ITEM 1. BUSINESS

Overview

Ligand Pharmaceuticals Incorporated ("Ligand" or the "Company"), a Delaware corporation, is a biopharmaceutical company which believes it is a leader in the discovery and development of small-molecule drugs that regulate hormone-activated intracellular receptors ("IRs") and Signal Transducers and Activators of Transcription ("STATs"). IRs play a key role in regulating gene activity and the genetic processes affecting many diseases, including certain cancers, gynecological disorders and cardiovascular, inflammatory and skin diseases. STATs mediate specific changes in gene expression and consequently in cell function after exposure to cytokines. Ligand has developed a productive approach to STATs and IR-targeted drug development based primarily on its exclusive worldwide licenses to STATs and IR technology developed by Ligand's scientists and its collaborators, including scientists at The Salk Institute, Rockefeller University, New York University ("NYU") and Baylor College of Medicine ("Baylor"). Ligand and these collaborators have successfully identified and characterized the majority of the more than 40 IRs discovered to date. Additionally, Ligand has licensed patents and patent applications for many of these IRs. Ligand is developing new drugs through a combination of internal and collaborative programs, including the formation of a new research and development company, Allergan Ligand Retinoid Therapeutics, Inc. ("ALRT") with Allergan, Inc. ("Allergan") and substantial collaborations with SmithKline Beecham ("SmithKline"), American Home Products, Abbott Laboratories ("Abbott") and Glaxo Wellcome (formerly Glaxo, Inc.) ("Glaxo"). Ligand has initiated human clinical trials for four products: the retinoids Oral ALRT 1057 and Topical ALRT 1057 on behalf of ALRT, and Targretin^TM (LGD 1069 Oral and Topical), which are Ligand's first products. Ligand also has 17 non-retinoid lead compounds in various stages of development, including a three compound series being developed by American Home Products, as well as an osteoporosis development candidate resulting from its collaboration with Pfizer, Inc. ("Pfizer") which is now under preclinical development by Pfizer.

In May 1995, Glycomed Incorporated ("Glycomed") was merged into a wholly-owned subsidiary of the Company ("the Merger") and is currently operated as a wholly-owned subsidiary of the Company. Glycomed is a biopharmaceutical company conducting research and development of compounds based on biological activities of complex carbohydrates. In connection with the Merger, Ligand assumed control of Glycomed's product pipeline which includes Galardin”, a matrix metalloproteinase inhibitor ("MMPI"), as well as several other compounds in preclinical development for inflammatory diseases and cancer. Ligand believes that joining the scientific expertise of Glycomed and Ligand broadens and deepens Ligand's technology pipeline in the inflammatory disease and cancer fields.

In December 1994, the Company and Allergan formed ALRT to continue the research and development activities previously conducted by the Allergan-Ligand Joint Venture ("the Joint Venture"). In June 1995 the Company and ALRT completed a public offering of 3,250,000 units with aggregate proceeds of $32.5 million (the "Offering"). Each unit consisted of one share of ALRT's callable common stock and two warrants, each warrant entitling the holder to purchase one share of the common stock of the Company. Immediately prior to the consummation of the Offering, the Company contributed $17.5 million in cash and Allergan contributed $50.0 million in cash to ALRT, providing for a total of $100 million for retinoid product research and development.

Ligand's ability to rapidly develop lead compounds using its proprietary cell-culture based co-transfection assay has enabled it to pursue development of selected compounds internally while leaving additional candidates for collaborative efforts. Drugs targeted for internal development are those that address diseases treated by cancer and gynecological specialists while drugs that address disorders typically treated by primary care physicians are targeted through strategic collaborations. In addition to ALRT, Ligand's collaborative arrangements with seven strategic partners are in the following areas:

* Equity or debt convertible into equity.

** Funding from Joint Venture prior to initiation of ALRT activities.

*** Research was completed in 1993.

Ligand has also in-licensed two products. In September 1994, Ligand was appointed by Cetus Oncology Corporation ("Cetus Oncology") as the sole distributor of Proleukin®, an oncology product, within Canada for a five-year period beginning on the date of the first sale of Proleukin® by Ligand in Canada. Ligand paid Cetus Oncology $250,000 upon execution of the agreement and made an additional milestone payment to Cetus Oncology upon the receipt of government approval for the sale of Proleukin® in Canada. Ligand formed a wholly owned subsidiary, Ligand Pharmaceuticals (Canada) Inc. ("LCI") to conduct operations in Canada in accordance with the agreement with Chiron, LCI initially hired three sales representatives to market Proleukin® in Canada.

In March 1995, Ligand was also appointed by QLT PhotoTherapeutics, Inc., ("QLT") as the exclusive distributor, with exclusive rights within Canada, to PHOTOFRIN®, a product for the treatment of esophageal and superficial bladder cancer. The agreement covers an initial ten year period beginning on the date of the first sale of PHOTOFRIN® by Ligand in Canada. Ligand paid QLT $180,800 upon execution of the agreement with future payments based on sales volume.

These two agreements and the formation of LCI represent Ligand's first steps in its transition from the development stage to full commercial operations. The establishment of a Canadian marketing force in LCI is a reflection of the Company's intentions to eventually expand throughout North America.

Backround

Ligand seeks small molecule drugs which mimic or block the actions of hormones, such as, estrogen, retinoic acid, or cortisone and cytokines, such as, interferon, erythropoietin, or interleukins. Building upon dramatic scientific advances in understanding how hormones and cytokines exert their powerful effects within the body, Ligand uses state-of-the-art drug discovery approaches to create improved medicines for treating unmet medical needs. Beginning 10 years ago, the biochemical mechanism of (non-protein) hormone action has been discovered to be mediated by members of a large family of related proteins termed IRs. Beginning four years ago, the biochemical mechanism of action of most cytokines was discovered to be mediated by members of the JAK family of tyrosine protein kinases and by members of the STAT family of proteins inside cells. Ligand has close ties to key academic research scientists, including Dr. Ron Evans at The Salk Institute and Dr. Bert O'Malley at Baylor, in whose laboratories many of the fundamental discoveries in the field of IRs were and continue to be made, and to Dr. James Darnell at Rockefeller University and Dr. James Ihle at St. Jude Childrens' Hospital, in whose laboratories seminal discoveries in the STAT / JAK field were made and significantly extended. Certain hormones change cell and, therefore, organ function by activating IRs, leading to changes in the pattern of gene expression within the cell. Most cytokines change cell and, therefore, organ function by activating JAKs, which in turn activate STATs, leading to changes in the pattern of gene expression within the cell. Ligand uses the cloned human IRs and JAKs and STATs and proprietary tools and approaches ("IR technology" and "STAT / JAK technology") to efficiently create improved drugs which mimic or block the actions of selected hormones or cytokines. The similarities between cytokine and hormone mechanisms of action allow Ligand to efficiently leverage its drug discovery resources in these two areas.

Ligand's scientific co-founder and exclusive consultant, Dr. Ronald Evans at The Salk Institute, was the first to clone and characterize an IR in 1985. Since that time, more than 40 IRs have been defined and identified, the majority of them by Ligand's scientists or its exclusive collaborators. IRs play key roles in a variety of diseases, including certain cancers, gynecological disorders and cardiovascular, inflammatory and skin diseases. The attractiveness of the IRs as drug targets has been demonstrated by effective IR-targeted drugs on the market for many of these diseases. The use of most of these drugs has been limited, however, by significant side effects. These drugs were developed and commercialized for their therapeutic benefits prior to the discovery of the IRs and, because of the lack of research tools based on these IRs, often cross-react with the IRs for hormones other than the intended target, resulting in side effects. Examples of currently-marketed hormone-related drugs acting on IRs are glucocorticoids (steroids used to treat inflammation), Tamoxifen® (an estrogen antagonist used in the treatment of breast cancer) and various retinoids such as Retin-A® (used to treat acne and psoriasis). Ligand believes that there are new, specific opportunities to apply its IR expertise to make major improvements over currently-marketed drugs and also to create drugs with novel IR targets, mechanisms of action or clinical utilities.

IRs are a family of hormone-activated proteins that act inside cells to directly regulate gene activity and cell function. The hormones that interact with IRs are small organic, non-peptide molecules and are small-molecule examples of ligands, a general class of molecules that bind to receptors. Many ligands influence the functions of their receptors, often by inducing a change in the biochemical activities of the receptor. Ligands that activate the receptor are referred to as agonists; ligands that interfere with activation of the receptor are called antagonists.

Drugs commercialized by pharmaceutical companies are usually agonist or antagonist ligands for various receptors (or inhibitors of various enzymes). However, many of the hormones themselves are useful drugs. The known non-peptide hormones are the retinoids, the sex steroids (estrogens, progestins and androgens), the adrenal steroids (glucocorticoids and mineralocorticoids), vitamin D and thyroid hormone. These hormones act through their IRs to regulate the activity of genes in order to maintain and restore balanced cellular function within the body. Hormonal imbalances can lead to a variety of diseases 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 in the treatment of diseases in which the underlying cause is not hormonal imbalance.

Ligand's drug discovery efforts focus on ligand binding and receptor activation. Ligand is developing as drugs synthetic compounds that are either agonists or antagonists of target IRs. Agonists bind to target IRs and induce shape changes similar to those induced by natural hormones, exerting similar effects on gene activity. Antagonists bind to the IR, but by contrast, fail to activate the IR and block activation by the hormones. Consequently, after formation of a ligand-IR complex with an antagonist, the subsequent events usually induced by the hormonal agonist are disrupted. The IRs have evolved to be controlled by small molecules, which makes them suitable targets for small molecule drugs mimicking or blocking the actions of their natural regulatory ligands.

Ligand's early recognition of the drug discovery opportunities inherent in emerging IR research has enabled it to build a strong proprietary position and accumulate valuable expertise in IRs applicable to drug discovery and development. Ligand has created powerful new tools to explore and manipulate non-peptide hormone action for therapeutic benefit, building on its scientific findings about the molecular basis of hormone action. Ligand has exclusive relationships in the field of IRs with Dr. Ronald Evans of The Salk Institute and with Baylor where many of the core discoveries have been made and has exclusively licensed most of these discoveries.

Ligand has designed and engineered the only known in vitro preclinical assay systems which simulate the actual cellular processes controlled by IRs and allow Ligand to determine whether a small molecule is an agonist or antagonist of any human IR. Ligand uses these proprietary cell-culture based co-transfection assays, which are described in more detail below, to rapidly and accurately predict the probable therapeutic and side-effect profiles of compounds with potential as drugs. Ligand believes that its IR expertise will allow it to discover and develop drugs that have equal or greater therapeutic efficacy and reduced incidence and severity of side effects compared to existing drugs targeting IRs. Ligand is developing small molecule drugs, which act within the body's natural regulatory mechanisms and are expected to be well-suited to oral administration.

In many diseases, there is an imbalance of cytokine action. For example, some inflammatory conditions may represent excessive actions of certain interleukins or interferons. In these conditions, it may prove beneficial to block the actions of specific cytokines. In other pathological states, there is insufficient activity of specific cytokines. For example, in patients with chronic renal failure diminished erythropoietin ("EPO") release by the damaged kidneys results in the inadequate production of red blood cells, resulting in anemia. Recombinant human EPO protein (Epogen®)can be administered to effectively correct this anemia, but must be injected. Many other cytokines are useful as injected protein medicines, including interferons (Intron-A®, Roferon®, Betaseron®), interleukins (Proleukin® - which Ligand markets in Canada), hematopoietic growth factors (Epogen®, Neupogen®), and others. Each of these and many other cytokines appears to exert its actions through JAK / STAT signal transduction pathways. Ligand is utilizing STAT / JAK technology to seek low molecular weight compounds which can mimic or block the actions of medically relevant cytokines for uses in various pathological conditions, including cancer, inflammation, and disorders of blood cell formation. Because these will be are small molecules, whereas the cytokines themselves are proteins, they offer potential significant advantages, including oral activity and greater ease of manufacture and stability. Ligand's STAT / JAK technology forms the basis for the Company's collaboration with SmithKline seeking small molecule mimetics of EPO, Granulocyte- Colony Stimulating Factor ("G-CSF"), and optionally thrombopoietin and for a portion of the collaboration with Abbott, seeking interferon antagonists for the treatment of inflammation.

Glycomed's drug discovery efforts focus its expertise and core technology to seek small molecule, potentially orally active drugs to modulate the biological processes involving complex carbohydrates and other cell surface or extracellular matrix components for the treatment of inflammation and cancer. Since the Merger, Glycomed's research has been focused on two programs (1) selection antagonists for the treatment of inflammation in a collaboration with Sankyo Pharmaceuticals and (2) MMPIs for the treatment of inflammation and cancer. Glycomed scientists are working to identify potential development candidates in these programs. One MMPI compound, GalardinTM, has completed a Phase II/III clinical trial in patients with corneal injury. The Company intends to seek a partner to further the development and commercialization of GalardinTM for ophthalmic use.

Business Strategy

Ligand's business strategy is to maximize the application of its broad IR and STATs drug discovery platform in advancing commercial drug development opportunities. This strategy focuses internally on areas where Ligand can most effectively utilize its development resources and externally where collaborative relationships provide necessary additional capital resources and marketing expertise.

• Internally, Ligand is focusing on the discovery, development and marketing of small-molecule drugs that address diseases, such as cancer and gynecological disease, treated by medical specialists, and by seeking to in-license or acquire later-stage products in these medical specialties. Ligand believes it can focus on these niche markets allowing it to realize certain commercial possibilities within the scope of a small company's capabilities. Ligand has initiated human clinical trials with four products, the retinoids Oral ALRT 1057 and Topical ALRT 1057, on behalf of ALRT, and Ligand's first products, Targretin” (LGD 1069 Oral and Topical). Ligand also has 17 lead non-retinoid compounds being developed internally or with partners which are in various stages of development, including a three compound series being developed by American Home Products. From these compounds, additional clinical candidates are expected to be selected in the next year. Ligand's other internal programs include androgen receptor agonists or antagonists for the treatment of male hormone replacement therapy, osteoporosis, prostate cancer, and other disorders. Ligand intends to pursue the cancer applications emerging from these projects internally, but may seek a collaboration with a pharmaceutical partner to exploit broader clinical applications. In Ligand's internal STAT/JAK programs, screening for small molecule cytokine agonists and antagonists is underway. Glycomed internal programs focus on the development of small molecules for the treatment of inflammation and cancer.

• Externally, Ligand is collaborating with large pharmaceutical companies, with the goal of building a royalty-based business through the application of its technologies to primary care markets, such as cardiovascular, inflammatory, broad aspects of women's health and other diseases. In addition to ALRT, Ligand has established five major collaborative arrangements to discover and develop drugs that address disorders principally treated by primary care physicians, specifically hematopoiesis with SmithKline Beecham, female health disorders with American Home Products, inflammatory disease with Abbott, cardiovascular disease with Glaxo, osteoporosis with Pfizer and has inherited a collaboration through the Merger, with Sankyo Company, Ltd., ("Sankyo") in inflammation based on cell adhesion research. Ligand believes its collaborators provide the significant resources needed to successfully introduce products into primary care markets. Each of these arrangements provides 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, with Ligand receiving research revenue during the drug discovery stage, additional milestone revenue for successful compounds moving through clinical development and milestone revenue as well as royalty revenue on sales of drugs marketed by its collaborators. One of these programs, the Pfizer collaboration, has resulted in a development candidate for the treatment of osteoporosis which may enter human clinical trials this year.

Over the past four years, Ligand has substantially expanded its product portfolio and its collaborator program base in order to reduce the risks inherent in a one-product or limited program company. Ligand believes that it has in place today a strong product and program portfolio.

Ligand's IR Drug Discovery Opportunities

Ligand and its collaborators have made major discoveries pertaining to IRs and their ligands in four general areas: (i) the identification of the IR superfamily, (ii) the recognition of IR subtypes, (iii) the discovery of orphan IRs and (iv) the recognition of interactions of IRs with other transcription factors. Ligand believes that each of these four broad areas of knowledge provides important opportunities to discover drugs. Certain of Ligand's programs, which are in various stages of research and development, build on its proprietary IR technology to take advantage of specific opportunities within each of these areas.

IR Superfamily. The receptors for all the non-peptide hormones are closely related members of a superfamily of proteins. This protein superfamily has become known as the intracellular receptors or IRs, because these receptors are located inside target cells, unlike the receptors for neurotransmitters and protein or peptide hormones and growth factors, which are anchored in and span the plasma membranes of cells. The similarity in structure among IRs reflects a similarity in their mechanisms of action. After binding its ligand, an IR acts directly on a target gene to control its activity. Human IRs for all the known non-peptide hormones have now been cloned, primarily by Ligand's scientists or its collaborators, building an understanding of the definition of the similar underlying mechanisms of action shared by all the non-peptide hormones.

Ligand believes that the relatedness of the IRs for all the non-peptide hormones has major implications for drug discovery. First, because the IRs share a common mechanism of action, drug discovery insights about one IR often can be directly applied to other members of the IR superfamily bringing synergy to Ligand's IR-focused drug discovery efforts. Second, based on its understanding of the IRs, Ligand has developed a powerful drug discovery assay (co-transfection assay) which can be used to analyze the agonist or antagonist activity of small molecules for any known human IRs. Third, the understanding that the IRs are structurally similar has enabled Ligand to pinpoint the basis for side effects of some currently-existing drugs and to discover improved drug candidates. These drugs were developed and commercialized for their therapeutic benefits prior to the discovery of the six known retinoid-responsive IRs and often cross-react with the IRs for hormones other than the intended target, resulting in side effects. Ligand's proprietary assays can detect this sort of cross reactivity and permit Ligand to develop drugs with reduced IR cross reactivity and greater specificity. Ligand believes that its compounds, optimized using its IR technology, will have substantially better side-effect profiles.

IR Subtypes. For some of the non-protein hormones, several closely related but non-identical IRs have been discovered. These alternate receptors for the same hormone are called IR subtypes. Six subtypes of the IRs for retinoids and four subtypes of the IRs for thyroid hormone have been discovered and the genes for these IRs are exclusively licensed by Ligand. Additionally, two functionally significant progesterone receptor ("PR") subtypes and two androgen receptor ("AR") subtypes have recently been identified. The receptor subtypes for each of these hormones are activated only in certain tissues and control overlapping but non-identical sets of genes, implying specific physiological roles. For other IRs of medical importance, including the IRs for glucocorticoids and estrogens, Ligand is utilizing its proprietary IR technologies to identify possible subtypes for these IRs.

Ligand believes that the discovery of subtypes of IRs which are the targets of current drugs will>

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