S. and Europe
 
  NSCLC first-line   Phase III
 
  NSCLC monotherapy   Planned Phase II/III
 
  NSCLC second/third line   Planned Phase II/III
 
  Advanced breast cancer   Phase II
 
  Renal cell cancer   Phase II
 
       
Targretin gel
  CTCL   Marketed in U.S.
 
  Hand dermatitis (eczema)   Planned Phase II/ III
 
  Psoriasis   Phase II
 
       
LGD4665 (Thrombopoietin oral mimic)
  Chemotherapy-induced thrombocytopenias (TCP), other TCPs   IND Track
 
       
LGD5552 (Glucocorticoid agonists)
  Inflammation, cancer   IND Track
 
       
Selective androgen receptor modulator, e.g.,
LGD3303 (agonist/antagonist)
  Male hypogonadism, female & male osteoporosis, male & female sexual dysfunction, frailty. Prostate cancer, hirsutism, acne, androgenetic alopecia.   Pre-clinical
     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 ability to predict the outcome of complex research, our ability to predict the results of clinical studies, regulatory requirements placed upon us by regulatory authorities such as the FDA and EMEA, our ability 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 the “Risks and Uncertainties” section for additional discussion of the uncertainties surrounding our research and development initiatives.

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Selling, General and Administrative Expenses
     Selling, general and administrative expenses were $65.8 million for 2004 compared to $52.5 million for 2003 and $41.8 million for 2002. The increase in 2004 is primarily due to costs associated with 36 additional Ligand sales representatives hired to promote AVINZA as further discussed under “Recent Developments – Sales Force Activity/Realignment” above, and higher advertising and promotion expenses for AVINZA in connection with our co-promotion activities with Organon which started in March 2003. The 36 additional sales representatives were hired in the second and third quarters of 2004 resulting in higher expenses in the third and fourth quarters of 2004 compared to the first two quarters of 2004 and the full year of 2003. Marketing expenses also increased in 2004 as a result of our increased emphasis on physician-attended product information and advisory meetings for AVINZA. Additionally, selling, general and administrative expenses reflect increased costs incurred in 2004 in connection with the development of an alternate source of supply (Cardinal Health PGS LLC or “Cardinal”) for AVINZA. See further discussion of our agreement with Cardinal under “Liquidity and Capital Resources — Contractual Obligations.”
     The increase in 2003 compared to 2002 is primarily due to costs associated with additional Ligand sales representatives hired to promote AVINZA and higher advertising and promotion expenses for AVINZA which was launched in June 2002. Additionally, marketing expenses increased in 2003 in connection with our increased emphasis on physician-attended product information and advisory meetings for our oncology products. Selling, general and administrative expense for 2003 also includes a $0.7 million interest accrual recorded in the fourth quarter of 2003 for a legal judgment against the Company, related to ongoing litigation with Boston University resulting from amounts withheld from Boston University in connection with the Company’s 1998 acquisition of Seragen. We continue to believe that the plaintiff’s claims are without merit and have appealed the judgment in this case as well as the award of interest and the calculation of damages. The appeal has been fully briefed and was argued in June 2005 and the parties are awaiting the court’s decision.
     Selling, general and administrative expenses are expected to increase in 2005 due to the full year impact of hiring of an additional 36 pain specialist sales representatives as discussed above. Additionally, 2005 expenses will increase due to significantly higher accounting and legal expenses incurred in connection with the restatement of our consolidated financial statements, SEC investigation and shareholder litigation as more fully discussed above under “The Restatement and Other Related Matters.”
Co-promotion Expense
     Co-promotion expense payable to Organon amounted to $30.1 million in 2004 compared to $9.4 million for 2003. As further discussed under “Overview”, we pay Organon, under the terms of our co-promotion agreement, 30% of net AVINZA sales, determined in accordance with GAAP and our standard accounting principles up to $150.0 million and higher percentage payments for net sales in excess of $150.0 million. For 2003, we were required to pay Organon 30% of net AVINZA sales in excess of $35.0 million. Co-promotion expense recognized for 2004 and 2003 was determined based upon the Company’s shipments of AVINZA to wholesalers under the sell-in revenue recognition method. Sell-in AVINZA revenue recognized for 2004 and 2003 was $100.3 million and $66.2 million, respectively. For 2003, the co-promotion expense of $9.4 million was recorded in the fourth quarter, the period in which sell-in revenues exceeded the $35.0 million threshold. As further discussed under “Overview”, however, AVINZA shipments made to wholesalers did not meet the revenue recognition criteria under GAAP and such transactions were restated using the sell-through method.
     Because this sell-in revenue was not in accordance with GAAP, we believe that we have overpaid Organon under the terms of the agreement by approximately $18.6 million as of December 31, 2004. We have notified Organon regarding the overpayment and our intention to apply such overpayment to future amounts due under the co-promotion agreement calculated under GAAP and our revised standard accounting principles. Organon has expressed its disagreement with this position and we are currently in discussions with Organon. While the discussions continue, the payments made are reflected in our 2004 and 2003 consolidated financial statements as co-promotion expense, $9.2 million in 2004 and $9.4 million in 2003, respectively. Therefore, the consolidated financial statements included herein do not recognize the overpayment pending resolution of the matter. Until this matter is resolved, we will continue to account for co-promotion expense based on net sales determined using the sell-in method.

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Other Expenses, Net
     Other expenses, net were $7.5 million for 2004 compared to $20.4 million for 2003 and $8.4 million for 2002. Interest expense increased to $12.3 million for 2004 compared to $11.1 million for 2003 and $6.3 million for 2002. Interest expense in 2004 and 2003 primarily represents interest on the $155.3 million of 6% convertible subordinated notes that we issued in November 2002. The increase in interest expense in 2004 compared to the prior year is due primarily to interest on a note payable secured by one of our corporate office buildings and was partially offset by factoring expense attributable to our account receivable factoring arrangement (as more fully discussed in Note 6 to the consolidated financial statements).
     Effective December 31, 2003, the entity from which we leased the building (Nexus Equity VI LLC or “Nexus”) was consolidated in connection with the implementation of FIN 46(R) “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51.” Prior to that, the lease arrangement with Nexus was treated as an operating lease. We subsequently acquired the portion of Nexus we did not previously own in April 2004.
     The 2002 interest expense represents interest on the $20.0 million in issue price of zero coupon convertible senior notes that were converted into common stock in March 2002 and interest on our outstanding $50.0 million face value of convertible subordinated debentures that were redeemed in June 2002. The increase in interest expense in 2003 compared to 2002 is partially offset by the reduction in debt conversion expense of which $2.0 million was incurred in March 2002 in connection with the early conversion of $20.0 million in issue price of zero coupon convertible senior notes into common stock.
     In 2004, Other, net reflects income of $3.7 million compared to net expenses of $10.0 million in 2003. In September 2004, we agreed to vote our shares of X-Ceptor in favor of the acquisition of X-Ceptor by Exelixis Inc. (“Exelixis”). Exelixis’ acquisition of X-Ceptor was subsequently completed on October 18, 2004 and in connection therewith, Ligand received shares of Exelixis common stock. The shares were restricted securities for which a resale registration statement has been filed. Such shares are subject to trading restrictions for up to two years. Additionally, approximately 21% of the shares were placed in escrow for up to one year to satisfy indemnification and other obligations. We recorded a net gain on the transaction in the fourth quarter of 2004 of approximately $3.7 million, based on the fair market value of the consideration received.
     Other, net expenses of $10.0 million in 2003 include the March 2003 write-off of a $5.0 million one-time payment made in July 2002 to X-Ceptor Therapeutics, Inc. (or X-Ceptor) to extend Ligand’s right to acquire the outstanding stock of X-Ceptor not already held by Ligand. In March 2003, we informed X-Ceptor that we would not exercise the purchase right and wrote-off the purchase right valued at $4.0 million that was recorded in 1999.
Cumulative Effect of Accounting Change
     In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, which was subsequently revised in December 2003 (“FIN 46(R)”). FIN 46(R) requires the consolidation of certain variable interest entities (“VIEs”) by the primary beneficiary of the entity if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or if the equity investors lack the characteristics of a controlling financial interest.
     We implemented FIN 46(R) effective December 31, 2003, and consolidated the entity from which we lease one of our two corporate office buildings as of that date, as we determined that the entity is a VIE, as defined by FIN 46(R), and that we would absorb a majority of its expected losses if any, as defined by FIN 46(R). Accordingly, we consolidated the assets of the entity, which consist of land, the building, and related tenant improvements, with a total carrying value of $13.6 million, net of accumulated depreciation. Additionally, we consolidated the entity’s debt of $12.5 million and non-controlling interest of $0.6 million. In connection with the implementation of FIN 46(R), we also recorded a $2.0 million charge ($0.03 per share) as a cumulative effect of the accounting change on December 31, 2003.

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Income Taxes
     Income tax expense was $0.2 million for 2004 compared to approximately $0.1 million for each of 2003 and 2002. At December 31, 2004, we have both federal and state net operating loss carryforwards of approximately $530.2 million and $94.1 million, respectively, which will begin expiring in 2005. The difference between the federal and California tax loss carryforwards is primarily due to the capitalization of research and development expenses for California income tax purposes and the 50% to 60% limitation on losses incurred prior to 2004 in California. We have $25.0 million of federal research and development credits carryforwards which will expire beginning in 2005, and $13.7 million of California research and development credits that have no expiration date.
     Pursuant to Internal Revenue Code Sections 382 and 383, use of a portion of net operating loss and credit carryforwards will be limited because of cumulative changes in ownership of more than 50% that occurred within three periods during 1989, 1992 and 1996. In addition, use of Glycomend’s and Seragen’s preacquisition tax net operating and credit carryforwards will also be limited because the acquisitions by the Company represent changes in ownership of more than 50%. Such tax net operating loss and credit carryforwards have been reduced, including the related deferred tax assets. In addition, it is possible that we have had subsequent changes in ownership since 1996 that could further limit our net operating loss and credit carryforwards generated during that period. We have not determined whether any such cumulative ownership change has occurred and if so, the extent of any resulting carryforward limitations. The Company’s research & development credits pertain to federal and California jurisdictions. These jurisdictions require that the Company create minimum documentation and support, such as done via a “Research & Development Credit Study.” In the absence of sufficient documentation and support these government jurisdictions may disallow some or all of the credits. Although the Company has not performed a formal study, the Company believes that it maintains sufficient documentation to support the benefitting of the credits in the consolidated financial statements. Prior to utilizing a significant portion of the credits to reduce taxes payable, the Company will review its documentation and support to determine if a formal study is necessary.
Liquidity and Capital Resources
     We have financed our operations through private and public offerings of our equity securities, collaborative research and development and other revenues, issuance of convertible notes, product sales, capital and operating lease transactions, accounts receivable factoring and equipment financing arrangements and investment income.
     Working capital was a deficit of $43.9 million at December 31, 2004 compared to a deficit of $16.9 million at December 31, 2003. Cash, cash equivalents, short-term investments, and restricted investments totaled $ 114.9 million at December 31, 2004 compared to $100.7 million at December 31, 2003. We primarily invest our cash in United States government and investment grade corporate debt securities. Restricted investments at December 31, 2004 consist of shares of Exelixis common stock that have certain trading limitations received in connection with the sale of our shares of X-Ceptor and certificates of deposit held with a financial institution as collateral under equipment financing and third-party service provider arrangements. Restricted investments at December 31, 2003 also included U.S. government securities required to be held with a trustee to pay the semi-annual interest payments due in 2004 on the 6% convertible subordinated notes issued in November 2002. In connection with the restatement, for the year ended December 31, 2002, cash and cash equivalents relating to a letter of credit totaling $1.6 million was reclassified to short-term investments.
Operating Activities
     Operating activities provided cash of $5.8 million in 2004 and $0.3 million in 2003 and used cash of $26.9 million in 2002. Operating cash flow in 2004 benefited from increased product sales and $32.5 million of cash received in connection with the sale to Royalty Pharma AG of rights to future royalties from certain collaborative partners’ net sales of three SERM products compared to cash received in 2003 of $12.5 million for royalty rights sales. Operating cash was negatively impacted, however, by higher operating expenses including development expenses to fund clinical trials of our existing products in new indications including Phase III registration trials for Targretin capsules in NSCLC, and higher selling and marketing expenses for AVINZA.
     Non-cash operating items in 2004 decreased $17.2 million compared to 2003. The decrease includes a development milestone of approximately $2.0 million received from Pfizer, in connection with Pfizer’s filing with

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the FDA of a new drug application for lasofoxifene, paid in stock in September 2004. Non-cash activity in 2004 also includes a net gain on sale of equity investments totaling $3.7 million. Non-cash operating items in 2003 include the $9.0 million write-off of the $5.0 million X-Ceptor payment to extend our X-Ceptor purchase right and capitalization of the purchase right of $4.0 million in March 2003, in connection with our decision to not acquire X-Ceptor, and the non-cash cumulative effect of the change in accounting principle (approximately $2.0 million) recognized in connection with the implementation of FIN 46(R).
     Changes in operating assets and liabilities provided cash of $41.2 million in 2004 primarily due to increases in deferred revenue of $47.9 million and accounts payable and accrued liabilities of $9.8 million, partially offset by increases in accounts receivable and inventories of $11.9 million and $3.3 million, respectively. This compares to cash provided by changes in operating assets and liabilities in 2003 of $69.9 million due to increases in deferred revenue of $57.0 million and accounts payable and accrued liabilities of $24.2 million, partially offset by increases in accounts receivable and inventories of $6.5 million and $3.5 million, respectively. The increase in deferred revenue in each period reflects shipments of product into the wholesale and retail distribution channels offset in part by end-customer product demand recognized as revenue under the sell-through revenue recognition method. The increase in accounts receivable in each period reflects increasing wholesaler purchases in connection with the growth of product demand, primarily AVINZA for which co-promotion activities with Organon started in 2003. Likewise, the increase in accounts payable and accrued liabilities for each year primarily reflects the growth in Medicaid rebates and government chargebacks in connection with the growth in demand of AVINZA and ONTAK. Operating cash flows in 2003 also benefited from the impact of the accounts receivable factoring arrangement which was entered into in the second quarter of 2003.
     Operating cash flow in 2003 compared to 2002 benefited from increased product shipments, as reflected in the increase in deferred revenue. The increase in 2003 was also due to increases in our sales related liability accounts.
     We expect operating cash flows to benefit in 2005 from increased product demand due primarily to growth in AVINZA. Operating cash is expected to be negatively impacted, however, by lower product shipments to wholesalers in accordance with reduced inventory levels we negotiated with our major wholesaler customers in the distribution service agreements. The impact of the lower shipments will be partially offset by lower fees paid under the distribution service agreements. Operating cash flows are expected to be further negatively impacted by higher selling and marketing expenses on AVINZA and increased accounting and legal expenses incurred in connection with the restatement of our consolidated financial statements as further discussed above under “Background of the Restatement.” Consistent with 2004, we are required to pay interest of approximately $9.3 million in 2005 on the $155.3 million in 6% convertible subordinated notes issued in November 2002.
Investing Activities
     Investing activities provided cash of $19.6 million in 2004 and used cash of $14.2 million in 2003 and $124.1 million in 2002. Cash provided by investing activities for 2004 reflects net proceeds of $14.1 million from the sale of short-term investments and $9.2 million from the maturing of restricted investments which was subsequently used to pay interest on our 6% Convertible Subordinated Notes. The use of cash in 2004 reflects $3.6 million for capital purchases. The use of cash in 2003 reflects the net purchase of short-term investments of $18.0 million, a $4.1 million payment to Elan in connection with the November 2002 restructuring of the AVINZA license and supply agreement and capital purchases of $2.8 million. Cash provided by investing activities for 2003 includes $10.4 million from the maturing of restricted investments which was subsequently used to pay interest on our 6% Convertible Subordinated Notes.
     The use of cash in 2002 includes $100.0 million paid to Elan to restructure the AVINZA license and supply agreement and $1.3 million in related transaction fees. The use of cash in 2002 also includes the restriction of $18.0 million of the proceeds from the Company’s issuance in November 2002 of 6% Convertible Subordinated Notes. The $18.0 million was required to be invested in a U.S. government securities and placed with a trustee to pay the first four scheduled interest payments on the notes. Other investing activity in 2002 includes a $5.0 million payment to X-Ceptor Therapeutics, Inc. (X-Ceptor) and capital expenditures of $3.2 million, partially offset by net proceeds of $4.1 million from the sale of short-term investments. The payment to X-Ceptor was pursuant to a 1999 investment agreement where we maintained the right to acquire all of the outstanding stock of X-Ceptor not held by Ligand at June 30, 2002, or to extend the purchase right for 12 months by providing additional funding of $5.0

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million. In April 2002, we elected to extend the purchase right and payment was subsequently made in July 2002. In March 2003, Ligand informed X-Ceptor that it would not exercise the purchase right.
Financing Activities
     Financing activities provided cash of $7.9 million in 2004 compared to $32.1 million in 2003 and $171.1 million in 2002. Cash provided by financing activities in 2004 includes net proceeds of $6.6 million from the exercise of employee stock options and stock purchases under our employee stock purchase plan and $1.8 million of net proceeds received under equipment financing arrangements. Cash provided by financing activities in 2003 includes net proceeds of $45.0 million from the issuance of common stock through a private placement of 3,483,593 shares of our common stock, $4.5 million from the exercise of employee stock options and employee stock purchases, and $1.1 million from equipment financing arrangements. The net proceeds of $45.0 million from the private placement were used to support our working capital priorities, including qualifying second source manufacturer(s) for AVINZA, work on a second generation formulation of ONTAK, continuing expansion of commercial support activities for AVINZA and ONTAK, and for general corporate purposes. These proceeds were offset by the $15.9 million repurchase and retirement of approximately 2.2 million shares of our outstanding common stock held by an affiliate of Elan in connection with a November 2002 share repurchase agreement completed in February 2003, and payments of $2.5 million on equipment financing arrangements.
     Cash provided by financing activities in 2002 includes net proceeds of $150.1 million from the issuance of 6% Convertible Subordinated Notes in November 2002, net proceeds of $66.1 million through a private placement of 4,252,500 shares of our common stock, and $3.8 million from the exercise of employee stock options and employee stock purchases. This was partially offset by the $50.0 million early redemption of convertible subordinated debentures in June 2002. The Convertible Subordinated Notes issued in November 2002 pay interest at a semi-annual rate of 6% and mature on November 16, 2007. Of the net proceeds, $18.0 million was used to pay the first four scheduled interest payments.
     Certain of our property and equipment is pledged as collateral under various equipment financing arrangements. As of December 31, 2004, $6.6 million was outstanding under such arrangements with $2.6 million classified as current. Our equipment financing arrangements have terms of three to five years with interest ranging from 4.73% to 10.66%.
     We believe our available cash, cash equivalents, short-term investments and existing sources of funding will be sufficient to satisfy our anticipated operating and capital requirements through at least the next 12 months. Our future operating and capital requirements will depend on many factors, including: the effectiveness of our commercial activities; the pace of scientific progress in our research and development programs; the magnitude of these programs; the scope and results of preclinical testing and clinical trials; the time and costs involved in obtaining regulatory approvals; the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; competing technological and market developments; the ability to establish additional collaborations or changes in existing collaborations; the efforts of our collaborators; and the cost of production. We will also consider additional equipment financing arrangements similar to arrangements currently in place.
Leases and Off-Balance Sheet Arrangements
     As of December 31, 2003, we leased one of our corporate office buildings from Nexus Equity VI LLC (“Nexus”), a limited liability company in which Ligand held a 1% ownership interest. No Ligand officer or employee had any financial interest with regard to this lease arrangement or with Nexus. The lease agreement provided for increases in annual rent of 4% and terminated in 2014. In addition, we had the option to either purchase the portion of Nexus that we did not own, purchase the property from the lessor at a purchase price equal to the outstanding debt on the property plus a calculated return on the investment made by Nexus’ other shareholder, sell the property to a third party, or renew the lease arrangement.
     This specific type of operating lease is commonly referred to as a “synthetic lease.” Prior to the issuance of FIN 46(R), synthetic leases represented a form of off-balance sheet financing under which they were treated as an operating

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lease for financial reporting purposes and as a financing lease for tax purposes. Under FIN 46(R), a synthetic lease is evaluated to determine i) if it qualifies as a VIE and if so, ii) the primary beneficiary required to consolidate the VIE.
     Under FIN 46(R), we determined that Nexus qualified as a VIE, and that we were the primary beneficiary of the VIE, as we would absorb the majority of the entity’s expected losses, if any, as defined by the Interpretation. In accordance with FIN 46(R), we consolidated Nexus as of December 31, 2003. See Note 3, “Significant Accounting Policies – Cumulative Effect of Accounting Change” section for information on the impact of the Company’s adoption of FIN 46(R).
     In April 2004, we exercised our right to acquire the portion of Nexus that we did not own. The acquisition resulted in our assumption of the existing loan against the property and payment to Nexus’ other shareholder of approximately $0.6 million.
     We lease our other office and research facilities under operating lease arrangements with varying terms through July 2015. The agreements provide for increases in annual rents based on changes in the Consumer Price Index or fixed percentage increases ranging from 3% to 7%.
     Contractual Obligations
     As of December 31, 2004, future minimum payments due under our contractual obligations are as follows (in thousands):
                                         
   
Payments Due by Period
   
 
    Total     Less than 1 year     1-3 years     3-5 years     After 5 years  
Capital lease obligations (1)
  $ 7,365     $ 2,980     $ 3,684     $ 701     $ ¾  
Operating lease obligations
    22,464       2,939       4,177       3,721       11,627  
Loan payable to bank (2)
    15,190       1,191       2,381       11,618       ¾  
6% Convertible Subordinated Notes (3)
    183,195       9,315       173,880       ¾       ¾  
Other liabilities (4)
    3,549       3,000       549       ¾       ¾  
Distribution service agreements
    6,864       6,864       ¾       ¾       ¾  
Consulting agreements
    418       418       ¾       ¾       ¾  
Manufacturing agreements (5)
    11,232       11,131       100       ¾       ¾  
 
                             
Total contractual obligations
  $ 250,277     $ 37,839     $ 184,771     $ 16,040     $ 11,627  
 
                             
 
(1)   Includes $0.8 million of interest payments.
 
(2)   Includes interest of $0.9 million, $1.7 million, and $0.5 million for 2005, the period from 2006 to 2007 and 2008, respectively.