[LATHAM & WATKINS LLP LETTERHEAD]
February 3, 2006
Jim B. Rosenberg
Senior Assistant Chief Accountant
United States Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
RE: Ligand Pharmaceuticals, Inc.
Form 10-K for the Fiscal Year Ended December 31, 2004
Filed November 18, 2005
File No. 000-20720
Dear Mr. Rosenberg,
This letter is in response to your letter dated January 24, 2006 regarding the
above reference filing. In your letter, you asked the following questions in
connection with the company's above referenced filings. For your convenience, we
have reiterated the staff's comments below.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
CRITICAL ACCOUNTING POLICIES
NET PRODUCT SALES, ALLOWANCE FOR RETURN LOSSES, ONTAK END-CUSTOMER RETURNS,
MEDICAID REBATES, GOVERNMENT CHARGEBACKS, MANAGED HEALTH CARE REBATES AND OTHER
CONTRACT DISCOUNTS, PAGES 118 AND 119
1. We have referred to your December 31, 2004 Form 10-K filed on November
18, 2005 solely to evaluate your compliance with comment 1 of our
December 14, 2004 comment letter and the related verbal comment issued
on February 11, 2005 and have not otherwise reviewed your filing.
Please expand your critical accounting estimate disclosure for each of
the captions listed above on pages 118 and 119 to address the
following:
o Augment your assertion that amounts "may be materially
different than our estimates" by quantifying the reasonably
likely effect of changes in these estimates on your results of
operations and financial position. If you are unable to
quantify the reasonably likely effect, please disclose this
fact. In addition, clarify on pages 103 and 104 whether the
impact of a 20% variance on your estimated Medicaid and
managed care contract rebate accruals for AVINZA and a 20%
variance to your Medicaid rebate and estimated chargeback
accruals for ONTAK is reasonably likely. We believe that a
meaningful
February 3, 2006
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LATHAM & WATKINS LLP
sensitivity analysis should be based on reasonably ikely
changes and not on hypothetical changes. Please review your
analysis accordingly.
RESPONSE:
For the Company's allowances for ONTAK end-customer returns, government
chargebacks and other discounts, the Company believes that the reasonably likely
effect of changes in estimates on its results of operations and financial
position would not be material. This assessment is based on the Company's
experience, the nature of the activity for each account and the materiality of
such accounts. By way of reference, the balances of the ONTAK end-customer
returns and the government chargebacks reserve accounts as of December 31, 2004
were approximately $2.0 million and $0.5 million, respectively. Disclosure to
this effect will be added to the applicable sections of the critical accounting
estimates section of the MD&A. I have attached as Exhibit A exemplary language
for this disclosure.
With respect to this additional disclosure, as you know, the Company has a
currently pending S-1 registration statement before the Commission. The Company
respectfully requests that this enhanced disclosure, and other enhanced
disclosure discussed in this letter, be included in the S-1 and future Forms
10-K, including the upcoming 2005 Form 10-K, rather than amending its 2004 Form
10-K. The Company respectfully submits that because the new disclosure can be
easily and quickly added to the pending S-1 this is the most expedient and least
confusing way to get this information in the hands of investors. Moreover, since
the Company will additionally include the new disclosures in its 2005 Form 10-K
due to be filed in a little over a month, there would be little if any
incremental benefit to investors in amending the Company's 2004 Form 10-K.
Due to the inherent difficulties in predicting the impact of rapidly evolving
Medicaid, Medicare, and other federal and state government programs, however,
the Company believes that it is not in a position to accurately quantify the
reasonably likely effect on its results of operations and financial position of
changes in estimates related to provisions for Medicaid and managed care
rebates. Similarly, due to the difficulty in predicting potential changes to
losses to be incurred on returns as a result of price changes (given the
difficulty in predicting future prescription levels and wholesaler inventory
practices, among other factors), the Company does not believe that it is in a
position to accurately quantify the reasonably likely effect of changes to the
allowance for return losses. Accordingly, disclosure will be added to the
critical accounting estimate section of the MD&A in the Form S-1 and the
Company's 2005 10-K to discuss each of these limitations. In addition, while the
Company cannot quantify the reasonably likely effect, it believes that providing
the reader with a reference point of the potential impact of changes to its
estimates is useful. Accordingly, the Company will revise its disclosure to note
the impact of a 10-20% variance solely for reference purposes. Please see
Exhibit A for exemplary disclosure.
o We note your schedule on page 187 for the allowances for loss on returns,
rebates, chargebacks and other discounts, ONTAK end-customer and Panretin
returns. Please reference this schedule in your critical accounting
estimate section of the MD&A. In addition, please provide separate line
items in your schedule for the provision for sales made in the current
period and the provision for sales made in prior periods. In your Results
of Operations MD&A discussion, please quantify and discuss the effects that
changes in estimates for these accruals had for each period presented. If
you are unable to determine changes in estimates for each period, disclose
this fact and explain in the disclosure why management believes the
financial statements are fairly stated.
February 3, 2006
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LATHAM & WATKINS LLP
RESPONSE:
In its Form S-1 and all future filings of its Form 10-K beginning with the 2005
Form 10-K, the Company will also include the schedule of allowances for loss on
returns, rebates, chargebacks and other discounts, ONTAK end-customer and
Panretin returns, which now appears on page 187, in the critical accounting
estimate section of the MD&A. In regard to that portion of the comment relating
to separate line item disclosure for current sales and prior sales, however,
please note that the provisions for sales for 2004, 2003, and 2002 were restated
to conform to the Company's restated sell-through revenue recognition
methodology. Based on the timing of the completion of the restatement and
therefore the ability to look back and specifically identify actual expenses to
the product sales that were recognized on the restated sell-through basis, the
recorded provisions represent the actual expenses incurred in each of the
respective periods. Accordingly, the amounts presented do not include changes in
estimates.
As noted above, the schedule of allowances is included in the S-1 and will be
included in the critical accounting estimates section of the MD&A of all future
Form 10-K filings beginning with the Company's 2005 Form 10-K. Additionally, if
they are material, the Company will add separate line items for the provision
for sales made in the current period and the provision for sales made in prior
periods for those accounts for which data is available (specifically, Medicaid
rebates, chargebacks, managed care rebates and other discounts).
However, for ONTAK end-customer returns and for losses on returns due to changes
in prices, Ligand, as noted in the Company's response letter dated January 27,
2005, is unable to precisely correlate returns or credit activity by lot (i.e.
expiration) during any one reporting period to product sales by lot in that or
any other reporting period due to the fact that sales recognized for any
individual lot may span several reporting periods. Likewise the return of units
of any lot may occur during the same reporting period in which the sales were
recognized or span several reporting periods.
In this context it is important to note that the Company's revenue recognition
policy for ONTAK is now based on the sell-through methodology whereby revenue is
recognized upon shipment of product from the Company's wholesaler customers to
end-users of ONTAK. When determining its estimates for ONTAK end-user returns,
the Company uses all available information including historical returns data
which has been a relatively small number of units and in terms of activity
fairly consistent over the last five years. By way of reference, the Company's
reserve for ONTAK end-customer returns as of December 31, 2004 was approximately
$2.0 million. Accordingly, the Company believes it has sufficient information
and therefore the ability to make reasonable estimates of the provision for
ONTAK end-customer returns for each reporting period.
The allowance for return losses represents an estimate of the Company's
liability for product that may be returned from the Company's wholesalers at a
selling price which is greater than the price at which the product was shipped
to the wholesaler due to subsequent price increases. It is important to note
that this account is specific to and represents a specialized component of the
Company's sell-through revenue recognition method although it is not directly
linked to revenue recognition. This is because the product for which the return
loss is determined is product that has not sold-through the distribution channel
and therefore has not been recognized as revenue. Again, when determining its
estimate of the allowance for loss on returns, the Company uses all available
information including actual returns experience on a lot by lot basis.
Accordingly, the Company believes it has sufficient information and therefore
the ability to make reasonable estimates of the provision for return losses for
each reporting period.
Therefore, in response to the Staff's comment, in future filings beginning with
its 2005 Form 10-K, the Company will quantify and discuss the effects of any
material changes to its assumptions and estimates in
February 3, 2006
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LATHAM & WATKINS LLP
the Results of Operations MD&A discussion. In addition, for those accounts for
which the Company can identify changes in estimates by period, any such material
changes will likewise be discussed in the Results of Operations MD&A discussion.
o Discuss in your Results of Operations MD&A discussion the reasons for
year-to-year fluctuations in the provisions for each item, particularly
the provision for Medicare rebates that increased from $511,000 in 2002
to $14,430,000 in 2004 and the provision for managed care rebates and
other contract discounts that increased from $34,000 in 2002 to
$5,773,000 in 2004.
RESPONSE:
The provision for Medicaid rebates and the provision for managed care rebates
primarily relate to the product AVINZA. Reference is made to the discussion in
the second paragraph on page 103 which clarifies the factors that negatively
impacted AVINZA sales. Additionally, the provision for chargebacks primarily
relates to the product ONTAK and is discussed in the carryover paragraph on page
104. The applicable discussions in the Form S-1 will provide an appropriate
cross reference to the table that will be included, as discussed above, in the
MD&A (and which now appears on page 187). As applicable, the 2005 Form 10-K will
provide similar disclosure.
* * * *
Thank you for your assistance in this matter. If you have any questions or
comments regarding the foregoing, please do not hesitate to contact the
undersigned at 202-637-2242.
Very truly yours,
/s/ John Huber
John Huber
Latham & Watkins LLP
cc: Lisa Vanjoske
Dana Hartz
EXHIBIT A
THE FOLLOWING IS AN EXCERPT FROM THE COMPANY'S MOST RECENT CRITICAL ACCOUNTING
POLICIES DISCLOSURE IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" MARKED TO SHOW CHANGES IN RESPONSE TO STAFF
COMMENTS. THIS EXHIBIT AND THE CHANGES MARKED REPRESENT SAMPLE DISCLOSURES ONLY
AND ARE NOT TO BE CONSTRUED OR RELIED UPON AS ACTUAL DISCLOSURES OF THE COMPANY.
ALLOWANCE FOR RETURN LOSSES
Product sales are also net of adjustments for losses resulting from price
increases the Company may experience on product returns from its wholesaler
customers. 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. Upon an announced price increase, typically in the quarter
prior to when a price increase becomes effective, 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 price and the previous price used to value the
allowance. Due to estimates and assumptions inherent in determining the amount
of return losses, the actual amount of product returns may be materially
different from our estimates. IN ADDITION, BECAUSE OF THE INHERENT DIFFICULTIES
OF PREDICTING POSSIBLE CHANGES TO THE ESTIMATES AND ASSUMPTIONS USED TO
DETERMINE LOSSES TO BE INCURRED ON RETURNS FROM PRICE CHANGES DUE TO, AMONG
OTHER FACTORS, CHANGES IN FUTURE PRESCRIPTION LEVELS AND WHOLESALER INVENTORY
PRACTICES, WE ARE UNABLE TO QUANTIFY AN ESTIMATE OF THE REASONABLY LIKELY EFFECT
OF ANY SUCH CHANGES ON OUR RESULTS OF OPERATIONS OR FINANCIAL POSITION. FOR
REFERENCE PURPOSES, A 10% - 20% VARIANCE TO OUR ESTIMATED ALLOWANCE FOR RETURNS
LOSSES WOULD RESULT IN A $___ TO $___ ADJUSTMENT TO NET PRODUCT SALES.
ONTAK END-CUSTOMER RETURNS
Under the sell-through method of revenue recognition, the estimate of
product returns from the wholesalers does not result in a gross to net sales
adjustment since the shipment of product to the wholesalers does not result in
revenue recognition. For ONTAK, revenue is recognized when product is shipped
from wholesalers to end-customers, primarily hospitals and clinics that have the
capability to administer the product to patients. These customers have the right
to return expired product to the wholesaler who in turn can return the product
to the Company. In accordance with SFAS 48, we record a return provision upon
sell-through of ONTAK by establishing a reserve in an amount equal to our
estimate of sales recorded but for which the related products are expected to be
returned by the end customer. We determine our estimate of the sales return
accrual based on historical experience. Due to the estimates and assumptions
inherent in determining the amount of ONTAK end-customer returns, the actual
amount of product returns may be materially different from our estimates. BASED
ON THE COMPANY'S EXPERIENCE WITH RETURNS OF ONTAK FROM END-CUSTOMERS, HOWEVER,
WE DO NOT BELIEVE THAT A MATERIAL CHANGE TO OUR ESTIMATED ALLOWANCE FOR ONTAK
END-CUSTOMER RETURNS IS REASONABLY LIKELY.
MEDICAID REBATES
Our products are subject to state government-managed Medicaid programs
whereby discounts and rebates are provided to participating state governments.
We account for Medicaid rebates by establishing an accrual in an amount equal to
our estimate of Medicaid rebate claims attributable to sales recognized in that
period. We determine our estimate of the Medicaid rebates accrual primarily
based on historical experience regarding Medicaid rebates, as well as current
and historical prescription activity provided by external sources, current
contract prices and any expected contract changes. We additionally consider any
legal interpretations of the applicable laws related to Medicaid and qualifying
federal and state government programs and any new information regarding changes
in the Medicaid programs' regulations and guidelines that would impact the
amount of the rebates. We adjust the accrual periodically throughout each period
to reflect actual experience, expected changes in future prescription volumes
and any changes in business circumstances or trends. Due to estimates and
assumptions inherent in determining the amount of rebates, the actual amount of
claims for rebates may be materially different from our estimates. IN ADDITION,
BECAUSE OF THE INHERENT DIFFICULTIES OF PREDICTING THE IMPACT ON OUR ESTIMATES
AND ASSUMPTIONS OF RAPIDLY EVOLVING STATE MEDICAID PROGRAMS AND REGULATIONS, WE
ARE UNABLE TO QUANTIFY AN ESTIMATE OF THE REASONABLY LIKELY EFFECT OF ANY SUCH
CHANGES ON OUR RESULTS OF OPERATIONS OR FINANCIAL POSITION. FOR REFERENCE
PURPOSES, A 10% - 20%
VARIANCE TO OUR ESTIMATED ALLOWANCE FOR STATE MEDICAID REBATES WOULD RESULT IN
A $___ TO $___ ADJUSTMENT TO NET PRODUCT SALES.
GOVERNMENT CHARGEBACKS
Our products are subject to certain programs with federal government
entities and other parties whereby pricing on products is extended below
wholesaler list price to participating entities. These entities purchase
products through wholesalers at the lower vendor price, and the wholesalers
charge the difference between their acquisition cost and the lower vendor price
back to us. We account for chargebacks by establishing an accrual in an amount
equal to our estimate of chargeback claims. We determine our estimate of the
chargebacks primarily based on historical experience regarding chargebacks and
current contract prices under the vendor programs. We consider vendor payments
and our claim processing time lag and adjust the accrual periodically throughout
each period to reflect actual experience and any changes in business
circumstances or trends. Due to estimates and assumptions inherent in
determining the amount of government chargebacks, the actual amount of claims
for chargebacks may be materially different from our estimates. BASED ON THE
COMPANY'S EXPERIENCE WITH GOVERNMENT CHARGEBACKS, HOWEVER, WE DO NOT BELIEVE
THAT A MATERIAL CHANGE TO OUR ESTIMATED ALLOWANCE FOR CHARGEBACKS IS REASONABLY
LIKELY.
MANAGED HEALTH CARE REBATES AND OTHER CONTRACT DISCOUNTS
We offer rebates and discounts to managed health care organizations and
to other contract counterparties such as hospitals and group purchasing
organizations in the U.S. We account for managed health care rebates and other
contract discounts by establishing an accrual in an amount equal to our estimate
of managed health care rebates and other contract discounts. We determine our
estimate of the managed health care rebates and other contract discounts accrual
primarily based on historical experience regarding these rebates and discounts
and current contract prices. We also consider the current and historical
prescription activity provided by external sources, current contract prices and
any expected contract changes and adjust the accrual periodically throughout
each period to reflect actual experience and any changes in business
circumstances or trends. Due to estimates and assumptions inherent in
determining the amount of rebates and contract discounts, the actual amount of
claims for rebates and discounts may be materially different from our estimates.
IN ADDITION, BECAUSE OF THE INHERENT DIFFICULTIES OF PREDICTING THE IMPACT ON
OUR ESTIMATES AND ASSUMPTIONS OF RAPIDLY EVOLVING MANAGED CARE PROGRAMS, WE ARE
UNABLE TO QUANTIFY AN ESTIMATE OF THE REASONABLY LIKELY EFFECT OF ANY SUCH
CHANGES ON OUR RESULTS OF OPERATIONS OR FINANCIAL POSITION. FOR REFERENCE
PURPOSES, A 10% - 20% VARIANCE TO OUR ESTIMATED ALLOWANCE FOR MANAGED HEALTH
CARE AND OTHER CONTRACT DISCOUNTS WOULD RESULT IN A $___ TO $___ ADJUSTMENT TO
NET PRODUCT SALES.
INVENTORIES
Our inventories are stated at the lower of cost or market value. Cost is
determined using the first-in, first-out method. We record reserves for
estimated obsolescence to account for unsaleable products including products
that are nearing or have reached expiration, and slow-moving inventory. If
actual future demand or market conditions are less favorable than our estimates,
then additional material inventory write-downs might be required.
ACQUIRED TECHNOLOGY AND PRODUCT RIGHTS
Acquired technology and product rights represent payments related to our
acquisition of ONTAK and license and royalty rights for AVINZA. In accordance
with SFAS 142, these payments are amortized on a straight line basis since the
pattern in which the economic benefit of these assets are consumed (or otherwise
used up) cannot be reliably determined. Accordingly, acquired technology and
product rights are amortized on a straight-line basis over 15 years, which
approximated the remaining patent life at the time the assets were acquired and
represents the period estimated to be benefited. Specifically, we are amortizing
the ONTAK asset through June 2014, which is approximate to the expiration date
of its U.S. patent of December 2014. The AVINZA asset is being amortized through
November 2017, the expiration of its U.S. patent.
IMPAIRMENT OF LONG-LIVED ASSETS
We review long-lived assets, including acquired technology and product
rights and property and equipment, during the fourth quarter of each year, or
whenever events or circumstances indicate that the carrying amount of the assets
may not be fully recoverable. We measure the recoverability of assets to be held
and used by comparing the carrying amount of an asset to the future undiscounted
net cash flows expected to be generated by the asset. If an asset is considered
to be impaired, the impairment to be recognized is measured as the amount by
which the carrying amount of the asset exceeds its fair value. Fair value of our
long-lived assets are determined using the expected cash flows discounted at a
rate commensurate with the risk involved. Assumptions and estimates used in the
evaluation of
impairment may affect the carrying value of long-lived assets, which could
result in impairment charges in future periods.
We believe that the future cash flows to be received from our long-lived
assets will exceed the assets' carrying value, and accordingly have not recorded
any impairment losses through December 31, 2004. Our impairment assessment could
be impacted by various factors including a more than insignificant disruption of
supply, new competing products or technologies that could result in a
significant decrease in the demand for or the pricing of our products,
regulatory actions that require us to restrict or cease promotion of the
products, a product recall to address regulatory issues, and/or patent claims by
third parties.
INCOME TAXES
Income taxes are accounted for under the liability method. This approach
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of differences between the tax basis of assets or
liabilities and their carrying amounts in the consolidated financial statements.
A valuation allowance is provided for deferred tax assets if it is more likely
than not that these items will either expire before we are able to realize their
benefit or if future deductibility is uncertain. Developing the provision for
income taxes requires significant judgment and expertise in federal and state
income tax laws, regulations and strategies, including the determination of
deferred tax assets and liabilities and, if necessary, any valuation allowances
that may be required for deferred tax assets. Our judgments and tax strategies
are subject to audit by various taxing authorities. While we believe we have
provided adequately for our income tax liabilities in our consolidated financial
statements, adverse determinations by these taxing authorities could have a
material adverse effect on our consolidated financial condition and results of
operations.
STOCK-BASED COMPENSATION
We grant stock options to our employees at an exercise price equal to the
fair value of the shares at the date of grant and account for these stock option
grants in accordance with APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES ("APB 25") and related interpretations. Under APB 25, when stock
options are issued with an exercise price equal to the market price of the
underlying stock on the date of grant, no compensation expense is recognized in
the statement of operations. Refer to Note 3 of the notes to consolidated
financial statements for pro-forma disclosures of the impact on our consolidated
financial statements of accounting for stock options under the fair-value
requirements of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION.