Download Appendix-A - Zacks Small Cap Institutional Research

March 24, 2005
Research Associate: Shilpa Chandak, CA, B.Com
Editor: Ian Madsen, MBA, CFA
[email protected]
Tel: 1-800-767-3771, x 417
Research Digest
www.zackspro.com
Ligand Pharma.
155 North Wacker Drive
(LGND - NASDAQ)
Chicago, IL 60606
$7.73
New Comments in Yellow
Overview
Ligand Pharmaceuticals has been able to establish a number of potentially very favorable R&D
collaborations and partnerships with some of the world’s largest pharmaceutical companies. The company
seeks to utilize its research focus to develop a sizable high margin royalty stream over the next several years
that will in turn fund more proprietary products later in the decade. Additionally, the company has products
for pain maintenance and various hematologic cancers than contribute to current revenues. LGND is on the
verge of its first positive fiscal year in 2004, and lead product Avinza (pain) will be the driving force.
On March 17, 2005 prior to its conference call, management announced that 4Q04 and FY04 earnings would
be delayed, along with its 10-K filing due to review of revenue recognition. Ligand stated that the review is in
its early stages and that it does not know when it will be completed. The review is largely related to how
sales are recorded when the product has a right of return, and the review applies to current and past
financial reporting.
Strengths/Opportunities
Avinza for pain management has experienced a solid
ramp, and analysts believe the drug has captured 4%
market share so far (in-line with management goals).
The company seeks additional label expansion of Ontak,
current marketed for CTCL, into other hematologic
cancers such as NHL and CLL.
A Targretin Gel has the potential to reaccelerate the
franchise growth in CTCL and open up new sales into
chronic hand dermatitis.
The restructuring of the Ontak royalty deal with Eli Lilly,
and LGND with Royalty Pharma is designed to be
accretive to the company.
The SERM partnerships with both WYE and PFE are
progressing into late stage clinical development.
Weaknesses/Threats
Sustained Release Opioid drugs such as Avinza have
come under heavy scrutiny from the DEA over their
highly addictive nature.
Avinza sales in the Q3-04 came in below expectations
on Medicare rebates and product returns
We found a lack of visibility into the R&D pipeline and
the collaborations with large-cap pharmaceutical
companies.
Some believe that management guidance for 2004 is
too aggressive
Delay in filing 10k due to revenue recognition
The Company markets a number of 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 Tcell lymphoma (CTCL); Targretin capsules and Targretin gel for the treatment of CTCL in patients who
are refractory to at least one prior systemic therapy, and Panretin gel for the treatment of Kaposi's
sarcoma (KS) in AIDS patients.
LGND also has a number of high profile R&D collaborations with many in the large-cap pharmaceutical
industry. Specifically a PPAR (peroxisome proliferation activated receptor) program with LLY has the
potential to bring a significant breakthrough product to the market for Type 2 diabetes. LGND also has
ongoing partnerships with WYE and PFE to develop a SERM (selective estrogen receptor modulator)
product for osteoporosis. In total LGND has a partnership with seven major pharmaceuticals companies,
including three products currently in Phase III clinical trials. The eventual high margin royalty payments
expected in the coming years should these products become a success would lead to sizable profitability
increases for this small biotechnology company.
© Copyright 2003, Zacks Investment Research. All Rights Reserved.
Sales
Avinza capsules are a modified-release formulation of morphine sulfate indicated for once daily
administration for the relief of moderate to severe pain requiring continuous, around-the-clock opioid
therapy for an extended period of time. The product received approval in 2002. LGND currently copromotes Avinza with Organon Pharmaceuticals and will pay a 30% royalty on the first $150M in sales.
Sales in the Q3-04 came in $7M below estimates at $28.3M. LGND management attributed the Avinza
shortfall to a higher level of Medicaid, an imbalanced sales force structure, commercial contract rebates,
and product returns. According to IMS health, total Avinza sales in July, August, and September reached
$38M representing a 21% sequential growth over Q204. Avinza sales increased due to 10% price
increase in January and another 9% price rise in July 2004. An analyst (Banc of America) believes that
the shortfall was caused by decrease in inventory level and de-stocking during the quarter. Contract
rebates and product returns were also factors that contributed towards it. One analyst (Roth Capital) feels
that product returns should stabilize in future, as lots from development stage batches have now been
fully withdrawn from the channel and their 6-month policy return limit has expired. In the call,
management mentioned the sales force restructuring and rebalancing plan. However other (Banc of
America) believes that such an action is unlikely to yield meaningful sales improvement in the absence of
a better understanding of both inventory management and contract revenue issues. Our digest average
for 2004 Avinza sales declined from $128M to $107.5M after the Q3-04 report.
LGND is optimistic on the revenue per script trends with Avinza based on the increase in price, a
decrease in coupon use, and a shirt to higher doses. The current revenue per script of around $150 is
expected to increase to $160-$170 by year-end as rebates subside. This gives some analysts (Natexis,
Fortis Bank, Roth Capital) optimism that LGND can still deliver total sales within the guided range.
Avinza’s market share continues to grow in the Q3-04 to 4.8% up from 4.5% in March, 2004. In 3Q-04
Avinza prescriptions increased by 11% over the previous quarter. Analysts (Friedman Billings) believe
that Avinza’s favorably listing with Medicaid could allow it to capture nearly 80% of the $300-$350M
business. While talking to doctors at the American Pain Society meeting, they found the drug (Avinza) is
differentiated on its once-daily dosage and improved sleep profile. Peak Avinza sales look to be around
$500M (Friedman Billings, Natexis). Although management commented that all Avinza sales are subject
to the right of return, they refused to provide clarity on whether other products might be included in any
potential adjustment, or on the possibility that no adjustment will be necessary. Additionally, LGND was
tight-lipped on whether the review was spurred by changes in 4Q product return trends relative to
previous periods. LGND expanded the manufacturing and packing agreement with Cardinal Health in the
Q4, allowing for greater supply in the midst of relatively positive demand trends.
Avinza Sales
2003A
$66.1M
2004E
$100-$110
2005E
$125-$200
2006E
$140-$290
Est. Growth
40-50%
Ontak is indicated for the treatment of patients with persistent or recurrent Cutaneous T-Cell Lymphoma
(CTCL). The drug is a recombinant DNA-derived cytotoxic protein composed of the amino acid
sequences for diphtheria toxin fragments A and B followed by the sequences for interleukin-2. Ontak is
produced as a fusion protein designed to direct the cytocidal action of diphtheria toxin to cells that
express the IL-2 receptor. This mechanism inhibits cellular protein synthesis and causes the (cancer)
cell death. The drug is also used off-label for other hematologic cancers such as Non-Hodgkin’s
Lymphoma (NHL) and Chronic Lymphocytic Leukemia (CLL). On December 5, 2004 LGND presented
interim data from a Phase II trial of Ontak in the treatment of T-Cell Lymphoma. Data from 17 heavily pretreated patients demonstrated an overall response rate of 53% and a complete response rate of 12%.
The median progression-free survival among the responders was 5 months. Although the Phase II study
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was small, in conjunction with the previously reported data in B-cell Lymphoma, an analyst (UBS)
believes future off-label use of Ontak will be further supported.
LGND presented encouraging data at the American Society of Hematology (ASH) conference in early
December 2003 on Ontak. Four abstracts showing Ontak’s activity in NHL, CCL, Graft-Verse-Host
Disease, and transplantation all demonstrate potential label expansion for Ontak in the future. With a
CTCL indication Ontak has roughly $200M peak sales potential (Friedman Billings), but markets for NHL
and NSCLC are enormous, and could potentially double the peak sales opportunity of the drug. Yet, our
digest average for 2005 of only $47.1M is rather conservative. Q3-04 sales were $9.9 million. One
analyst (Roth Capital) is very optimistic and believes label expansion opportunities, favorable distribution
service agreements and introduction of second-generation formulations should boost growth in the future.
Another analyst (Banc of America) is quite skeptical about the company achieving its in-line product
revenue estimates due to inadequate new clinical data, which could have accelerated additional off label
use of Ontak and Targretin.
Ontak Sales
2003A
$34.4M
2004E
$36-$38
2005E
$38-$60
2006E
$41-$65
Est. Growth
15%-17%
Targretin Capsule sales were in-line in Q3-2004 at $4.8M. The drug is currently approved for CTCL, with
estimated 2004 sales of roughly $18M. LGND is looking to expand its Targretin franchise by conducting
two Phase III clinical trials in 600 patients with NSCLC. The company is looking to show that front-line
Targretin + chemotherapy extends lives of patients with NSCLC. This trial is considered high risk / high
reward by one analyst (Banc of America). The two clinical trials are:
 SPIRIT I: An international trial studying Targretin + cisplatin + vinorelbine versus cisplatin +
vinorelbine alone.
 SPIRIT II: A US trial studying Targretin + paclitaxel + carboplatin versus paclitaxel +
carboplatin alone.
According to LGND, Phase III studies of the SPIRIT I and SPIRIT II are on track for the final analysis due
at the end of 1Q-05. Results from the study will likely be announced within the next month. One analyst
(Roth Capital) believes given the pending positive Phase III trial results, there might be a potential upside
to the stock due to huge market opportunity. One analyst (Wachovia) feels that data from randomized
trials evaluating other retinoids in clinical development suggest that the rexinoid class, to which agents
such as Targretin belong, offer distinct clinical benefits in a variety of solid-tumor settings.
The company also has a Targretin Gel product for CTCL, but seeks an additional label expansion into
severe chronic hand dermatitis. LGND is progressing into Phase II/III trials to study the Gel in hand
dermatitis with 528 patients. One analyst (Roth Capital) considers it as a $400 million market
opportunity. Analysts expect data mid-2004. An eventual approval could reaccelerate the Targretin
franchise. If the Phase II/III data is positive, LGND could file the NDA by year-end 2004.
CMS announced 0074he reimbursement of Targretin gels and capsules for CTCL patients which boosted
the sales in 2Q-04.However, another analyst (Banc of America) believes that changes to 2004 CMS
regulations might have a negative impact on demand growth.
LGND also markets a Panretin Gel for Kaposi’s Sarcoma (KS). KS, purplish-black lesions on the skin,
mucous membranes or internal organs, is often common in AIDS patients.
Targretin Caps
Gel Sales
2003A
$10.1M
$4.0M
2004E
$17-$20
$5-$6
2005E
$20-$29
$7-$9
2006E
$22-$60
$8-$10
Est. Growth
50%-55%
28-30%
LGND has a very significant number of partnerships and co-development ventures that might present an
intriguing potential royalty stream in the years to come. Specifically LGND has partnered with a number
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of large-cap pharmaceutical companies such as Eli Lilly, Wyeth, Pfizer, Glaxo, and Abbott. We have
listed a number of these partnerships below:
 Eli Lilly: LGND and LLY are co-developing a number of PPAR (peroxisome proliferation activated
receptor) products for commercialization. The first, a gamma PPAR labeled LY818 started Phase III
clinical trials for Type II diabetes in the Q1-2004. The second, an alpha PPAR labeled LY674 should
move into Phase II clinical trials for atherosclerosis in mid-2004. LLY announced in early March it
would begin Phase III trials with LY818 shortly. Phase II clinical trial of LY818 has shown positive
results. The aforesaid drug has displayed comparable to superior efficacy to the popular diabetic drug
Avandia. LGND will receive low double-digit royalties on LY818. Peak LY818 sales could reach near
a billion dollars in Type II diabetes.
 Wyeth: LGND and WYE are co-developing a SERM (selective estrogen receptor modulator) for
osteoporosis called bazedoxifene. The drug is in Phase III clinical trials as a single agent, and
Phase III clinical trials with WYE’s Premarin as a combination osteoporosis/HRT candidate. Wyeth
intends to file a new drug application for the prevention of osteoporosis in 2005 and for the treatment
of osteoporosis in 2007 and for a combination of bazedoxifene and conjugated estrogen (CE) for
osteoporosis and menopausal symptoms in 2007. LGND and WYE are also working on ERA923 for
Breast Cancer (Phase II), and NSP989 for HRT (Phase II).
 Pfizer: LGND and PFE are co-developing a SERM for osteoporosis called lasofoxifene. The
candidate is in Phase III clinical trials. PFE plans to file the NDA by mid-2004. This is a big positive
for LGND, which receives mid-single digit royalties on sales (First Albany, Friedman Billings).
 TAP: LGND and TAP are together working on a SARM (selective androgen receptor modulator for
male and female sexual dysfunction, osteoporosis, frailty, and male hypogonadism. LGD2226 is in
the pre-IND stage for male hypogonadism. LGND is also working with Abbott on a number of
preclinical candidates in glucocorticordagonist for inflammation.
 Glaxo: LGND and GSK are co-developing GW516 for Dyslipidemia (Phase I) and SB49711t for
Thrombocytopenia (Phase I).
On November 9, 2004 LGND announced the restructuring of two complicated royalty agreements, which
was designed to be accretive to the company. In the revised Ontak royalty deal with Eli Lilly, LGND will
have the option to pay off the U.S. sales royalty of $33M to Eli Lilly in January or April 2005. Eli Lilly will
have options to trigger the same royalty buy-down for a total of up to $37.0 million in 2005, If Ligand
decides to excise both options, the company does not need to pay royalties before 2006 in U.S with
Avinza sales less than $38 million. However, Ligand will pay for the royalties for 2007 and beyond,
depending on the sales.
Under the amended terms of another deal Ligand and Royalty Pharma amended, the latter will purchase
an additional 1.625% of the three SERM products' net sales for $32.5 million. As a result, Royalty
Pharma increased its rights to a total of 3.0125% of the SERM products sales for ten years following first
commercial sale of each product.
In total LGND has a sizable partnership with seven major pharmaceutical companies, with three products
in Phase III clinical trials. Specifically it is the PPAR and SERM programs with LLY, WYE, and PFE that
make LGND look interesting at this level (UBS, First Albany). In fact, another analyst (Banc of America)
has LGND listed as one of its “potential takeout candidates” for 2004.
Partnerships
2003A
$26.5
2004E
$46-$48
2005E
$9-$30
2006E
$15-$50
Est. Growth
5-10%
LGND should deliver impressive total revenue growth heading into 2004. While 2002 sales were less
than $100M, the company should be able to more than triple that amount to well over $375M in 2007.
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We note that 2004 should be a very interesting year for LGND with a number of Phase III partnership
trials commencing and potentially presenting preliminary data, along with in-house products such as
Targretin and Ontak seeking expanded labels.
Total Revs.
2003A
$141.1M
2004E
$205-$218
2005E
$220-$300
2006E
$300-$400
2007E
$340-$500
Est. Growth
30%-35%
Quick Take: Our digest average for 2004 revenues decreased after the Q3-2004 report ().
Margin
LGND should begin to see manufacturing improvement heading into 2004 as products such as Ontak
and Avinza begin to ramp. As, most of the Phase III products partnered with large-cap pharma
companies such as LLY, WYE, and PFE begin to reach the market, gross margins should soar. The
royalty payment from potential PPAR and SERM products will reach near 100% as the pharma partners
handle the bulk of the manufacturing. This trend of higher royalty payments expected in the coming
years leads a number of analysts (Banc of America, First Albany) to model near 85% gross margin by
2007-2008. We encourage investors to take a look at how this ramp will benefit LGND by analyzing
some long-term models from the sell-side.
2004E Margins:
Digest Average
Gross Margin
81.0%
Operating Margin
3.8%
Net Margin
-0.8%
The company will also see dramatic improvement in both percent R&D and SG&A expense in the coming
years. As total revenues begin to ramp through new products and partnerships payments, the operating
margin will soar.
R&D should track around $71M in 2004 (33% of sales), and show only a modest increase to about $78M
in 2005 (28% of sales). Yet, SG&A, which will track around $63M in 2004 (30% of sales), will increase as
new product rollouts and increased promotional marketing for Ontak and Avinza kick in. 2005 SG&A
should track around $74M, or 27% of sales. Organon co-promotion expenses of $8.5M were below
estimate due to lower than expected Avinza sales.
Quick Take: Our digest average for net margin in 2004 increased after the Q3-2004 report ().
Earnings Per Share
LGND reported a sizable loss in the Q3-2004 due to the lower than expected Avinza sales. The
company delivered ($0.09). Our digest average for the full-year 2004 is only $(0.03), well below
management guidance of $0.03-$0.09.
Street Consensus
Company Guidance
Low Estimate
High Estimate
2004E
($0.03)
$0.03 - $0.09
($0.15)
$0.03
2005E
$0.06
($0.10)
$0.32
Our range on EPS for both 2004 and 2005 is enormous. This is due to the timing of milestone payments
from many of the company’s partners. These payments can create big swings in EPS due to their size
and 100% margin. We expect clarity on the timing for some of these payments later in 2004.
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LGND has lowered its guidance to $170-$180M in product sales in 2004, and $216-$231M in total
revenues. LGND tightened its EPS guidance to $0.03-$0.09 for 2004. Analysts (First Albany, Roth
Capital) believe that LGND might not be able to achieve the lowered guidance. We note that LGND had
$80.4M in cash on hand at the end of the Q3-04, or roughly $1.09/share.
Quick Take: Our digest average for EPS in 2004 increased after the Q3-2004 report ().
Long-Term Growth
We have highlighted two things that we believe will have the largest impact on LGND future long-term
growth rate. The first is the progressing Phase III trials with SERM products at WYE and PFE, and the
PPAR program at LLY. These products have the opportunity to deliver near 100% gross margin royalty
payments to LGND should they eventually reach final market approval. We have seen estimates that
model this products at over a $1B opportunity, in turn potentially returning multi-million dollar payments to
LGND going forward. LLY highlighted its ongoing PPAR program during its early December ‘Analyst’s
Day’, hoping to initiate a Phase III program on LY818 in early 2004. Analysts (First Albany, Roth Capital,
Friedman Billings, UBS) are very optimistic on this potential.
The second interesting long-term growth rate factor is the ongoing debate between the DEA (Drug
Enforcement Administration) and the FDA over the regulation of prescription painkillers like OxyContin
(Purdue Pharma) and Avinza. These opioid drugs are highly addictive and can bring along intense
withdrawal symptoms during and after use. Clearly the dangers of using an opioid pain medication have
been widely documented. The DEA would like to see prescriptions of this class of drugs limited. The
FDA disagrees, and instead leaves the prescription decision in the hands of the primary care physician.
One analyst (Friedman Billings) believes that even a potential compromise between the two regulatory
agencies might lead to tight scrutiny and control over drugs like OxyContin and Avinza.
On November 9, 2004 LGND announced the restructuring of two complicated royalty agreements, which
was designed to be accretive to the company. In the revised Ontak royalty deal with Eli Lilly, LGND will
have the option to pay off the U.S. sales royalty to Eli Lilly for $33M. Eli Lilly will have options to trigger
the same royalty buydown for a total of up to $37.0 million in 2005. Under the terms of another deal
Ligand and Royalty Pharma amended, the latter will purchase an additional 1.625% of the three SERM
products' net sales for $32.5 million.
Target Price/Valuation
Based on our digest average for 2005 of $0.06, the shares are trading at roughly 129X 2005 EPS.
Based on this forward looking 2005 EPS and valuation measure, LGND looks fairly in-line with peers.
The current price of $7.73 equates to a market capitalization of roughly $571M. Is LGND worth $0.80B
based on the current product lineup of Ontak and Avinza? Probably not; therefore, the ongoing
partnership programs focusing on PPAR with LLY and SERM with WYE and PFE must show positive
data in the coming year. Most of the analysts (Friedman Billings, Roth Capital, First Albany, Fortis Bank)
have reduced their target price estimates due to lowered guidance. Our digest average of $11.25 shows
modest upside from today because it incorporates a high $21 estimate from another (UBS, Friedman
Billings) analyst that is more optimistic on the shares.
We also pose the question – would it cost more than $0.7B to reproduce LGND’s current product portfolio
and partnership program? Probably so; therefore, LGND may be an attractive biotechnology acquisition
for one of the large-cap pharmaceuticals it currently has collaboration with such as LLY, WYE, GSK,
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ABT, or PFE. Or, another biotech with core-focus in oncology and metabolic disorders such as BIIB may
be an interesting combination.
Upcoming Events
Date
1H-2004
1H-2004
Mid-2004
Mid-2004
Mid-2004
November 9, 2004
December 5, 2004
Event
Data from Phase II Ontak in NSCLC
Initiate Phase II/III on Targretin Gel
Initiate Phase III on LY818 PPAR
Initiate Phase II on LY674 PPAR
Ongoing Phase III on SERM products
The restructuring of the Ontak royalty deal
with Eli Lilly and LGND with Royalty
Pharma.
Data from Phase II Ontak in T- cell
Lymphoma.
Comments
‘Proof-of-Concept’ study
Severe Chronic Hand Dermatitis
With LLY in Type-2 Diabetes
With LLY in Atherosclerosis
WYE and PFE
LGND reported that its 4-year relationship with its financial auditor Deloittee & Touche has ended.
Management indicated that there were no disagreements between the company and the auditors over
accounting principles and financial statement disclosures. However, majority of the sell side analysts are
concerned about this unexplained resignation. During the quarter, the company hired financial advisory
firm BDO Seidman as its new auditor
Individual Analyst Opinions
POSITIVE RATINGS
First Albany – Buy ($13): The analyst states,” We are maintaining our Buy rating following an increase in market
share by Avinza, as reported by IMS Health for the week ended March 11. Although concerns regarding lawsuits
and other possible forms of scrutiny will weigh on the stock, we are maintaining our rating, based on the deeply
discounted valuation of the specialty pharmaceuticals business and the Targretin lung cancer "lottery ticket," which
now appears free.”
Wachovia – Outperform: The analyst states,” Data is expected in Q1 2005 from two randomized Phase III trials
evaluating Targretin as an adjuvant to front-line non-small cell lung cancer therapy. If positive, Targretin, already
approved for a small indication, could reach $800 million in revenue by 2010. Our sum-of-parts analysis suggests a
positive risk/reward benefit at current trading levels. LGND also stands to receive meaningful royalty streams and
milestone payments from 2-4 other products in late-stage development at pharmaceutical partners.”
NEUTRAL RATINGS
Roth Capital – Neutral ($8.5): On the delay the analyst states, We believe its possible that Avinza historical sales,
product returns, the level of return reserves against those returns, and current wholesale inventories may have
caused a red flag among the company's auditors causing the delay. We also believe that this issue may have
complicated the requirement of executive certification of internal controls, as required in Sarbanes-Oxley.”
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Friedman, Billings – Market Perform ($8): The analyst states, “Ligand announced that it is delaying the release
of its 10-K due to a review of its revenue recognition practices. We are lowering our price target to $8 from $10, and
we are maintaining our Market Perform rating. Our lower price target is based on a revised EPS estimate of $0.26 in
2007, which is based on lower Avinza estimates derived from competitive concerns unrelated to the accounting
issues, times a PE of 40x and discounted at 25%.”
Banc of America – Neutral ($9): The analyst states, “Prior to its conference call this morning, Ligand announced
that 4Q04 and FY04 earnings would be delayed, along with its 10-K filing. Despite today's weakness, we would
continue to avoid LGND shares on the prospects for future adjustments and unknown outcome of the current
review. Additionally, we are skeptical about the outcome of the SPIRIT I and II results, expected in 1Q05. We
believe investor concern will persist until these concerns are resolved.”
UBS- Neutral ($8): The analyst states,” Based on today's announcement, we believe LGND shares are likely to
trend down until resolution of this accounting matter is reached. We are placing our rating, price target and
estimates under review as we believe the risk associated with a possible negative restatement of prior financial
results has increased.”
NEGATIVE RATINGS
None
Appendix-A
Analyst sales estimates by product, EPS forecasts, and a consensus income statement are available in LGND.xls.
Appendix-B
Quick Take Score: How our digest average changed after the 3Q -2004 report:
3 () = (Margins, EPS)
0 ()
1 () = (Revenues)
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