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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
COMMISSION FILE NUMBER: 000-30111
LEXICON GENETICS INCORPORATED
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 76-0474169
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
4000 RESEARCH FOREST DRIVE
THE WOODLANDS, TEXAS 77381
(Address of Principal Executive
Offices and Zip Code)
(281) 364-0100
(Registrant's Telephone Number,
Including Area Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $0.001 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
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. [ ]
The aggregate market value of voting stock held by non-affiliates of
the registrant was approximately $333.0 million as of March 7, 2001, based on
the closing price of the common stock on the Nasdaq National Market on such date
of $10.0625 per share. For purposes of the preceding sentence only, all
directors, executive officers and beneficial owners of ten percent or more of
the registrant's common stock are assumed to be affiliates. As of March 7, 2001,
48,469,173 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the registrant's definitive proxy statement
relating to the registrant's 2001 annual meeting of stockholders, which proxy
statement will be filed under the Securities Exchange Act of 1934 within 120
days of the end of the registrant's fiscal year ended December 31, 2000, are
incorporated by reference into Part III of this annual report on Form 10-K.
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LEXICON GENETICS INCORPORATED
TABLE OF CONTENTS
ITEM
PART I
1. Business...................................................................................... 1
2. Properties.................................................................................... 19
3. Legal Proceedings............................................................................. 19
4. Submissions of Matters to a Vote of Security Holders.......................................... 19
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters......................... 20
6. Selected Financial Data....................................................................... 21
7. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 22
7A. Quantitative and Qualitative Disclosure About Market Risk..................................... 25
8. Financial Statements and Supplementary Data................................................... 25
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... 25
PART III
10. Directors and Executive Officers of the Registrant............................................ 26
11. Executive Compensation........................................................................ 26
12. Security Ownership of Certain Beneficial Owners and Management................................ 26
13. Certain Relationships and Related Transactions................................................ 26
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................. 27
Signatures............................................................................................... 29
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The Lexicon name and logo and OmniBank(R) are registered trademarks and
LexVision(TM), Lexgen.com(TM), Internet Universal(TM) and e-Biology(TM) are
trademarks of Lexicon Genetics Incorporated.
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In this annual report on Form 10-K, "Lexicon," "we," "us" and "our"
refer to Lexicon Genetics Incorporated.
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FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This annual report on Form 10-K contains forward-looking statements.
These statements relate to future events or our future financial performance. We
have attempted to identify forward-looking statements by terminology including
"anticipate," "believe," "can," "continue," "could," "estimate," "expect,"
"intend," "may," "plan," "potential," "predict," "should" or "will" or the
negative of these terms or other comparable terminology. These statements are
only predictions and involve known and unknown risks, uncertainties and other
factors, including the risks outlined under "Item 1. Business - Risk Factors,"
that may cause our or our industry's actual results, levels of activity,
performance or achievements to be materially different from any future results,
levels or activity, performance or achievements expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. We are not under any duty to
update any of the forward-looking statements after the date of this annual
report on Form 10-K to conform these statements to actual results, unless
required by law.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Lexicon Genetics is a drug discovery company of the post-genome era,
using gene knockout technology to define the functions of genes for the
discovery of pharmaceutical products. We are using this technology to expand our
LexVision program and fuel drug discovery programs in cancer, cardiovascular
disease, immune disorders, neurological disease, diabetes and obesity. We have
established drug discovery alliances and functional genomics collaborations with
leading pharmaceutical and biotechnology companies, research institutions and
academic institutions throughout the world to commercialize our technology and
further develop our discoveries.
We generate our gene function discoveries using knockout mice - mice
whose DNA has been altered to disrupt, or "knock out," the function of the
altered gene. Our patented gene trapping and gene targeting technologies enable
us to rapidly generate these knockout mice by altering the DNA of genes in a
special variety of mouse cells, called embryonic stem (ES) cells, which can be
cloned and used to generate mice with the altered gene. We employ an integrated
platform of advanced medical technologies to systematically discover the
functions and potential pharmaceutical uses of the genes we have knocked out. We
believe that our LexVision database, which captures and catalogues the
information resulting from this analysis, and our OmniBank library of more than
100,000 knockout mouse clones provide us and our collaborators significant
opportunities to discover and develop pharmaceutical products based on genomics
- - the study of genes and their function.
We made substantial business and technical progress in the year 2000:
o We commenced our LexVision program and, in September 2000,
established our first LexVision collaboration with
Bristol-Myers Squibb Company, under which we could receive
between $15 million and $25 million in access and delivery
fees, in addition to milestone payments and royalties on
products Bristol-Myers Squibb develops using our technology;
o We established drug discovery alliances with Abgenix, Inc. for
the discovery of human monoclonal antibody drugs and with
Arena Pharmaceuticals, Inc. for the discovery of small
molecule drugs that target an important class of genes called
G protein-coupled receptors, or GPCRs;
o We entered into functional genomics collaborations with
American Home Products, Boehringer Ingelheim Pharmaceuticals,
Inc., Pharmacia Corp. and Tularik, Inc.;
o We expanded our functional genomics collaboration with
Millennium Pharmaceuticals, Inc. and completed the first year
of our collaborations with Johnson & Johnson and N.V. Organon,
both of which were signed in December 1999;
o We nearly doubled the size of our OmniBank library, which we
estimate now contains gene knockout clones for more than 40%
of all genes in the mammalian genome;
o We obtained key patents covering our gene trapping technology
and gene function discoveries; and
o We completed a $220 million initial public offering, one of
the largest in the history of the biotechnology industry.
Lexicon Genetics was incorporated in Delaware in July 1995, and
commenced operations in September 1995. Our corporate headquarters are located
at 4000 Research Forest Drive, The Woodlands, Texas 77381, and our telephone
number is (281) 364-0100. Our corporate website is located at
www.lexicon-genetics.com. Information found on our website should not be
considered part of this annual report on Form 10-K.
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GENOMICS AND DRUG DISCOVERY
The Human Genome
The human genome is comprised of complementary strands of
deoxyribonucleic acid, or DNA, molecules organized into 23 pairs of chromosomes.
Genes, which carry the specific information, or code, necessary to construct, or
express, the proteins that regulate human physiology and disease, make up
approximately three to five percent of the genome. The remaining 95% to 97% of
DNA in chromosomes does not code for protein. It is now estimated that the
entire human genome contains approximately 30,000 to 50,000 genes within a total
of approximately 3.5 billion nucleotide base pairs of "genomic" or "chromosomal"
DNA.
The information contained in genes is used to express proteins via a
two-step process. The first step in protein expression is called transcription,
in which the DNA sequence of a gene is copied into a molecule known as
ribonucleic acid, or RNA. A splicing process within the cell then removes the
introns, or non-coding segments, from the transcript, thereby creating a
messenger RNA, or mRNA. In the second step, the mRNA directs the assembly of the
protein product of the gene in a process called translation.
The Human Genome Project and other publicly and privately-funded DNA
sequencing efforts have invested considerable resources to sequence the genes in
the human genome, culminating in the completion of a "working draft" of sequence
from the human genome in the year 2000 and its publication in February 2001. The
sequence of a gene alone, however, does not permit reliable predictions of its
function in physiology and disease. As a result, the databases of gene sequences
generated by these efforts can be compared by analogy to a dictionary that
contains thousands of words, but only a handful of definitions.
Functional Genomics
The efforts to discover these definitions - to define the functions of
the genes in the human genome and, in doing so, discover which genes encode
pharmaceutically-relevant drug targets and therapeutic proteins - are commonly
referred to as functional genomics. Researchers use a variety of methods to
obtain clues about gene function, such as gathering information about where a
gene's transcript is found and where the corresponding protein is expressed in
the cell. Experiments are also conducted using cell culture, biochemical studies
and non-mammalian organisms. While these methods may provide useful information
about gene function at the biochemical and cellular levels, their ability to
provide information about how genes control mammalian physiology, and thus their
usefulness for drug discovery and development, is significantly limited.
We believe that the method for determining a gene's function that has
the greatest relevance and highest value for drug discovery is to disrupt, or
knock out, the gene in a mouse and assess the physiological, pathological and
behavioral consequences of the disruption of the gene's function. The results of
such an analysis can determine the function and disease relevance of a
particular gene and the potential of the gene or the protein it encodes as a
drug target or therapeutic protein.
This method of defining gene function possesses a number of advantages
in discovering the most promising human drug targets and therapeutic proteins:
o Humans and mice are very similar genetically - large regions
of the two genomes contain similar genes in similar order;
o Humans and mice share very similar physiology - as a result,
the mouse is one of the most widely-used animal model systems
in the pharmaceutical industry; and
o The mouse is the only mammal for which ES cell cloning
technology has been well-established, and it is also the only
mammal that can be genetically engineered on a large scale.
The use of knockout mice has led to substantial successes in
identifying gene function. The methods traditionally used to generate knockout
mice, however, are labor-intensive, slow and often unpredictable, requiring
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highly-skilled scientific personnel and often a year or more of work. These
impediments have limited the rate at which knockout mice may be produced and,
therefore, the rate at which the genes in the mammalian genome may be analyzed.
We estimate that, to date, knockout mice have been made and analyzed for only a
small fraction of all genes.
OUR TECHNOLOGY PLATFORM
We have developed and refined gene-specific gene targeting and
genome-wide gene trapping technologies that enable us to overcome many of the
limitations of traditional methodologies for generating gene knockouts. We are
using these technologies to rapidly generate knockout mice for the analysis of
the functions of hundreds of genes each year. We employ an integrated platform
of advanced medical technologies to systematically analyze the functions and
pharmaceutical relevance of these genes.
Gene Targeting
We use gene targeting technology to rapidly generate knockout mice with
alterations in selected genes. Our gene targeting technology, which is covered
by several key patents, enables us to generate highly-specific alterations in
targeted genes, including alterations that selectively disrupt, or conditionally
regulate, the function of the targeted gene. We believe that our experience and
scale of production using gene targeting technology provide us with substantial
advantages in efficiency and speed relative to others using traditional methods
to generate knockout mice.
We use our gene targeting technology with a second technology known as
Cre/lox recombinase technology to generate alterations that selectively disrupt,
or conditionally regulate, the function of the targeted gene. We use several
other technologies that enable the regulation of the function of targeted genes
by different methods. The regulation of gene activity using these technologies
may closely model the pharmacological action of drugs that interact with
specific targets.
Gene Trapping
We are using our patented gene trapping technology, a high-throughput
method of generating knockout mouse clones that we invented, to expand our
OmniBank library. Our gene trapping technology uses a type of virus called a
retrovirus that has been genetically engineered. These retroviruses infect cells
in vitro, integrate into the chromosome of the cell and deliver molecular traps
for genes. The gene trap disrupts the function of the gene into which it
integrates, permitting the generation of knockout mice. In addition, the gene
trap stimulates transcription and use the cell's own splicing machinery to
extract a transcript of the trapped gene from the chromosome for automated DNA
sequencing. Because our gene trapping vectors are designed to trap genes in a
manner largely independent of their levels of expression, our OmniBank database
and library includes even those genes that are very rarely expressed. Apply our
gene trapping technology to human cell lines has also allowed us to capture DNA
sequence from thousands of human genes.
We use our gene trapping retroviruses in an automated process to
rapidly and cost-effectively create knockout mouse clones. Our OmniBank library
currently contains more than 100,000 frozen ES cell clones identified by DNA
sequence in a relational database. We are currently generating approximately
1,500 genetically engineered knockout ES cell clones per week using our gene
trapping technology. We estimate that our OmniBank library currently contains
gene knockout clones for more than 40% of all genes in the mammalian genome.
LexVision Technology Platform
We employ an integrated platform of advanced medical technologies to
rapidly and systematically discover and catalogue the functions of the genes we
have knocked out using our gene trapping and gene targeting technologies. This
state-of-the-art technology platform enables us to assess the phenotypic
consequences, or function in a living mammal, of the knocked-out gene across a
variety of parameters relevant to human disease, including cancer,
cardiovascular disease, immune disorders, neurological disease, diabetes and
obesity. Most of the technologies we employ are non-invasive, permitting
longitudinal studies of gene function over time that are not feasible using
conventional techniques for the analysis of knockout mice. The information
resulting from this
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analysis is captured in the LexVision relational database for our use, and use
by our collaborators, to discover genomics-based pharmaceutical products.
Drug Discovery Programs
We are using the discoveries made in our LexVision program to fuel drug
discovery programs in cancer, cardiovascular disease, immune disorders,
neurological disease, diabetes and obesity. We are conducting drug discovery
efforts in these areas on our own and in collaboration with the companies with
which we have established drug discovery alliances.
Research and Development Expenses
In 2000, we incurred $31.6 million on company-sponsored research and
development activities, including $10.9 million of stock-based compensation
expense.
OUR STRATEGY
We believe that genomics represents an opportunity for the development
of drugs that address medical needs for which there are presently no effective
treatments, as well as drugs that are more effective or have fewer side effects
than the treatments that are currently available. Drugs on the market today
interact with a total of about 500 specific protein targets, each of which is
encoded by a gene. While estimates of the total number of potential drug targets
encoded within the human genome vary, many experts believe that genomics
research could discover as many as 5,000 new targets for pharmaceutical
development. Very little is known about the functions of most genes, however,
presenting a major challenge to traditional drug discovery research.
We believe that the solution to this challenge requires redefining the
way drug discovery is conducted by systematically determining the functions of
large numbers of genes in mice, which, as mammals, share significant genetic and
physiological similarities with humans. We believe that the resulting
information will enable us and our collaborators to discover the most promising
drug targets and therapeutic proteins from the human genome.
Our principal objective is to establish a leadership position in drug
target and therapeutic protein discovery. The key elements of our strategy
include the following:
o expand and complete our OmniBank library using our gene
trapping technology to generate gene knockouts throughout the
mouse genome;
o expand our LexVision database using our integrated platform of
advanced medical technologies to systematically discover and
catalogue the functions of large numbers of genes that encode
potential drug targets and therapeutic proteins;
o establish additional drug discovery alliances and functional
genomics collaborations with researchers at pharmaceutical
companies, biotechnology companies and academic institutions;
and
o develop promising drug candidates through collaborations or
with our own resources.
COMMERCIALIZATION
We believe that the genes we identify and the gene functions we define
have the potential to be valuable in the discovery and development of
therapeutic proteins, antibody, small molecule and gene therapy drugs,
diagnostics, and pharmacology and toxicology applications. Our commercialization
strategy is to:
o establish additional subscription agreements for access to our
LexVision database and OmniBank database and library;
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o enter into additional functional genomics collaborations for
the development and analysis of knockout mice;
o expand our e-Biology collaborations;
o continue progress on our existing drug discovery alliances and
establish additional drug discovery and development alliances
with leading pharmaceutical and biotechnology companies; and
o develop a select group of pharmaceutical products on our own.
In implementing our commercialization strategy, we have entered into
the following collaboration and alliance agreements:
LexVision Collaboration
Bristol-Myers Squibb Company. We established a LexVision collaboration
with Bristol-Myers Squibb in September 2000, under which Bristol-Myers Squibb
has non-exclusive access to our LexVision database and OmniBank library for the
discovery of small molecule drugs. We could receive between $15 million and $25
million in access and delivery fees under this agreement, in addition to
milestone payments and royalties on products Bristol-Myers Squibb develops using
our technology. The agreement has a term of five years, although either party
may terminate the agreement after three years.
Drug Discovery Alliances
Abgenix, Inc. We established a drug discovery alliance with Abgenix in
July 2000 to discover novel antibody drugs using our functional genomics
technologies and Abgenix's technology for generating fully human monoclonal
antibodies. We and Abgenix will each have the right to obtain exclusive
commercialization rights, including sublicensing rights, for an equal number of
qualifying antibodies, and will each receive milestone payments and royalties on
sales of antibody drugs from the collaboration that are commercialized by the
other party or a third party sublicensee. Each party will bear its own expenses
under the collaboration. The agreement has a term of three years, subject to the
right of the parties to extend the term for up to three additional one-year
periods.
Arena Pharmaceuticals, Inc. We established a joint research
collaboration with Arena in June 2000 to discover novel drug candidates that
target an important class of receptors called G protein-coupled receptors, or
GPCRs, using our proprietary functional genomics technologies and Arena's
CART(TM) technology. Each company will fund its own efforts and share equally in
upfront fees, milestones and royalties generated from products developed from
alliance GPCRs. We expect most of these products to be licensed to third
parties, but we and Arena may elect to jointly fund further development of
select products discovered in the alliance.
Functional Genomics Collaborations
Millennium Pharmaceuticals, Inc. We established a multi-year functional
genomics agreement in July 1999 for the creation of gene-targeted knockout mice
for use by Millennium in the validation of potential drug targets identified and
selected by Millennium. We had a separate agreement with Millennium for access
to our human gene sequence database that expired in April 2000. We substantially
expanded our functional genomics agreement with Millennium in June 2000,
increasing the number of knockout mice that we will generate for Millennium over
the remaining term of the agreement. The term of the agreement extends until
June 2002.
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OmniBank Universal Agreements. The OmniBank Universal program allows
pharmaceutical and biotechnology companies to obtain non-exclusive access to our
OmniBank database and to obtain OmniBank and gene-targeted knockout mice under
predefined terms. Pharmaceutical and biotechnology companies that identify drug
targets of interest through either OmniBank or custom knockout mice also have
the option to engage us to analyze the phenotypes of those mice. We typically
receive annual subscription fees and fees for knockout mice with annual minimum
commitments and, under some of these agreements, may receive royalties on
products developed using novel genes discovered in OmniBank. We have entered
into agreements with the following companies under this program:
COMPANY DATE OF AGREEMENT END OF ACCESS PERIOD
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Abgenix, Inc. January 2001 January 2004
Tularik Inc. October 2000 October 2003
American Home Products March 2000 March 2003
Boehringer Ingelheim Pharmaceuticals, Inc. February 2000 February 2003
(a subsidiary of Boehringer Ingelheim GmBH, International)
Pharmacia Corp. January 2000 January 2003
The R.W. Johnson Pharmaceutical Research Institute December 1999 December 2001
(a subsidiary of Johnson & Johnson)
N.V. Organon December 1999 December 2002
(a subsidiary of Akzo Nobel)
DuPont Pharmaceuticals Company July 1998
(a subsidiary of E.I. du Pont de Nemours and Company)
We have entered into additional functional genomics collaboration
agreements with more than 30 companies and academic institutions throughout the
world under which we receive research fees for the generation of knockout mice
and, with participating institutions, certain rights to license inventions or
royalties on products discovered using such mice.
e-Biology Global Collaboration Program. Finding the best targets for
drug discovery among the estimated 30,000 to 50,000 genes contained in the human
genome is a task of such complexity and scale that it will require the combined
efforts of leading research scientists worldwide. The identification of drug
targets and therapeutic proteins using our technology will require the
application of in-depth scientific and medical knowledge to prioritize genes for
functional studies and to execute those studies. Therefore, we believe that the
magnitude of our OmniBank functional genomics resource uniquely enables
collaboration through the Internet to accelerate the discovery of gene function.
Researchers at pharmaceutical companies, biotechnology companies and
academic institutions worldwide subscribe to our OmniBank database through the
Internet. Our bioinformatics software allows subscribers to mine our OmniBank
database for interesting genes and knockout mice. Subscribers can acquire
OmniBank knockout mice on a non-exclusive basis and determine the function of
genes under our e-Biology collaboration program. In this program, we receive
fees for OmniBank knockout mice and, with participating institutions, certain
rights to license inventions or to receive royalties on pharmaceutical products
discovered using our mice. In cases where we do not obtain such rights, our
e-Biology collaborations leverage the value of OmniBank since we may also elect
to pursue any clone acquired through that program for gene function research
either on our own or with a commercial collaborator. We believe that Lexgen.com
and our e-Biology collaborations will allow us to harvest high-value functional
genomics information for application in drug discovery and facilitate
collaborations between us and pharmaceutical and biotechnology companies. We
have entered into more than 100 agreements under our e-Biology collaboration
program with researchers at leading institutions throughout the world.
Technology Sublicenses. We have granted non-exclusive, internal-use
sublicenses under certain of our gene targeting patent rights to a total of
fourteen leading pharmaceutical and biotechnology companies. These agreements
typically have a term of one to three years, in some cases with provisions for
subsequent renewals.
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PATENTS AND PROPRIETARY RIGHTS
We will be able to protect our proprietary rights from unauthorized use
by third parties only to the extent that those rights are covered by valid and
enforceable patents or are effectively maintained as trade secrets. Accordingly,
patents and other proprietary rights are an essential element of our business.
We seek patent protection for the genes, proteins and drug targets that we
discover. Specifically, we seek patent protection for:
o the sequences of genes that we believe to be novel, including
full-length genes and the partial gene sequences contained in
our human gene trap and OmniBank databases, the proteins they
encode and their predicted utility as a drug target or
therapeutic protein;
o the utility of genes and the drug targets or therapeutic
proteins they encode based on our discoveries of their
biological functions using knockout mice; and
o various enabling technologies in the fields of mutagenesis, ES
cell manipulation and transgenic or knockout mice.
We own or have exclusive rights to three issued U.S. patents that cover
our gene trapping technology and five issued U.S. patents that cover specific
knockout mice and discoveries of the functions of genes made using knockout
mice. We have licenses under 38 additional U.S. patents, and corresponding
foreign patents and patent applications, in the fields of gene targeting, gene
trapping and genetic manipulation of mouse ES cells. These include patents
covering the use of positive-negative selection, isogenic DNA and Cre/lox
technology to which we hold exclusive rights in certain fields. We have filed or
have exclusive rights to more than 300 pending patent applications in the United
States, the European Patent Office, the national patent offices of other foreign
countries or under the Patent Cooperation Treaty, covering our gene trapping
technology, the DNA sequences of genes and other products and processes.
Collectively, these patent applications cover, among other things, more than 200
full-length human gene sequences, more than 50,000 partial human gene sequences,
and more than 35,000 knockout mouse clones and corresponding mouse gene
sequence tags. Patents typically have a term of no longer than 20 years from the
date of filing.
All of our employees, consultants and advisors are required to execute
a confidentiality agreement upon the commencement of employment or consultation.
In general, the agreement provides that all inventions conceived by the employee
or consultant, and all confidential information developed or made known to the
individual during the term of the agreement, shall be our exclusive property and
shall be kept confidential, with disclosure to third parties allowed only in
specified circumstances. We cannot assure you, however, that these agreements
will provide useful protection of our proprietary information in the event of
unauthorized use or disclosure of such information.
COMPETITION
The biotechnology and pharmaceutical industries are highly competitive
and characterized by rapid technological change. We face significant competition
in each of the aspects of our business from for-profit companies such as Human
Genome Sciences, Inc., Incyte Pharmaceuticals, Inc., Millennium Pharmaceuticals,
Inc., Deltagen, Inc., DNX (a subsidiary of Xenogen Corporation) and Celera
Genomics, among others, many of which have substantially greater financial,
scientific and human resources than we do. In addition, the Human Genome Project
and a large number of universities and other not-for-profit institutions, many
of which are funded by the U.S. and foreign governments, are also conducting
research to discover genes and their functions.
While we are not aware of any other commercial entity that is
developing large-scale gene trap mutagenesis in ES cells, we face significant
competition from entities using traditional knockout mouse technology and other
technologies. Several companies and a large number of academic institutions
create knockout mice for third parties using these methods, and a number of
companies create knockout mice for use in their own research.
Many of our competitors in drug discovery and development have
substantially greater research and product development capabilities and
financial, scientific, marketing and human resources than we have. As a result,
our competitors may succeed in developing products earlier than we do, obtaining
approvals from the FDA or other regulatory agencies for those products more
rapidly than we do, or developing products that are more effective than
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those we propose to develop. Similarly, our collaborators face similar
competition from other competitors who may succeed in developing products more
quickly, or developing products that are more effective, than those developed by
our collaborators. We expect that competition in this field will intensify.
GOVERNMENT REGULATION
Regulation of Pharmaceutical Products
The development, production and marketing of any pharmaceutical
products developed by us or our collaborators will be subject to extensive
regulation by United States and foreign governmental authorities. In the United
States, new drugs are subject to regulation under the Federal Food, Drug and
Cosmetic Act and biological products are subject to regulation both under
certain provisions of that Act and under the Public Health Services Act. The FDA
regulates, among other things, the development, testing, manufacture, safety,
efficacy, record keeping, labeling, storage, approval, advertising, promotion,
sale and distribution of biologics and new drugs. The process of obtaining FDA
approval has historically been costly and time-consuming.
The standard process required by the FDA before a pharmaceutical agent
may be marketed in the United States includes:
o preclinical tests;
o submission to the FDA of an Investigational New Drug
application, or IND, which must become effective before human
clinical trials may commence;
o adequate and well-controlled human clinical trials to
establish the safety and efficacy of the drug or biologic in
our intended application;
o for drugs, submission of a New Drug Application, or NDA, or a
Biologic License Application, or BLA, with the FDA; and
o FDA approval of the NDA or BLA prior to any commercial sale or
shipment of the drug.
In addition to obtaining FDA approval for each product, each drug
manufacturing establishment must be inspected and approved by the FDA. All
manufacturing establishments are subject to inspections by the FDA and by other
federal, state and local agencies and must comply with current Good
Manufacturing Practices requirements.
The preclinical studies can take several years to complete, and there
is no guarantee that an IND based on those studies will become effective to even
permit clinical testing to begin. Once clinical trials are initiated, they
generally take two to five years, but may take longer, to complete. After
completion of clinical trials of a new drug or biologic product, FDA marketing
approval of the NDA or BLA must be obtained. This process requires substantial
time and effort and there is no assurance that the FDA will accept the NDA or
BLA for filing and, even if filed, that approval will be granted. In the past,
the FDA's approval of the NDA or BLA has taken, on average, two to five years;
if questions arise, approval can take more than five years.
In addition to regulatory approvals that must be obtained in the United
States, a drug product is also subject to regulatory approval in other countries
in which it is marketed, although the requirements governing the conduct of
clinical trials, product licensing, pricing, and reimbursement vary widely from
country to country. No action can be taken to market any drug product in a
country until an appropriate application has been approved by the regulatory
authorities in that country. FDA approval does not assure approval by other
regulatory authorities. The current approval process varies from country to
country, and the time spent in gaining approval varies from that required for
FDA approval. In some countries, the sale price of a drug product must also be
approved. The pricing review period often begins after market approval is
granted. Even if a foreign regulatory authority approves a drug product, it may
not approve satisfactory prices for the product.
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Other Regulations
In addition to the foregoing, our business is and will be subject to
regulation under various state and federal environmental laws, including the
Occupational Safety and Health Act, the Resource Conservation and Recovery Act
and the Toxic Substances Control Act. These and other laws govern our use,
handling and disposal of various biological, chemical and radioactive substances
used in and wastes generated by our operations. We believe that we are in
material compliance with applicable environmental laws and that our continued
compliance with these laws will not have a material adverse effect on our
business. We cannot predict, however, whether new regulatory restrictions on the
production, handling and marketing of biotechnology products will be imposed by
state or federal regulators and agencies or whether existing laws and
regulations will not adversely affect us in the future.
EMPLOYEES AND CONSULTANTS
We believe that our success will be based on, among other things,
achieving and retaining scientific and technological superiority and identifying
and retaining capable management. We have assembled a highly qualified team of
scientists as well as executives with extensive experience in the biotechnology
industry.
As of March 1, 2001, the Company employed 322 persons, of whom 64 hold
M.D., Ph.D. or D.V.M. degrees and 46 hold other advanced degrees. We believe
that our relationship with our employees is good.
SCIENTIFIC ADVISORY PANEL MEMBERS
We have consulting relationships with a number of scientific advisors,
organized into panels focused on specific human diseases or conditions. At our
request, these advisors review the feasibility of product development programs
under consideration, provide advice concerning advances in areas related to our
technology and aid in recruiting personnel. Most of these advisors receive cash
and stock-based compensation for their services, as well as access to our
OmniBank database and mice from our OmniBank library. All of the advisors are
employed by academic institutions or other entities and may have commitments to
or advisory agreements with other entities that may limit their availability to
us. Our advisors are required to disclose and assign to us any ideas,
discoveries and inventions they develop in the course of providing consulting
services to us. We also use consultants for various administrative needs. None
of our consultants or advisors is otherwise affiliated with us. Our scientific
advisors and consultants include the following persons:
NAME AND PANEL AFFILIATION TITLE
- -------------- ----------- -----
AGING AND CANCER
Carlo M. Croce, M.D. Thomas Jefferson University Director, Kimmel Cancer Center
Richard Fishel, Ph.D. Thomas Jefferson University Professor of Microbiology and Immunology
H. Earl Ruley, Ph.D. Vanderbilt University Professor, Department of Microbiology and
Immunology
ENDOCRINOLOGY AND OSTEOPOROSIS
John D. Brunzell, M.D. University of Washington Professor of Medicine, Division of
Metabolism, Endocrinology & Nutrition
Raif S. Geha, M.D. Harvard Medical School Professor of Pediatrics and Immunology
J. Wesley Pike, Ph.D. University of Cincinnati Professor, Department of Molecular and
Cellular Physiology
Clifford J. Rosen, M.D. Maine Center for Osteoporosis Medical Director for the Maine Center for
Research and Foundation Osteoporosis Research and Foundation
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CARDIOVASCULAR
Thomas M. Coffman, M.D. Duke University Medical Center Professor of Medicine, Chief Division of
Nephrology
Howard Rockman, M.D. Duke University Medical Center Associate Professor of Medicine
Oliver Smithies, Ph.D. University of North Carolina Excellence Professor, Department of
Pathology and Laboratory Medicine
METABOLISM, DIABETES AND OBESITY
Qais Al-Awqati, M.D. Columbia University Professor Physiology and Cell Biophysiology
Wolf-Georg Forsmann, M.D., Ph.D. Neidersachsisches Institut fur Direktor, Professor Neidersachsisches
Peptid-Forschung Institut fur Peptid-Forschung GmbH
Kenneth Heskel Gabbay, M.D. Baylor College of Medicine Head, Section of Molecular Diabetes and
Metabolism, Department of Pediatrics
Beverly Koller, Ph.D. University of North Carolina Assistant Professor, Department of Medicine
G. Stanley McKnight, Ph.D. University of Washington Professor, Department of Pharmacology
Richard D. Palmiter, Ph.D. University of Washington Professor of Biochemistry and Howard Hughes
Medical Institute Investigator
GENOMICS AND BIOINFORMATICS
Eric Douglas Green, M.D., Ph.D. National Human Genome Research Chief, Genome Technology
Institute
Steven R. Gullans, Ph.D. Harvard Institutes of Medicine Associate Professor of Medicine
Paul S. Meltzer, M.D., Ph.D. National Human Genome Research Head, Section of Molecular Genetics, Cancer
Institute Genetics Branch
William R. Pearson, Ph.D. University of Virginia Professor of Biochemistry
Gregory D. Schuler, Ph.D. National Center for Staff Scientist
Biotechnology Information
NEUROLOGY AND DEGENERATIVE DISEASES
Robert Edwards, M.D. University of California San Professor, Department of Neurology and
Francisco Physiology
Jeffrey L. Noebels, M.D., Ph.D. Baylor College of Medicine Professor of Neurology, Neuroscience and
Molecular Genetics
Rudolph E. Tanzi, Ph.D. Harvard Medical School Associate Professor of Neurology
(Neuroscience)
Laurence Tecott, M.D., Ph.D. University of California San Assistant Professor, Department of Psychiatry
Francisco
RISK FACTORS
Our business is subject to risks and uncertainties, including those
described below:
RISKS RELATED TO OUR BUSINESS
We have a history of net losses, and we expect to continue to incur net losses
and may not achieve or maintain profitability
We have incurred net losses since our inception, including net losses
of approximately $26.0 million for the year ended December 31, 2000. As of
December 31, 2000, we had an accumulated deficit of approximately $54.9 million.
We are unsure when we will become profitable, if ever. The size of our net
losses will depend, in part, on the rate of growth, if any, in our revenues and
on the level of our expenses.
We derive substantially all of our revenues from subscriptions to our
databases, functional genomics collaborations for the development and, in some
cases, analysis of knockout mice, and technology licenses, and will
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continue to do so for the foreseeable future. Revenues from database
subscriptions, collaborations and licenses are uncertain because our existing
agreements have fixed terms or relate to specific projects of limited duration.
Our ability to secure future agreements will depend upon our ability to address
the needs of our potential future subscribers and collaborators.
A large portion of our expenses are fixed, including expenses related
to facilities, equipment and personnel. In addition, we expect to spend
significant amounts to fund research and development and to enhance our core
technologies. As a result, we expect that our operating expenses will increase
significantly in the near term and, consequently, we will need to generate
significant additional revenues to achieve profitability. Even if we do achieve
profitability, we may not be able to sustain or increase profitability on a
quarterly or annual basis.
Our quarterly operating results have been and likely will continue to fluctuate,
and we believe that quarter-to-quarter comparisons of our operating results are
not a good indication of our future performance
Our quarterly operating results have fluctuated in the past and are
likely to do so in the future. In addition to the risks and uncertainties
described in this section, some of the factors that could cause our operating
results to fluctuate include:
o our ability to establish new database subscriptions or
research contracts with collaborators and new technology
licenses, and the timing of such arrangements;
o the expiration or other termination of database subscriptions
or research contracts with our collaborators or technology
licenses, which may not be renewed or replaced;
o the success rate of our discovery efforts leading to milestone
payments and royalties;
o the timing and willingness of our collaborators to
commercialize products which would result in milestone
payments and royalties; and
o general and industry-specific economic conditions, which may
affect our and our collaborators' research and development
expenditures.
Due to the likelihood of fluctuations in our revenues and expenses, we
believe that quarter-to-quarter comparisons of our operating results are not a
good indication of our future performance. Our operating results in some
quarters may not meet the expectations of stock market analysts and investors.
In that case, our stock price would probably decline.
We are an early-stage company with an unproven business strategy
Our business strategy of using our gene sequence databases and knockout
mice to select promising candidates for drug target development and
commercializing our discoveries through collaborations and alliances is
unproven. Our success will depend upon our ability to enter into additional
collaboration and alliance agreements on favorable terms, determine which genes
have potential value and select an appropriate commercialization strategy for
each potential product we or our collaborators choose to pursue.
Biotechnology and pharmaceutical companies have successfully developed
and commercialized only a limited number of gene-based products to date. We have
not proven our ability to identify gene-based drugs or drug targets with
commercial potential, or to develop or commercialize drugs or drug targets that
we do identify. It is difficult to successfully select those genes with the most
potential for commercial development, and we do not know that any products based
on genes that we discover can be successfully commercialized. In addition, we
may experience unforeseen technical complications in the processes we use to
generate our gene sequence database and functional genomics resources. These
complications could materially delay or limit the use of those databases and
resources, substantially increase the anticipated cost of generating them or
prevent us from implementing our processes at appropriate quality and throughput
levels.
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We face substantial competition in the discovery of the DNA sequences of genes
and their functions and in our drug discovery and product development efforts
There are a finite number of genes in the human genome, and we believe
that the majority of such genes have been identified by us or others conducting
genomic research and that virtually all will be identified within the next few
years. We face significant competition in our efforts to discover and patent the
sequence and other information derived from such genes from entities using
alternative, and in some cases higher volume and larger scale, approaches for
the same purpose.
We also face competition from entities using more traditional methods
to discover genes related to particular diseases. Many of these entities have
substantially greater financial, scientific and human resources than we do. A
large number of universities and other not-for-profit institutions, many of
which are funded by the U.S. and foreign governments, are also conducting
research to discover genes. A substantial portion of this research has been
conducted under the international Human Genome Project, a multi-billion dollar
program funded by the U.S. government and The Wellcome Trust. One or more of
these entities may discover and establish a patent position in one or more of
the genes that we wish to study or use in the development of a pharmaceutical
product.
We face significant competition in our drug discovery and product
development efforts from entities using traditional knockout mouse technology
and other functional genomics technologies, as well as from those using other
traditional drug discovery techniques. These competitors may develop products
earlier than we do, obtain regulatory approvals faster than we can and develop
products that are more effective than ours. Our ability to use our patent rights
to prevent competition in the creation and use of knockout mice is more limited
outside of the United States. Competitors could discover and establish patents
in genes or gene products that we or our collaborators identify as a drug target
or therapeutic protein. Numerous companies, academic institutions and government
consortia are engaged in efforts to determine the function of genes and gene
products. Furthermore, other methods for conducting functional genomics research
may ultimately prove superior, in some or all respects, to the use of knockout
mice. In addition, technologies more advanced than or superior to our gene
trapping technology may be developed, thereby rendering our gene trapping
technology obsolete.
We rely heavily on collaborators to develop and commercialize products based on
genes that we identify as promising candidates for development as drug targets
Since we do not currently possess the resources necessary to develop,
obtain approvals for or commercialize potential products based on genes
contained in our databases or genes that we identify as promising candidates for
development as drug targets or therapeutic proteins, we must enter into
collaborative arrangements to develop and commercialize these products. We will
have limited or no control over the resources that any collaborator may devote
to this effort. Any of our present or future collaborators may not perform their
obligations as expected. These collaborators may breach or terminate their
agreements with us or otherwise fail to conduct product discovery, development
or commercialization activities successfully or in a timely manner. Further, our
collaborators may elect not to develop products arising out of our collaborative
arrangements or may not devote sufficient resources to the development,
approval, manufacture, marketing or sale of these products. If any of these
events occurs, we may not be able to develop or commercialize potential
products.
Some of our agreements provide us with rights to participate in the
commercial development of compounds or therapeutic approaches derived from our
collaborations or access to our databases, technology or intellectual property.
We may not be able to obtain such rights in future collaborations or agreements.
Our ability to obtain such rights depends in part on the validity of our
intellectual property, the advantages and novelty of our technologies and
databases and our negotiating position relative to each potential collaborator
or customer. Previous attempts by others in the industry to obtain these rights
with respect to the development of knockout mice and related technologies have
generated considerable controversy, especially in the academic community.
Any cancellation by or conflicts with our collaborators could harm our business
Our collaboration agreements may not be renewed and may be terminated
in the event either party fails to fulfill its obligations under these
agreements. Any failure to renew or cancellation by a collaborator could mean a
significant loss of revenues and volatility in our earnings.
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In addition, we may pursue opportunities in fields that could conflict
with those of our collaborators. Moreover, disagreements could arise with our
collaborators over rights to our intellectual property or our rights to share in
any of the future revenues of compounds or therapeutic approaches developed by
our collaborators. These kinds of disagreements could result in costly and
time-consuming litigation. Any conflict with our collaborators could reduce our
ability to obtain future collaboration agreements and could have a negative
impact on our relationship with existing collaborators, adversely affecting our
business and revenues. Some of our collaborators could also become competitors
in the future. Our collaborators could develop competing products, preclude us
from entering into collaborations with their competitors or terminate their
agreements with us prematurely. Any of these developments could harm our product
development efforts.
We have no experience in developing and commercializing products on our own
Our ability to develop and commercialize products on our own will
depend on our ability to internally develop preclinical, clinical, regulatory
and sales and marketing capabilities, or enter into arrangements with third
parties to provide those functions. We may not be successful in developing these
capabilities or entering into agreements with third parties on favorable terms,
or at all. Further, our reliance upon third parties for these capabilities could
reduce our control over such activities and could make us dependent upon these
parties. Our inability to develop or contract for these capabilities would
significantly impair our ability to develop and commercialize products.
We may engage in future acquisitions, which may be expensive and time consuming
and from which we may not realize anticipated benefits
We may acquire additional businesses, technologies and products, if we
determine that these businesses, technologies and products complement our
existing technology or otherwise serve our strategic goals. We currently have no
commitments or agreements with respect to any acquisitions. If we do undertake
any transactions of this sort, the process of integrating an acquired business,
technology or product may result in operating difficulties and expenditures and
may absorb significant management attention that would otherwise be available
for ongoing development of our business. Moreover, we may never realize the
anticipated benefits of any acquisition. Future acquisitions could result in
potentially dilutive issuances of our equity securities, the incurrence of debt
and contingent liabilities and amortization expenses related to goodwill and
other intangible assets, which could adversely affect our results of operations
and financial condition.
If we lose our key personnel or are unable to attract and retain additional
personnel, we may be unable to pursue collaborations or develop our own products
We are highly dependent on Arthur T. Sands, M.D., Ph.D., our president
and chief executive officer, as well as other principal members of our
management and scientific staff. The loss of any of these personnel would have a
material adverse effect on our business, financial condition or results of
operations and could inhibit our product development and commercialization
efforts. Although we have entered into employment agreements with some of our
key personnel, including Dr. Sands, these employment agreements are for a
limited period of time and not all key personnel have employment agreements.
Recruiting and retaining qualified scientific personnel to perform
future research and development work will be critical to our success.
Competition for experienced scientists is high. Failure to recruit and retain
scientific personnel on acceptable terms could prevent us from achieving our
business objectives.
We may encounter difficulties in managing our growth, which could increase our
losses
We have experienced a period of rapid growth that has placed and, if
this growth continues, will continue to place a strain on our human and capital
resources. If we are unable to manage our growth effectively, our losses could
increase. The number of our employees increased from 57 at December 31, 1997 to
93 at December 31, 1998, 122 at December 31, 1999, 287 at December 31, 2000 and
322 at March 1, 2001. We intend to increase the number of our employees
significantly during the remainder of 2001. Our ability to manage our operations
and growth effectively requires us to continue to expend funds to improve our
operational, financial and management controls,
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reporting systems and procedures. If we are unable to successfully implement
improvements to our management information and control systems in an efficient
or timely manner, or if we encounter deficiencies in existing systems and
controls, our management may not have adequate information to manage our
day-to-day operations.
Because our entire OmniBank mouse clone library is located at a single facility,
the occurrence of a disaster could significantly disrupt our business
Our OmniBank mouse clone library and its back-up are stored in liquid
nitrogen freezers located at our facility in The Woodlands, Texas. If a disaster
such as a fire, flood, hurricane, tornado or similar event significantly damages
or destroys the facility in which our mouse clone library and back-up are
stored, our business could be disrupted until we could regenerate the library
and, as a result, our stock price could decline. Our business interruption
insurance may not be sufficient to compensate us in the event of a major
interruption due to such a disaster.
We may need additional capital in the future and, if it is not available, we
will have to curtail or cease operations
Our future capital requirements will be substantial and will depend on
many factors, including our ability to obtain database subscription and
collaboration agreements and government grants, the amount and timing of
payments under such agreements and grants, the level and timing of our research
and development expenditures, market acceptance of our products, the resources
we devote to developing and supporting our products and other factors. Our
capital requirements will also be affected by any expenditures we make in
connection with license agreements and acquisitions of and investments in
complementary technologies and businesses.
We anticipate that our existing capital resources will enable us to
maintain our currently planned operations for at least the next several years.
However, changes may occur that would consume available capital resources
significantly sooner than we expect. If our capital resources are insufficient
to meet future capital requirements, we will have to raise additional funds to
continue the development of our technologies and complete the commercialization
of products, if any, resulting from our technologies. We may be unable to raise
sufficient additional capital; if so, we will have to curtail or cease
operations.
RISKS RELATED TO OUR INDUSTRY
Our ability to patent our discoveries is uncertain because patent laws and their
interpretation are highly uncertain and subject to change
The patent positions of biotechnology firms generally are highly
uncertain and involve complex legal and factual questions that will determine
who has the right to develop a particular product. No clear policy has emerged
regarding the breadth of claims covered in biotechnology patents. The
biotechnology patent situation outside the United States is even more uncertain
and is currently undergoing review and revision in many countries. Changes in,
or different interpretations of, patent laws in the United States and other
countries might allow others to use our discoveries or to develop and
commercialize our products without any compensation to us. We anticipate that
these uncertainties will continue for a significant period of time.
Our patent applications may not result in enforceable patent rights
Our disclosures in our patent applications may not be sufficient to
meet the statutory requirements for patentability. Additionally, our current
patent applications cover many genes and we expect to file patent applications
in the future covering many more genes. As a result, we cannot predict which of
our patent applications will result in the granting of patents or the timing of
the granting of our patents. Our ability to obtain patent protection based on
genes or partial gene sequences will depend, in part, upon identification of a
function for the gene or gene sequences sufficient to meet the statutory
requirement that an invention have utility and that a patent application
describe the invention with sufficient specificity. While the U.S. Patent and
Trademark Office has issued guidelines for the examination of patent
applications claiming gene sequences, their therapeutic uses and novel proteins
coded by such genes, the impact of these guidelines is uncertain and may delay
or negatively impact our patent position. Biologic data in addition to that
obtained by our current technologies may be required for issuance of patents or
human therapeutics. If required, obtaining such biologic data could delay, add
substantial
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costs to, or affect our ability to obtain patent protection. There can be no
assurance that the disclosures in our current or future patent applications,
including those we may file with our collaborators, will be sufficient to meet
these requirements. Alternatively, if the level of biologic or other
experimental data required to obtain a patent is determined to be minimal, then
other companies who emphasize determining the gene sequence without significant
biologic function information will obtain a prior and superior patent position
to us and our collaborators. Even if patents are issued, there may be current or
future uncertainty as to the scope of the coverage or protection provided by any
such patents. In addition, the Human Genome Project, as well as many companies
and institutions, have identified genes and deposited partial gene sequences in
public databases and are continuing to do so. These public disclosures might
limit the scope of our claims or make unpatentable subsequent patent
applications on full-length genes.
Other companies or institutions have filed and will file patent
applications that attempt to patent genes or gene sequences that may be similar
to our patent applications. The U.S. Patent and Trademark Office could decide
competing patent claims in an interference proceeding. Any such proceeding would
be costly, and we may not prevail. In addition, patent applications filed by
third parties may have priority over patent applications we file. In this event,
the prevailing party may require us or our collaborators to stop pursuing a
potential product or to negotiate a license arrangement to pursue the potential
product. We may not be able to obtain a license from the prevailing party on
acceptable terms, or at all.
Some court decisions indicate that disclosure of a partial sequence may
not be sufficient to support the patentability of a full-length sequence. These
decisions have been confirmed by recent pronouncements of the U.S. Patent and
Trademark Office. We believe that these court decisions and the uncertain
position of the U.S. Patent and Trademark Office present a significant risk that
the U.S. Patent and Trademark Office will not issue patents based on patent
disclosures limited to partial gene sequences, like those represented in our
human gene trap database. In addition, we are uncertain about the scope of the
coverage, enforceability and commercial protection provided by any patents
issued on the basis of partial gene sequences.
If other companies and institutions obtain patents claiming the functional uses
of genes and gene products based upon gene sequence information and predictions
of gene function, we may be unable to obtain patents for our discoveries of
biological functions in knockout mice
We intend to pursue patent protection covering the novel uses and
functions of new and known genes and proteins in mammalian physiology and
disease states. While an actual description of the biological function of a gene
or protein should enhance a patent position, we cannot assure you that such
information will increase the probability of issuance of any patents. Further,
many other entities are currently filing patents on genes which are identical or
similar to our filings. Many such applications seek to protect partial human
gene sequences, full-length gene sequences and the deduced protein products
encoded by the sequences while others use biological or other laboratory data.
Some of these applications attempt to assign biologic function to the DNA
sequences based on computer predictions. There is the significant possibility
that patents claiming the functional uses of genes and gene products will be
issued to our competitors based on such information.
We are presently involved in patent litigation and may be involved in future
patent litigation and other disputes regarding intellectual property rights, and
can give no assurances that we will prevail in any such litigation or other
dispute
Our potential products and those of our collaborators may give rise to
claims that they infringe the patents of others. This risk will increase as the
biotechnology industry expands and as other companies obtain more patents and
attempt to discover genes through the use of high-speed sequencers. In addition,
many companies have well-established patent portfolios directed to common
techniques, methods and means of developing, producing and manufacturing
pharmaceutical products. Other companies or institutions could bring legal
actions against us or our collaborators for damages or to stop us or our
collaborators from manufacturing and marketing the affected products. If any of
these actions are successful, in addition to our potential liability for
damages, these entities may require us or our collaborators to obtain a license
in order to continue to manufacture or market the affected products or may force
us to terminate manufacturing or marketing efforts.
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We may need to pursue litigation against others to enforce our patents
and intellectual property rights. Patent litigation is expensive and requires
substantial amounts of management attention. In addition, the eventual outcome
of any such litigation is uncertain.
On May 24, 2000, we filed a complaint against Deltagen, Inc. in U.S.
District Court for the District of Delaware alleging that Deltagen is willfully
infringing the claims of United States Patent No. 5,789,215, under which we hold
an exclusive license from GenPharm International, Inc. This patent covers
methods of engineering the animal genome, including methods for the production
of knockout mice by homologous recombination, using isogenic DNA technology. In
the complaint, we are seeking unspecified damages from Deltagen, as well as
injunctive relief. Deltagen has counterclaimed for a declaratory judgment that
the patent is invalid and unenforceable and is not infringed by Deltagen. On
November 14, 2000, Deltagen filed an amended counterclaim alleging antitrust
claims against us and GenPharm, for which Deltagen is seeking unspecified
damages.
On October 13, 2000, we filed a second complaint against Deltagen, Inc.
in U.S. District Court for the Northern District of California alleging that
Deltagen is willfully infringing the claims of United States Patents Nos.
5,464,764, 5,487,992, 5,627,059, and 5,631,153, under which also we hold
exclusive licenses from GenPharm International. These patents cover methods and
vectors for using positive-negative selection for producing gene targeted, or
"knockout," cells and animals, including the production of knockout mice by
homologous recombination. In the complaint, we are seeking unspecified damages
from Deltagen, as well as injunctive relief. Deltagen has counterclaimed for a
declaratory judgment that the patents are invalid and unenforceable and are not
infringed by Deltagen.
While we believe that our complaints against Deltagen are meritorious
and that Deltagen's counterclaims against us are without merit, we can provide
no assurance that we will prevail in our litigation against Deltagen or that, if
we prevail, any damages or equitable remedies awarded will be commercially
valuable. If Deltagen prevails in declaring our patents invalid or on its
antitrust claim against us, our business and financial position could be
adversely affected. Furthermore, we are likely to incur substantial costs and
expend substantial personnel time in pursuing our litigation against Deltagen.
We believe that there will continue to be significant litigation in our
industry regarding patent and other intellectual property rights. We and many of
our competitors have and are continuing to expend significant amounts of time,
money and management resources on intellectual property litigation. If we become
involved in additional litigation, it could consume a substantial portion of our
resources and could negatively affect our results of operations.
Patent litigation involves substantial risks. Each time we sue for
patent infringement we face the risk that the patent will be held invalid or
unenforceable. Such a determination is binding on us for all future litigation
involving that patent. Furthermore, in light of recent U.S. Supreme Court
precedent, our ability to enforce our patents against state agencies, including
state sponsored universities and research labs is limited by the Eleventh
Amendment to the U.S. Constitution. Finally, opposition by academicians and the
government may hamper our ability to enforce our patent against academic or
government research laboratories. Enforcement of our patents may cause our
reputation in the academic community to be injured.
Issued patents may not fully protect our discoveries, and our competitors may be
able to commercialize products similar to those covered by our issued patents
Issued patents may not provide commercially-meaningful protection
against competitors. Other companies or institutions may challenge our or our
collaborators' patents or independently develop similar products that could
result in an interference proceeding in the Patent and Trademark Office or a
legal action. In the event any single researcher or institution infringes upon
our or our collaborators' patent rights, enforcing these rights may be difficult
and time consuming. Others may be able to design around these patents or develop
unique products providing effects similar to our products. We may be required to
choose between pursuing litigation against infringers and being unable to
recover damages or otherwise enforce our patent rights.
In addition, others may discover uses for genes or proteins other than
those uses covered in our patents, and these other uses may be separately
patentable. Even if we have a patent claim on a particular gene, the holder of a
patent covering the use of that gene could exclude us from selling a product
that is based on the same use of that
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gene. In addition, with respect to certain of our patentable inventions, we have
decided not to pursue patent protection outside the United States, both because
we do not believe it is cost effective and because of confidentiality concerns.
Accordingly, our international competitors could develop, and receive foreign
patent protection for gene sequences and functions for which we are seeking U.S.
patent protection.
Our rights to the use of technologies licensed by third parties are not within
our control
We rely, in part, on licenses to use certain technologies which are
material to our business. We do not own the patents which underly these
licenses. Our rights to use these technologies and practice the inventions
claimed in the licensed patents are subject to our licensors abiding by the
terms of those licenses and not terminating them. In many cases, we do not
control the prosecution or filing of the patents to which we hold licenses. We
rely upon our licensors to prevent infringement of those patents. The scope of
our rights under our licenses may be subject to dispute by our licensors or
third parties.
We may be unable to protect our trade secrets
While we have entered into confidentiality agreements with employees
and collaborators, we may not be able to prevent the disclosure of our trade
secrets. In addition, other companies or institutions may independently develop
substantially equivalent information and techniques.
We may become subject to regulation under the Animal Welfare Act, which could
subject us to additional costs and permit requirements
The Animal Welfare Act, or AWA, is the federal law that currently
covers animals in laboratories. It applies to institutions or facilities using
any regulated live animals for research, testing, teaching or experimentation,
including diagnostic laboratories and private companies in the pharmaceutical
and biotechnology industries. The AWA currently does not cover rats or mice.
However, the United States Department of Agriculture, which enforces the AWA,
has entered into a proposed settlement agreement under which it has agreed to
commence the process of adopting regulations under the AWA to include mice
within its coverage.
Currently, the AWA imposes a wide variety of specific regulations which
govern the humane handling, care, treatment and transportation of certain
animals by producers and users of research animals, most notably personnel,
facilities, sanitation, cage size, feeding, watering and shipping conditions. If
the USDA includes mice in its regulations, we will become subject to
registration, inspections and reporting requirements. Compliance with the AWA
could be expensive, and the regulations eventually adopted by the USDA could
impair our research and production efforts.
We and our collaborators are subject to extensive and uncertain government
regulatory requirements, which could increase our operating costs or adversely
affect our ability to obtain government approval of products based on genes that
we identify in a timely manner or at all
Since we develop animals containing changes in their genetic make-up,
we may become subject to a variety of laws, guidelines, regulations and treaties
specifically directed at genetically modified organisms, or GMOs. The area of
environmental releases of GMOs is rapidly evolving and is currently subject to
intense regulatory scrutiny, particularly internationally. If we become subject
to these laws we could incur substantial compliance costs. For example, the
Biosafety Protocol, or the BSP, a recently adopted treaty, is expected to cover
certain shipments from the United States to countries abroad that have signed
the BSP. The BSP is also expected to cover the importation of living modified
organisms, a category that could include our animals. If our animals are not
contained as described in the BSP, our animals could be subject to the
potentially extensive import requirements of countries that are signatories to
the BSP.
Drugs and diagnostic products are subject to an extensive and uncertain
regulatory approval process by the FDA and comparable agencies in other
countries. The regulation of new products is extensive, and the required process
of laboratory testing and human studies is lengthy and expensive. The burden of
these regulations will fall on us to the extent we develop proprietary products
on our own. If the products are the result of a collaboration effort, these
burdens may fall on our collaborating partner or may be shared with us. We may
not be able to obtain
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FDA approvals for those products in a timely manner, or at all. We may encounter
significant delays or excessive costs in our efforts to secure necessary
approvals or licenses. Even if we obtain FDA regulatory approvals, the FDA
extensively regulates manufacturing, labeling, distributing, marketing,
promotion and advertising after product approval. Moreover, several of our
product development areas may involve relatively new technology and have not
been the subject of extensive product testing in humans. The regulatory
requirements governing these products and related clinical procedures remain
uncertain and the products themselves may be subject to substantial review by
foreign governmental regulatory authorities that could prevent or delay approval
in those countries. Regulatory requirements ultimately imposed on our products
could limit our ability to test, manufacture and, ultimately, commercialize our
products.
Security risks in electronic commerce or unfavorable internet regulation may
deter future use of our products and services
We provide access to our databases and the opportunity to acquire our
knockout mice on the Internet. A fundamental requirement to conduct
Internet-based electronic commerce is the secure transmission of confidential
information over public networks. Advances in computer capabilities, new
discoveries in the field of cryptography or other developments may result in a
compromise or breach of the algorithms we use to protect content and
transactions on Lexgen.com or proprietary information in our OmniBank database.
Anyone who is able to circumvent our security measures could misappropriate our
proprietary information, confidential customer information or cause
interruptions in our operations. We may be required to incur significant costs
to protect against security breaches or to alleviate problems caused by
breaches. Further, a well-publicized compromise of security could deter people
from using the Internet to conduct transactions that involve transmitting
confidential information.
Because of the growth in electronic commerce, Congress has held
hearings on whether to regulate providers of services and transactions in the
electronic commerce market, and federal or state authorities could enact laws,
rules or regulations affecting our business or operations. If enacted and
applied to our business, these laws, rules or regulations could render our
business or operations more costly, burdensome, less efficient or impracticable.
We use hazardous chemicals and radioactive and biological materials in our
business; any disputes relating to improper handling, storage or disposal of
these materials could be time consuming and costly
Our research and development processes involve the use of hazardous
materials, including chemicals and radioactive and biological materials. Our
operations also produce hazardous waste products. We cannot eliminate the risk
of accidental contamination or discharge or any resultant injury from these
materials. Federal, state and local laws and regulations govern the use,
manufacture, storage, handling and disposal of these materials. We could be
subject to civil damages in the event of an improper or unauthorized release of,
or exposure of individuals to, these hazardous materials. In addition, claimants
may sue us for injury or contamination that results from our use or the use by
third parties of these materials, and our liability may exceed our total assets.
Compliance with environmental laws and regulations may be expensive, and current
or future environmental regulations may impair our research, development or
production efforts.
We may be sued for product liability
We or our collaborators may be held liable if any product we or our
collaborators develop, or any product which is made with the use or
incorporation of any of our technologies, causes injury or is found otherwise
unsuitable during product testing, manufacturing, marketing or sale. Although we
currently have and intend to maintain product liability insurance, this
insurance may become prohibitively expensive, or may not fully cover our
potential liabilities. Inability to obtain sufficient insurance coverage at an
acceptable cost or otherwise to protect against potential product liability
claims could prevent or inhibit the commercialization of products developed by
us or our collaborators. If we are sued for any injury caused by our or our
collaborators' products, our liability could exceed our total assets.
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Public perception of ethical and social issues may limit or discourage the use
of our technologies, which could reduce our revenues
Our success will depend in part upon our ability to develop products
discovered through our gene trapping and knockout mouse technologies.
Governmental authorities could, for ethical, social or other purposes, limit the
use of genetic processes or prohibit the practice of our gene trapping and
knockout mouse technologies. Claims that genetically engineered products are
unsafe for consumption or pose a danger to the environment may influence public
perceptions. The subject of genetically modified organisms, like knockout mice,
has received negative publicity and aroused public debate in some countries.
Ethical and other concerns about our technologies, particularly the use of genes
from nature for commercial purposes and the products resulting from this use,
could adversely affect the market acceptance of our technologies.
ITEM 2. PROPERTIES
We currently lease approximately 104,000 square feet of space for our
corporate offices and laboratories in buildings located in The Woodlands, Texas,
a suburb of Houston, Texas. Our facilities at this location include a 28,000
square foot state-of-the art animal facility completed in January 1999. We
believe this is one of the largest facilities in the world dedicated to the
generation and analysis of knockout mice.
In October 2000, we entered into a synthetic lease agreement under
which the lessor purchased our current laboratory and office space and animal
facility and agreed to fund the construction of an additional 128,000
square-foot laboratory and office space and a second 60,000 square-foot animal
facility. The construction of these new facilities is expected to be completed
in the fourth quarter of 2001.
ITEM 3. LEGAL PROCEEDINGS
On May 24, 2000, we filed a complaint against Deltagen, Inc. in U.S.
District Court for the District of Delaware alleging that Deltagen is willfully
infringing the claims of United States Patent No. 5,789,215, under which we hold
an exclusive license from GenPharm International, Inc. This patent covers
methods of engineering the animal genome, including methods for the production
of knockout mice by homologous recombination, using isogenic DNA technology. In
the complaint, we are seeking unspecified damages from Deltagen, as well as
injunctive relief. Deltagen has counterclaimed for a declaratory judgment that
the patent is invalid and unenforceable and is not infringed by Deltagen. On
November 14, 2000, Deltagen filed an amended counterclaim alleging antitrust
claims against us and GenPharm, for which Deltagen is seeking unspecified
damages.
On October 13, 2000, we filed a second complaint against Deltagen, Inc.
in U.S. District Court for the Northern District of California alleging that
Deltagen is willfully infringing the claims of United States Patents Nos.
5,464,764, 5,487,992, 5,627,059, and 5,631,153, under which also we hold
exclusive licenses from GenPharm International. These patents cover methods and
vectors for using positive-negative selection for producing gene targeted, or
"knockout," cells and animals, including the production of knockout mice by
homologous recombination. In the complaint, we are seeking unspecified damages
from Deltagen, as well as injunctive relief. Deltagen has counterclaimed for a
declaratory judgment that the patents are invalid and unenforceable and are not
infringed by Deltagen.
While we believe that our complaints against Deltagen are meritorious
and that Deltagen's counterclaims against us are without merit, we can provide
no assurance that we will prevail in our litigation against Deltagen or that, if
we prevail, any damages or equitable remedies awarded will be commercially
valuable. If Deltagen prevails in declaring our patents invalid or on its
antitrust claim against us, our business and financial position could be
adversely affected. Furthermore, we are likely to incur substantial costs and
expend substantial personnel time in pursuing our litigation against Deltagen.
We are not a party to any material legal proceedings other than the
Deltagen litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended
December 31, 2000.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been quoted on The Nasdaq National Market under
the symbol "LEXG" since April 7, 2000. Prior to that time, there was no public
market for our common stock. The following table sets forth, for the periods
indicated, the range of the high and low closing prices per share for our common
stock as reported on The Nasdaq National Market.
HIGH LOW
---- ---
2000
Second Quarter (April 1, 2000 through June 30, 2000)............................ $35.00 $ 9.12
Third Quarter................................................................... $47.12 $24.69
Fourth Quarter.................................................................. $29.56 $10.75
As of March 7, 2001, there were approximately 138 holders of record of
our common stock.
We have never paid cash dividends on our common stock. We anticipate
that we will retain all of our future earnings, if any, for use in the expansion
and operation of our business and do not anticipate paying cash dividends in the
foreseeable future.
The effective date of the Registration Statement on Form S-1
(Registration No. 333-96469) filed under the Securities Act of 1933, as amended,
relating to the initial public offering of our common stock was April 6, 2000.
On the same date, we signed an underwriting agreement with J.P. Morgan
Securities, Inc., Credit Suisse First Boston Corporation, CIBC World Markets
Corp. and Punk, Ziegel & Company, L.P., the managing underwriters for the
initial public offering and the representatives of the underwriters named in the
underwriting agreement, for the initial public offering of 10,000,000 shares of
our common stock at an initial public offering price of $22.00 per share. The
offering commenced on April 7, 2000 and was closed on April 12, 2000. The
initial public offering resulted in gross proceeds of $220.0 million. We
received net proceeds of $203.2 million after deducting underwriting discounts
of $15.4 million and estimated offering expenses of $1.4 million.
Concurrently with the closing of the initial public offering, the
4,244,664 outstanding shares of our Series A Preferred Stock were automatically
converted into 12,733,992 shares of common stock. As a result, we no longer have
any outstanding preferred stock.
From the time of receipt through December 31, 2000, the net proceeds of
our initial public offering were applied toward:
o purchases and installation of equipment and build-out of facilities: $ 7,259,000
o repayment of indebtedness: $ 1,620,000
o working capital: $ 36,378,000
o short-term investments in U.S. Government debt obligations
and investment grade commercial paper: $157,943,000
Except for the repayment of $917,000 of indebtedness to a director in
the second quarter of 2000, we have made no payments to our directors or
officers or their associates, holders of 10% or more of any class of our equity
securities or to our affiliates, other than payments to officers for salaries in
the ordinary course of business.
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ITEM 6. SELECTED FINANCIAL DATA
The statements of operations data for each of the years ended December
31, 1998, 1999 and 2000, and the balance sheet data as of December 31, 1999 and
2000, have been derived from our audited financial statements included elsewhere
in this annual report on Form 10-K that have been audited by Arthur Andersen
LLP, independent public accountants. The statements of operations data for the
years ended December 31, 1996 and 1997, and the balance sheet data as of
December 31, 1996, 1997 and 1998 have been derived from our audited financial
statements not included in this annual report on Form 10-K. Our historical
results are not necessarily indicative of results to be expected for any future
period. The data presented below have been derived from financial statements
that have been prepared in accordance with accounting principles generally
accepted in the United States and should be read with our financial statements,
including the notes, and with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this annual report on
Form 10-K.
----------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1996 1997 1998 1999 2000
------------ ------------ ------------ ------------ ------------
STATEMENTS OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues ..................................... $ 306 $ 968 $ 2,242 $ 4,738 $ 14,459
Operating expenses:
Research and development, including
stock-based compensation of
$10,883 in 2000 ......................... 2,409 4,971 8,410 14,646 31,647
General and administrative,
including stock-based compensation of
$9,958 in 2000 .......................... 764 1,473 2,024 2,913 18,289
------------ ------------ ------------ ------------ ------------
Total operating expenses ..................... 3,173 6,444 10,434 17,559 49,936
------------ ------------ ------------ ------------ ------------
Loss from operations ......................... (2,867) (5,476) (8,192) (12,821) (35,477)
Interest income (expense), net ............... (12) 74 711 346 9,483
------------ ------------ ------------ ------------ ------------
Net loss ..................................... (2,879) (5,402) (7,481) (12,475) (25,994)
Accretion on redeemable
convertible preferred stock .............. -- -- (357) (535) (134)
------------ ------------ ------------ ------------ ------------
Net loss attributable to
common stockholders ...................... $ (2,879) $ (5,402) $ (7,838) $ (13,010) $ (26,128)
============ ============ ============ ============ ============
Net loss per common share,
basic and diluted ........................ $ (0.17) $ (0.23) $ (0.32) $ (0.53) $ (0.63)
============ ============ ============ ============ ============
Shares used in computing net
loss per common share, basic
and diluted ............................... 17,346,228 23,988,969 24,445,422 24,530,427 41,618,075
-------------------------------------------------------------
AS OF DECEMBER 31,
-------------------------------------------------------------
1996 1997 1998 1999 2000
--------- --------- --------- --------- ---------
BALANCE SHEET DATA: (IN THOUSANDS)
Cash, cash equivalents
and marketable securities ................ $ -- $ 1,980 $ 19,422 $ 9,156 $ 202,680
Working capital ............................ (303) 1,009 18,102 2,021 194,801
Total assets ............................... 1,090 4,917 28,516 22,295 220,693
Long-term debt, net of current portion ..... 81 5,268 5,024 3,577 1,834
Redeemable convertible preferred stock ..... -- -- 29,515 30,050 --
Accumulated deficit ........................ (3,551) (8,953) (16,434) (28,909) (54,903)
Stockholders' equity (deficit) ............. 521 (1,931) (9,034) (21,936) 207,628
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read with "Selected
Financial Data" and our financial statements and notes included elsewhere in
this annual report on Form 10-K.
OVERVIEW
We are defining the functions of genes for drug discovery using
knockout mice. Our proprietary gene trapping and gene targeting technologies
enable us to rapidly generate these knockout mice by altering the DNA of genes
in a special variety of mouse cells, called embryonic stem (ES) cells, which can
be cloned and used to generate mice with the altered gene. We employ an
integrated platform of advanced medical technologies to systematically analyze
the functions and pharmaceutical relevance of the genes we have knocked out. Our
LexVision program captures the information resulting from this analysis for our
use, and use by our collaborators, to discover pharmaceutical products based on
genomics - the study of genes and their function.
We derive substantially all of our revenues from subscriptions to our
databases, functional genomics collaborations for the development and, in some
cases, analysis of knockout mice, and technology licenses. To date, we have
generated a substantial portion of our revenues from a limited number of
sources.
Since our inception, we have incurred significant losses and, as of
December 31, 2000, we had an accumulated deficit of $54.9 million. Our losses
have resulted principally from costs incurred in research and development,
general and administrative costs associated with our operations, and non-cash
stock-based compensation expenses associated with stock options granted to
employees and consultants prior to our April 2000 initial public offering.
Research and development expenses consist primarily of salaries and related
personnel costs, material costs, legal expenses resulting from intellectual
property prosecution and other expenses related to our drug discovery and
LexVision programs, the expansion of our OmniBank library, the development and
analysis of knockout mice and our other functional genomics research efforts. We
expense our research and development costs as they are incurred. General and
administrative expenses consist primarily of salaries and related expenses for
executive, finance and other administrative personnel, professional fees and
other corporate expenses including business development and general legal
activities, as well as expenses related to our patent infringement litigation
against Deltagen, Inc. In connection with the expansion of our drug discovery
and LexVision programs, our OmniBank database and library and our functional
genomics research efforts, we expect to incur increasing research and
development and general and administrative costs. As a result, we will need to
generate significantly higher revenues to achieve profitability.
Deferred stock-based compensation and related amortization represents
the difference between the exercise price of stock options granted and the fair
value of our common stock at the applicable date of grant. Stock-based
compensation is amortized over the vesting period of the individual stock
options for which it was recorded, generally four years. If employees and
consultants continue to vest in accordance with their individual stock options,
we expect to record amortization expense for deferred stock-based compensation
as follows: $10.9 million during 2001, $10.9 million during 2002, $10.9 million
during 2003 and $900,000 during 2004. The amount of stock-based compensation
expense to be recorded in future periods may decrease if unvested options for
which deferred stock compensation expense has been recorded are subsequently
canceled or forfeited or may increase if additional options are granted to
individuals other than employees or directors.
Our quarterly operating results will depend upon many factors,
including our success in establishing new database subscription and research
contracts with collaborators, expirations of such contracts, the success rate of
our discovery efforts leading to milestones and royalties, the timing and
willingness of collaborators to commercialize products which may result in
royalties, and general and industry-specific economic conditions which may
affect research and development expenditures. As a consequence, our quarterly
operating results have fluctuated in the past and are likely to do so in the
future.
As of December 31, 2000, we had net operating loss carryforwards of
approximately $34.9 million. We also had research and development tax credit
carryforwards of approximately $1.7 million. The net operating loss and credit
carryforwards will expire at various dates beginning in 2011, if not utilized.
Utilization of the net operating losses and credits may be significantly limited
due to a change in ownership as defined by provisions of the Internal
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Revenue Code of 1986 and similar state provisions. The annual limitation may
result in the expiration of net operating losses and credits before utilization.
RESULTS OF OPERATIONS
Years Ended December 31, 1999 and 2000
Revenues. Total revenues increased 205% to $14.5 million in 2000 from
$4.7 million in 1999. Of the $9.8 million increase in total revenues, $2.4
million was derived from increased database subscription and technology license
fees and $7.4 million was derived from increased revenues from functional
genomics collaborations for the development and analysis of knockout mice.
In 2000, the Merck Genome Research Institute, or MGRI, and Millennium
Pharmaceuticals, Inc. represented 35% and 14% of revenues, respectively. In
1999, Millennium and ZymoGenetics, Inc. represented 28% and 23% of revenues,
respectively.
In September 2000, we concluded our 1997 agreement with MGRI. In
connection with the conclusion of the MGRI agreement, we recognized $3.1 million
of deferred revenues remaining from the $4.0 million cash payment made to us by
MGRI when the agreement was signed and an additional $1.0 million of revenue
related to a final, non-refundable cash payment that we received from MGRI. As a
result of these arrangements with MGRI, our revenues for the third quarter of
2000 were substantially greater than our revenues in prior quarters and in the
fourth quarter of 2000, and are likely to be significantly greater than our
quarterly revenues for at least the first quarter of 2001. As a result of these
and other factors, our quarterly operating results have fluctuated in the past
and are likely to do so in the future. We do not believe that quarter-to-quarter
comparisons of our operating results are a good indication of our future
performance.
Research and Development Expenses. Research and development expenses,
including stock-based compensation expense, increased 116% to $31.6 million in
2000 from $14.6 million in 1999. The largest part of the increase, $10.9
million, or 64% of the increase, represented stock-based compensation relating
to option grants made prior to our April 2000 initial public offering. The
remaining increase of $6.1 million was attributable to continued growth of
research and development activities, primarily related to increased personnel
costs to support the expansion of our drug discovery and LexVision programs, our
OmniBank database and library, the development and analysis of knockout mice and
our other functional genomics research efforts.
General and Administrative Expenses. General and administrative
expenses, including stock-based compensation expense, increased 528% to $18.3
million in 2000 from $2.9 million in 1999. The largest part of the increase,
$10.0 million, or 65% of the increase, represented stock-based compensation
relating to option grants made prior to our April 2000 initial public offering.
The remaining increase of $5.4 million was due primarily to additional personnel
costs for business development and finance and administration, as well as
expenses associated with our patent infringement litigation against Deltagen,
Inc.
Interest Income and Interest Expense. Interest income increased to $9.9
million in 2000 from $649,000 in 1999. This increase resulted from an increased
cash and investment balance as a result of proceeds received in our initial
public offering. Interest expense increased 39% to $422,000 in 2000 from
$303,000 in 1999.
Net Loss and Net Loss Per Common Share. Net loss attributable to common
stockholders increased to $26.1 million in 2000 from $13.0 million in 1999. Net
loss per common share increased to $0.63 in 2000 from $0.53 in 1999. Most of the
net loss for 2000 was attributable to stock-based compensation expense.
Excluding stock-based compensation expense and assuming the conversion of the
redeemable convertible preferred stock into common stock occurred on the date of
original issuance (May 1998), we would have had a net loss of $5.2 million and
$12.5 million in 2000 and 1999, respectively, and net loss per common share of
$0.11 and $0.33 in 2000 and 1999, respectively.
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Years Ended December 31, 1999 and 1998
Revenues. Total revenues increased 111% to $4.7 million in 1999 from
$2.2 million in 1998. Of the $2.5 million increase, $1.4 million was derived
from increased database subscription and license fees and $1.1 million was
derived from increased fees for the development of knockout mice.
In 1999, Millennium Pharmaceuticals, Inc. and ZymoGenetics, Inc.
represented 28% and 23% of revenues, respectively. In 1998, ZymoGenetics, Merck
& Co. Inc., and Genetics Institute represented 24%, 12% and 11% of revenues,
respectively.
Research and Development Expenses. Research and development expenses
increased 74% to $14.6 million in 1999 from $8.4 million for 1998. The increase
of $6.2 million was attributable to continued growth of research and development
activities, including $2.6 million related to increased personnel and laboratory
supply costs to support the generation of our human gene sequence databases,
OmniBank database and library and the development of knockout mice and $2.9
million related to higher operating expenses as a result of the completion of
our new animal facility in January 1999, with the remainder due to expansion in
operating activities. As of December 31, 1999, production costs incurred in the
development of knockout mice for commercial sale have not been significant.
General and Administrative Expenses. General and administrative
expenses increased 44% to $2.9 million during 1999 from $2.0 million for 1998.
The increase of $889,000 was due to $721,000 related to compensation for
business development, finance and administrative personnel, with the remainder
due to overall expansion in our operations.
Interest Income and Interest Expense. Interest income decreased 23% to
$649,000 in 1999 from $838,000 in 1998. This decrease resulted from a declining
cash and investment balance due to cash used in operating activities. Interest
expense increased 139% to $303,000 in 1999 from interest expense of $127,000 in
1998. This increase resulted from higher debt obligation balances in 1999.
Net Loss and Net Loss Per Common Share. Net loss increased to $12.5
million in 1999 from $7.5 million in 1998. Net loss per common share increased
to $0.53 in 1999 from $0.32 in 1998.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations from inception primarily through sales
of common and preferred stock, contract and milestone payments to us under our
database subscription and collaboration agreements and equipment financing
arrangements. From our inception through December 31, 2000, we had received net
proceeds of $241.4 million from issuances of common and preferred stock,
including $203.2 million of net proceeds from the initial public offering of our
common stock in April 2000. In addition, from our inception through December 31,
2000, we received $24.6 million in cash payments from database subscription and
technology license fees, functional genomics collaborations for the development
and analysis of knockout mice, sales of reagents and government grants, of which
$22.7 million had been recognized as revenues through December 31, 2000.
As of December 31, 2000, we had $202.7 million in cash, cash
equivalents and marketable securities, as compared to $9.2 million as of
December 31, 1999. We used $1.5 million in operations in 2000. This consisted of
the net loss for the year of $26.0 million offset by non-cash charges of $20.8
million related to stock-based compensation expense and $2.6 million related to
depreciation expense offset partially by a net decrease in other working capital
accounts of $1.0 million. We used $165.4 million in investing activities in
2000, principally as a result of the purchase of marketable securities with the
net proceeds of our initial public offering in April 2000, and purchases of
property and equipment.
In June 1999, we entered into a $5.0 million financing arrangement for
the purchase of property and equipment which is secured by the equipment
financed. As of December 31, 2000, we had drawn down a total of approximately
$4.2 million and had $832,000 remaining available under this arrangement. As of
December 31, 2000, $2.8 million of the borrowings were outstanding under this
arrangement. This facility accrues interest at a weighted-average rate of
approximately 11.7% and principal and interest is due in monthly installments
through 2003. This debt may be retired through payment at the end of the second
quarter of 2001.
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In October 2000, we entered into a synthetic lease agreement under
which the lessor purchased our current laboratory and office space and animal
facility and agreed to fund the construction of additional laboratory and office
space and a second animal facility. Including the purchase price for our
existing facilities, the synthetic lease provides for funding of up to $45.0
million in property and improvements. The term of the agreement is six years,
which includes the construction period and a lease period. Lease payments for
our existing facilities are approximately $795,000 per year. Lease payments for
the new facilities will begin upon completion of construction, which is expected
in the fourth quarter of 2001. Future lease payments are subject to fluctuation
based on LIBOR rates. Based on a year-end LIBOR rate of 6.4%, our total lease
payments for our existing facilities and the new facilities would be
approximately $3.0 million per year. At the end of the lease term, the lease may
be extended for one-year terms, up to seven additional terms, or we may purchase
the properties for a price including the outstanding lease balance. If we elect
not to renew the lease or purchase the properties, we must arrange for the sale
of the properties to a third party. Under the sale option, we have guaranteed a
percentage of the total original cost as the residual fair value of the
properties.
Our capital requirements depend on numerous factors, including our
ability to obtain database subscription and collaboration agreements, the amount
and timing of payments under such agreements, the level and timing of our
research and development expenditures, market acceptance of our products, the
resources we devote to developing and supporting our products and other factors.
We expect to devote substantial capital resources to continue our research and
development efforts, to expand our support and product development activities,
and for other general corporate activities. We believe that our current cash
balances, which include the net proceeds of our April 2000 initial public
offering and revenues to be derived from subscriptions to our databases,
functional genomics collaborations for the research, development and analysis of
knockout mice, will be sufficient to fund our operations for at least the next
several years. During or after this period, if cash generated by operations is
insufficient to satisfy our liquidity requirements, we may need to sell
additional equity or debt securities or obtain additional credit arrangements.
Additional financing may not be available on terms acceptable to us or at all.
The sale of additional equity or convertible debt securities may result in
additional dilution to our stockholders.
IMPACT OF INFLATION
The effect of inflation and changing prices on our operations was not
significant during the periods presented.
DISCLOSURE ABOUT MARKET RISK
Our exposure to market risk is confined to our cash and cash
equivalents which have maturities of less than three months. We maintain an
investment portfolio which consists of U.S. Government debt obligations and
investment grade commercial paper that mature one to twelve months after
December 31, 2000, which we believe are subject to limited credit risk. We
currently do not hedge interest rate exposure. Because of the short-term
maturities of our investments, we do not believe that an increase in market
rates would have any negative impact on the realized value of our investment
portfolio.
We have operated primarily in the United States and all sales to date
have been made in U.S. dollars. Accordingly, we have not had any material
exposure to foreign currency rate fluctuations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Disclosure about Market Risk" under "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
quantitative and qualitative disclosures about market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this Item are incorporated under
Item 14 in Part IV of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item as to the directors and executive
officers of the Company is hereby incorporated by reference from the information
appearing under the captions "Election of Directors" and "Executive Officers" in
the Company's definitive proxy statement which involves the election of
directors and is to be filed with the Securities and Exchange Commission
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 2000.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item as to the management of the
Company is hereby incorporated by reference from the information appearing under
the captions "Executive Compensation" and "Election of Director - Director
Compensation" in the Company's definitive proxy statement which involves the
election of directors and is to be filed with the Commission pursuant to the
Securities Exchange Act of 1934 within 120 days of the end of the Company's
fiscal year on December 31, 2000. Notwithstanding the foregoing, in accordance
with the instructions to Item 402 of Regulation S-K, the information contained
in the Company's proxy statement under the sub-heading "Report of the
Compensation Committee of the Board of Directors" and "Performance Graph" shall
not be deemed to be filed as part of or incorporated by reference into this
annual report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item as to the ownership by management
and others of securities of the Company is hereby incorporated by reference from
the information appearing under the caption "Stock Ownership of Certain
Beneficial Owners and Management" to the Company's definitive proxy statement
which involves the election of directors and is to be filed with the Commission
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item as to certain business
relationships and transactions with management and other related parties of the
company is hereby incorporated by reference to such information appearing under
the captions "Certain Transactions" and "Compensation Committee Interlocks and
Insider Participation" in the Company's definitive proxy statement which
involves the election of directors and is to be filed with the Commission
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 2000.
26
29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report:
1. Financial Statements
Page
-------
Report of Independent Public Accountants............................................ F-1
Balance Sheets...................................................................... F-2
Statements of Operations............................................................ F-3
Statements of Stockholders' Equity (Deficit)........................................ F-4
Statements of Cash Flows............................................................ F-5
Notes to Financial Statements....................................................... F-6
All other financial statement schedules are omitted
because they are not applicable or not required, or because
the required information is included in the financial
statements or notes thereto.
2. Exhibits
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 --- Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-96469) and incorporated by reference herein).
3.2 --- Restated Bylaws (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1
(Registration No. 333-96469) and incorporated by reference herein).
10.1 --- Employment Agreement with Arthur T. Sands, M.D., Ph.D. (filed as Exhibit 10.1 to the
Company's Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated
by reference herein).
10.2 --- Employment Agreement with James R. Piggott, Ph.D. (filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by
reference herein).
10.3 --- Employment Agreement with Jeffrey L. Wade, J.D. (filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by
reference herein).
10.4 --- Employment Agreement with Brian P. Zambrowicz, Ph.D. (filed as Exhibit 10.4 to the
Company's Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated
by reference herein).
10.5 --- Employment Agreement with Julia P. Gregory (filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by
reference herein).
10.6 --- Employment Agreement with Randall B. Riggs (filed as Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by
reference herein).
10.7 --- Form of Indemnification Agreement with Officers and Directors (filed as Exhibit 10.7
to the Company's Registration Statement on Form S-1 (Registration No. 333-96469)
and incorporated by reference herein).
10.8 --- 2000 Equity Incentive Plan (filed as Exhibit 10.8 to the Company's Registration Statement
on Form S-1 (Registration No. 333-96469) and incorporated by reference herein).
27
30
EXHIBIT NO. DESCRIPTION
----------- -----------
10.9 --- 2000 Non-Employee Directors' Stock Option Plan (filed as Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by
reference herein).
+10.10 --- LexVision Database and Collaboration Agreement with Bristol-Myers Squibb, dated
September 26, 2000 between Lexicon Genetics Incorporated and Bristol-Myers Squibb
Company (filed as Exhibit 16.1 to the Company's Current Report on Form 8-K dated
September 26, 2000 and incorporated by reference herein).
10.11 --- Master Loan and Security Agreement dated May 21, 1999, with FINOVA Capital Corporation
(filed as Exhibit 10.12 to the Company's Registration Statement on Form S-1
(Registration No. 333-964969) and incorporated by reference herein.).
*10.12 --- Synthetic Lease Financing Facility with First Security Bank, National Association, the
Lenders and Holders named therein, and Bank of America, N.A.
*23.1 --- Consent of Arthur Andersen LLP
24.1 --- Power of Attorney (contained in signature page)
- ---------------------
* Filed herewith.
+ Confidential treatment has been requested for a portion of this exhibit. The
confidential portions of this exhibit have been omitted and filed separately
with the Securities and Exchange Commission.
(b) Reports on Form 8-K:
On October 10, 2000, we filed a Current Report on Form 8-K dated
September 26, 2000 relating to the establishment of our LexVision(TM) Database
and Collaboration Agreement with Bristol-Myers Squibb Company.
28
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
LEXICON GENETICS INCORPORATED
Date: March 14, 2001 By: /s/ ARTHUR T. SANDS
-------------------------------------
Arthur T. Sands, M.D., Ph.D.
President and Chief Executive Officer
Date: March 14, 2001 By: /s/ JULIA P. GREGORY
-------------------------------------
Julia P. Gregory
Executive Vice President and
Chief Financial Officer
29
32
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Julia P. Gregory and Jeffrey L. Wade, or
either of them, each with the power of substitution, his attorney-in-fact, to
sign any amendments to this Form 10-K (including post-effective amendments), and
to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, here ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ARTHUR T. SANDS President and Chief Executive Officer March 14, 2001
- ------------------------------------ (Principal Executive Officer)
Arthur T. Sands, M.D., Ph.D.
/s/ JULIA P. GREGORY Executive Vice President and Chief Financial Officer March 14, 2001
- ------------------------------------ (Principal Financial and Accounting Officer)
Julia P. Gregory
/s/ C. THOMAS CASKEY Chairman of the Board of Directors March 14, 2001
- ------------------------------------
C. Thomas Caskey, M.D.
/s/ SAM L. BARKER Director March 14, 2001
- ------------------------------------
Sam L. Barker, Ph.D.
/s/ GORDON A. CAIN Director March 14, 2001
- ------------------------------------
Gordon A. Cain
/s/ PATRICIA M. CLOHERTY Director March 14, 2001
- ------------------------------------
Patricia M. Cloherty
/s/ ROBERT J. LEFKOWITZ Director March 14, 2001
- ------------------------------------
Robert J. Lefkowitz, M.D.
/s/ WILLIAM A. MCMINN Director March 14, 2001
- ------------------------------------
William A. McMinn
30
33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Lexicon Genetics Incorporated:
We have audited the accompanying balance sheets of Lexicon Genetics Incorporated
(a Delaware corporation) as of December 31, 1999 and December 31, 2000, and the
related statements of operations, stockholders' equity (deficit) and cash flows
for each of the three years in the period ended December 31, 2000. These
financial statements are the responsibility of Lexicon's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Lexicon Genetics Incorporated
as of December 31, 1999 and 2000, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2000, in
conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Houston, Texas
February 27, 2001
F-1
34
LEXICON GENETICS INCORPORATED
BALANCE SHEETS
------------------------------------
AS OF DECEMBER 31,
------------------------------------
1999 2000
--------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents ........................................................ $ 2,025,585 $ 37,811,039
Marketable securities ............................................................ 7,130,848 164,869,291
Accounts receivable, net of allowance for doubtful accounts
of $100,000 in 2000 ........................................................... 3,391,648 2,814,707
Prepaid expenses and other current assets ........................................ 76,257 536,480
--------------- ---------------
Total current assets .......................................................... 12,624,338 206,031,517
Property and equipment, net of accumulated depreciation of
$3,087,397 and $5,708,366, respectively .......................................... 9,388,624 14,477,235
Other assets ......................................................................... 281,605 184,200
--------------- ---------------
Total assets .................................................................. $ 22,294,567 $ 220,692,952
=============== ===============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................................................................. $ 591,590 $ 2,522,722
Accrued liabilities .............................................................. 600,686 3,023,725
Deferred revenue ................................................................. 8,209,574 4,671,818
Current portion of long-term debt ................................................ 874,174 1,012,246
Current portion of capital lease obligations ..................................... 127,119 --
Current portion of related party note payable .................................... 200,004 --
--------------- ---------------
Total current liabilities ..................................................... 10,603,147 11,230,511
Long-term debt, net of current portion ............................................... 2,854,365 1,833,982
Capital lease obligations, net of current portion .................................... 6,279 --
Related party note payable, net of current portion ................................... 716,663 --
--------------- ---------------
Total liabilities ............................................................. 14,180,454 13,064,493
Commitments and contingencies
Redeemable convertible Series A preferred stock, $.01 par value; 4,244,664 and
no shares authorized, respectively; 4,244,664
and no shares issued and outstanding, respectively ............................... 30,050,236 --
Stockholders' equity (deficit):
Preferred stock, $.01 par value; 5,755,336 and 5,000,000 shares
authorized, respectively; no shares issued and outstanding .................... -- --
Common stock, $.001 par value; 75,000,000 and 120,000,000 shares
authorized, 24,540,201 and 48,271,735 shares issued and
outstanding, respectively ..................................................... 24,540 48,272
Additional paid-in capital ....................................................... 7,863,392 296,119,625
Deferred stock compensation ...................................................... (915,422) (33,636,725)
Accumulated deficit .............................................................. (28,908,633) (54,902,713)
--------------- ---------------
Total stockholders' equity (deficit) .......................................... (21,936,123) 207,628,459
--------------- ---------------
Total liabilities and stockholders' equity (deficit) .......................... $ 22,294,567 $ 220,692,952
=============== ===============
The accompanying notes are an integral part of these financial statements.
F-2
35
LEXICON GENETICS INCORPORATED
STATEMENTS OF OPERATIONS
---------------------------------------------------------
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1999 2000
--------------- --------------- ---------------
Revenues:
Subscription and license fees ....................... $ 761,950 $ 2,197,696 $ 4,578,861
Collaborative research .............................. 1,072,205 2,120,016 9,504,400
Reagents ............................................ 204,445 229,967 276,719
Grants .............................................. 203,242 190,024 98,581
--------------- --------------- ---------------
Total revenues .................................... 2,241,842 4,737,703 14,458,561
Operating expenses:
Research and development, including stock-based
compensation of $10,883,123 in 2000 ............... 8,409,770 14,645,773 31,646,848
General and administrative, including stock-based
compensation of $9,957,959 in 2000 ................ 2,024,322 2,913,121 18,288,628
--------------- --------------- ---------------
Total operating expenses .......................... 10,434,092 17,558,894 49,935,476
--------------- --------------- ---------------
Loss from operations ................................... (8,192,250) (12,821,191) (35,476,915)
Interest income ........................................ 838,110 648,906 9,904,873
Interest expense ....................................... 126,665 302,802 422,038
--------------- --------------- ---------------
Net loss ............................................... (7,480,805) (12,475,087) (25,994,080)
Accretion on redeemable convertible preferred stock .... (356,946) (535,416) (133,854)
--------------- --------------- ---------------
Net loss attributable to common stockholders ........... $ (7,837,751) $ (13,010,503) $ (26,127,934)
=============== =============== ===============
Net loss per common share, basic and diluted ........... $ (0.32) $ (0.53) $ (0.63)
=============== =============== ===============
Shares used in computing net loss per common share,
basic and diluted ................................... 24,445,422 24,530,427 41,618,075
The accompanying notes are an integral part of these financial statements.
F-3
36
LEXICON GENETICS INCORPORATED
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
-------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY (DEFICIT)
-------------------------------------------------------------------------------------------
TOTAL
COMMON STOCK ADDITIONAL DEFERRED STOCKHOLDERS'
---------------------------- PAID-IN STOCK ACCUMULATED EQUITY
SHARES PAR VALUE CAPITAL COMPENSATION DEFICIT (DEFICIT)
------------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 1997 ......... 24,422,694 $ 24,423 $ 6,997,468 $ -- $ (8,952,741) $ (1,930,850)
Common stock warrants issued with
debt agreement ..................... -- -- 24,750 -- -- 24,750
Warrants issued in conjunction with
redeemable convertible Series A
preferred stock .................... -- -- 498,597 -- -- 498,597
Common stock warrants issued for
lease option ....................... -- -- 195,855 -- -- 195,855
Exercise of common stock options ..... 68,001 68 15,119 -- -- 15,187
Accretion on redeemable
convertible preferred stock to
redemption value ................... -- -- (356,946) -- -- (356,946)
Net loss ............................. -- -- -- -- (7,480,805) (7,480,805)
------------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 1998 ......... 24,490,695 24,491 7,374,843 -- (16,433,546) (9,034,212)
Exercise of common stock options ..... 49,506 49 22,910 -- -- 22,959
Accretion on redeemable
convertible preferred stock
to redemption value ................ -- -- (535,416) -- -- (535,416)
Deferred stock compensation .......... -- -- 1,001,055 (1,001,055) -- --
Amortization of deferred stock
compensation ....................... -- -- -- 85,633 -- 85,633
Net loss ............................. -- -- -- -- (12,475,087) (12,475,087)
------------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 1999 ......... 24,540,201 24,540 7,863,392 (915,422) (28,908,633) (21,936,123)
Initial public offering of
common stock ....................... 10,000,000 10,000 203,174,518 -- -- 203,184,518
Accretion on redeemable
convertible preferred stock
to redemption value ................ -- -- (133,854) -- -- (133,854)
Conversion of redeemable
convertible preferred stock
to common stock .................... 12,733,992 12,734 30,171,356 -- -- 30,184,090
Deferred stock compensation .......... -- -- 53,562,385 (53,562,385) -- --
Amortization of deferred stock
compensation ....................... -- -- -- 20,841,082 -- 20,841,082
Exercise of common stock options ..... 849,042 849 1,110,713 -- -- 1,111,562
Exercise of common stock warrants .... 148,500 149 371,115 -- -- 371,264
Net loss ............................. -- -- -- -- (25,994,080) (25,994,080)
------------- ------------- ------------- ------------- ------------- -------------
Balance at December 31, 2000 ......... 48,271,735 $ 48,272 $ 296,119,625 $ (33,636,725) $ (54,902,713) $ 207,628,459
============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these financial statements.
F-4
37
LEXICON GENETICS INCORPORATED
STATEMENTS OF CASH FLOWS
-----------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1999 2000
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ............................................................... $ (7,480,805) $ (12,475,087) $ (25,994,080)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation ......................................................... 756,600 1,901,446 2,620,969
Loss on sale of asset ................................................ 21,819 -- --
Amortization of deferred stock compensation .......................... -- 85,633 20,841,082
Amortization of lease option ......................................... 17,180 41,232 --
Amortization of deferred financing costs ............................. 24,750 -- --
Changes in operating assets and liabilities
(Increase) decrease in accounts receivable ......................... (1,070,309) (1,718,169) 576,941
Increase in prepaid expenses and other current assets .............. (12,875) (58,786) (460,223)
(Increase) decrease in other assets ................................ (3,736) (60,875) 97,405
Increase (decrease) in accounts payable and
accrued liabilities ............................................. 800,410 (401,170) 4,354,171
Increase (decrease) in deferred revenue ............................ 638,750 3,070,824 (3,537,756)
------------- ------------- -------------
Net cash used in operating activities ............................ (6,308,216) (9,614,952) (1,501,491)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment .................................... (5,658,953) (4,100,286) (7,709,580)
Purchase of marketable securities ...................................... (40,426,865) (12,549,053) (269,846,653)
Maturities of marketable securities .................................... 24,026,708 21,818,363 112,108,210
Proceeds from sale of asset ............................................ 47,000 -- --
------------- ------------- -------------
Net cash provided by (used in) investing activities .............. (22,012,110) 5,169,024 (165,448,023)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on capital lease obligations ........................ (209,569) (218,853) (133,398)
Proceeds from debt borrowings .......................................... -- 4,168,060 --
Repayment of debt borrowings ........................................... (100,000) (522,854) (1,461,478)
Proceeds from issuance of common stock ................................. 15,187 22,959 204,329,844
Proceeds from issuance of redeemable convertible
Series A preferred stock ............................................ 29,656,471 -- --
------------- ------------- -------------
Net cash provided by financing activities ........................ 29,362,089 3,449,312 202,734,968
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents ...................... 1,041,763 (996,616) 35,785,454
Cash and cash equivalents at beginning of year ............................ 1,980,438 3,022,201 2,025,585
------------- ------------- -------------
Cash and cash equivalents at end of year .................................. $ 3,022,201 $ 2,025,585 $ 37,811,039
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest ................................................. $ 49,331 $ 409,469 $ 422,038
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Purchases of equipment under capital lease obligations ................. $ 58,297 $ 49,052 $ --
Warrants issued in conjunction with lease option ....................... $ 195,855 $ -- $ --
Conversion of redeemable convertible preferred stock
into common stock ................................................... $ -- $ -- $ 30,184,090
Conversion of related party note payable into common stock ............. $ -- $ -- $ 337,500
The accompanying notes are an integral part of these financial statements.
F-5
38
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. ORGANIZATION AND OPERATIONS
Lexicon Genetics Incorporated (Lexicon or the Company) is a Delaware corporation
incorporated on July 7, 1995. Lexicon was organized to research, develop and
market products and services related to functional genomics and drug target
identification.
Lexicon has financed its operations from inception primarily through sales of
common and preferred stock, contract and milestone payments received under
subscription and collaboration agreements, and equipment financing arrangements.
Lexicon's future success is dependent upon many factors, including, but not
limited to, its ability to discover promising candidates for drug target or
therapeutic protein development using its gene knockout technology, establish
additional research contracts and agreements for access to its technology,
achieve milestones under such contracts and agreements, obtain and enforce
patents and other proprietary rights in its discoveries, comply with federal and
state regulations, and maintain sufficient capital to fund its activities. As a
result of the aforementioned factors and the related uncertainties, there can be
no assurance of Lexicon's future success.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the period. Actual results could differ from those estimates.
Cash, Cash Equivalents and Marketable Securities: Lexicon considers all highly
liquid investments with original maturities of three months or less to be cash
equivalents. Management determines the appropriate classification of its cash
equivalents and marketable securities at the time of purchase. Marketable
securities consist of U.S. Government agency debt obligations and investment
grade commercial paper that mature one to twelve months after December 31, 2000.
Management has classified Lexicon's marketable securities as held-to-maturity
securities in the accompanying financial statements. Held-to-maturity securities
are carried at purchase cost plus accrued interest, which approximates fair
value.
Concentration of Credit Risk: Lexicon's cash equivalents and marketable
securities represent potential concentrations of credit risk. Lexicon minimizes
potential concentrations of risk in cash equivalents and marketable securities
by placing investments in high-quality financial instruments. At December 31,
2000, management believes that Lexicon has no significant concentrations of
credit risk and has incurred no impairments in the carrying values of its cash
equivalents and marketable securities.
Significant Customers: For the years ended December 31, 1998, 1999 and 2000,
three, two and two entities represented 48%, 51% and 49% of Lexicon's revenues,
respectively.
Property and Equipment: Property and equipment are carried at cost and
depreciated using the straight-line method over the estimated useful life of the
assets which ranges from three to seven years. Maintenance, repairs and minor
replacements are charged to expense as incurred. Significant renewals and
betterments are capitalized.
Revenue Recognition: Revenues are earned from services performed pursuant to
database subscription and access agreements, and collaborations for the
development and, in some cases, analysis of knockout mice. Subscription and
access fees received are recognized ratably over the subscription or access
period. Payments received in advance under these arrangements are recorded as
deferred revenue until earned. Collaborative research payments are
F-6
39
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
non-refundable, regardless of the success of the research effort, and are
recognized as revenue as Lexicon performs its obligations related to such
research. Milestone-based fees are recognized upon completion of specified
milestones according to contract terms. Revenues for the supply of reagents to
collaboration partners and customers are recognized upon shipment.
Non-refundable sublicense fees are recognized as revenue upon the grant of the
sublicense to third parties, when performance is complete and there is no
continuing involvement. Grant revenue is recognized as the related costs are
incurred.
Research and Development Expenses: Research and development expenses consist of
costs incurred for company-sponsored as well as collaborative research and
development activities. These costs include direct and research-related overhead
expenses and are expensed as incurred. Research and development expenses also
include certain costs associated with the production of custom knockout mice
associated with specific collaborative research agreements. Through December 31,
2000, total production costs incurred have not been significant. Patent costs
and technology license fees for technologies that are utilized in research and
development and have no alternative future use are expensed when incurred.
Stock-based Compensation: As further discussed in Note 7, the Company recognized
approximately $20.8 million of stock-based compensation during 2000. This
expense is included in the financial statements as follows:
Research and development....................................................... $ 10,883,123
General and administrative..................................................... 9,957,959
---------------
Total stock-based compensation............................................ $ 20,841,082
===============
Net Loss Per Common Share: Net loss per common share is computed using the
weighted average number of shares of common stock outstanding. Shares associated
with stock options, warrants and convertible preferred stock are not included
because they are antidilutive.
The table below sets forth certain unaudited statements of operations data, and
net loss per common share and pro forma net loss per common share data, for each
quarter of 1999 and 2000. Net loss per common share included in the Company's
2000 quarterly reports on Form 10-Q for the 1999 and 2000 quarters ended June 30
and September 30 was based on pro forma weighted average shares outstanding
rather than actual weighted average shares outstanding, as is appropriately
reflected in the table below. Net loss per common share is computed using the
weighted average number of shares of common stock outstanding during the
applicable period. Pro forma net loss per common share is computed using the
weighted average number of common shares outstanding during the applicable
period, including pro forma effects of the automatic conversion of outstanding
redeemable convertible preferred stock into shares of Lexicon's common stock
effective upon the closing of Lexicon's initial public offering (see Note 6) as
if such conversion occurred on the date of original issuance (May 1998). Net
loss attributable to common stockholders includes the effect of accretion on
redeemable convertible preferred stock.
F-7
40
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
------------------------------------------------------------ ------------
QUARTER ENDED YEAR ENDED
------------------------------------------------------------ ------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 DECEMBER 31
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
1999
Net loss ......................................... $ (2,742,540) $ (3,250,296) $ (3,829,920) $ (2,652,331) $(12,475,087)
Net loss attributable to common stockholders ..... $ (2,876,395) $ (3,384,149) $ (3,963,774) $ (2,786,185) $(13,010,503)
Net loss per common share, basic and diluted ..... $ (0.12) $ (0.14) $ (0.16) $ (0.11) $ (0.53)
============ ============ ============ ============ ============
Pro forma net loss per common share, basic
and diluted ................................... $ (0.08) $ (0.09) $ (0.10) $ (0.07) $ (0.33)
============ ============ ============ ============ ============
Shares used in computing net loss per
common share .................................. 24,522,327 24,531,954 24,531,954 24,534,415 24,530,427
============ ============ ============ ============ ============
Shares used in computing pro forma net loss per
common share .................................. 37,256,319 37,265,946 37,265,946 37,268,407 37,264,419
============ ============ ============ ============ ============
2000
Net loss ......................................... $(13,418,099) $ (3,516,704) $ (1,539,880) $ (7,519,397) $(25,994,080)
Net loss attributable to common stockholders ..... $(13,551,953) $ (3,516,704) $ (1,539,880) $ (7,519,397) $(26,127,934)
Net loss per common share, basic and diluted ..... $ (0.55) $ (0.08) $ (0.03) $ (0.16) $ (0.63)
============ ============ ============ ============ ============
Pro forma net loss per common share, basic
and diluted ................................... $ (0.36) $ (0.08) $ (0.03) $ (0.16) $ (0.58)
============ ============ ============ ============ ============
Shares used in computing net loss per
common share .................................. 24,613,012 45,816,588 47,780,441 48,123,053 41,618,075
============ ============ ============ ============ ============
Shares used in computing pro forma net loss per
common share .................................. 37,347,004 46,796,126 47,780,441 48,123,053 45,027,724
============ ============ ============ ============ ============
3. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1999 and 2000, are as follows:
------------------------------------------------
AS OF DECEMBER 31,
USEFUL LIVES ------------------------------
IN YEARS 1999 2000
------------ ------------ ------------
Computers and software ............ 3 $ 2,275,528 $ 4,413,649
Furniture and fixtures ............ 5-7 386,760 1,077,528
Laboratory equipment .............. 7 4,678,492 9,082,785
Leasehold improvements ............ 7 5,135,241 5,611,639
------------ ------------
12,476,021 20,185,601
Less: Accumulated depreciation .... (3,087,397) (5,708,366)
------------ ------------
Net property and equipment .... $ 9,388,624 $ 14,477,235
============ ============
As of December 31, 1999, Lexicon held equipment under capital lease obligations
totaling $133,398. These capital lease obligations were repaid during 2000.
4. FINANCING AND DEBT OBLIGATIONS
In June 1999, Lexicon entered into a $5,000,000 financing agreement for the
purchase of property and equipment. As of December 31, 2000, Lexicon had drawn
down a total of $4,168,060 and had $831,940 remaining available under this
arrangement. As of December 31, 2000, $2,846,228 of borrowings were outstanding
under this arrangement, all of which was secured by the financed equipment. This
facility accrues interest at a weighted average rate of 11.7% and principal and
interest is due in monthly installments of $106,054 through 2003.
In August 1997, Lexicon entered into note purchase agreements with two
individuals under which they received an aggregate of $1,100,000 in exchange for
the issuance of two notes payable in the amount of $100,000 and $1,000,000,
respectively, the latter of which was payable to a member of the Board of
Directors. Lexicon paid the entire balance of the $100,000 note in 1998.
Furthermore, during 2000, $337,500 of the $1,000,000 note was used to exercise
warrants held by the director and the remaining balance was repaid to the
director.
F-8
41
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES
Lexicon recognizes deferred tax liabilities and assets for the expected future
tax consequences of events that have been recognized differently in the
financial statements and tax returns. Under this method, deferred tax
liabilities and assets are determined based on the difference between the
financial statement carrying amounts and tax bases of liabilities and assets
using enacted tax rates and laws in effect in the years in which the differences
are expected to reverse. Deferred tax assets are evaluated for realization based
on a more-likely-than-not criteria in determining if a valuation should be
provided.
The components of Lexicon's deferred tax assets (liabilities) at December 31,
1999 and 2000, are as follows:
------------------------------
AS OF DECEMBER 31,
------------------------------
1999 2000
------------ ------------
Deferred tax assets:
Net operating loss carry-forwards ........................ $ 9,466,857 $ 12,207,590
Technology license ....................................... 114,293 64,260
Research and development tax credits ..................... 670,663 1,735,064
Start-up and organizational costs ........................ 38,332 81,452
Stock based compensation ................................. -- 2,680,937
Accrued expenses and other ............................... -- 61,683
------------ ------------
Total deferred tax assets ........................... 10,290,145 16,830,986
Deferred tax liabilities:
Property and equipment ................................... (234,490) (780,229)
Other .................................................... (42,312) (3,151)
------------ ------------
Total deferred tax liabilities ...................... (276,802) (783,380)
Less: Valuation allowance .................................. (10,013,343) (16,047,606)
------------ ------------
Net deferred tax assets ............................. $ -- $ --
============ ============
As of December 31, 2000, Lexicon has generated net operating loss (NOL)
carryforwards of approximately $34.9 million and research and development tax
credits of approximately $1.7 million available to reduce future income taxes.
These carryforwards begin to expire in 2011. A change in ownership, as defined
by federal income tax regulations, could significantly limit Lexicon's ability
to utilize its carryforwards. Lexicon's ability to utilize its current and
future NOLs to reduce future taxable income and tax liabilities may be limited.
Additionally, because federal tax laws limit the time during which these
carryforwards may be applied against future taxes, Lexicon may not be able to
take full advantage of these attributes for federal income tax purposes. As
Lexicon has had cumulative losses and there is no assurance of future taxable
income, valuation allowances have been established to fully offset the deferred
tax assets of approximately $10.0 million and $16.0 million at December 31, 1999
and 2000, respectively. The valuation allowance increased approximately $6.0
million during 2000, primarily due to Lexicon's net loss.
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND CAPITAL STOCK
Stock Dividend: Lexicon's Board of Directors declared a stock dividend to effect
a stock split of three shares for every one share of common stock then
outstanding, effective April 5, 2000. The accompanying financial statements and
footnotes give retroactive effect to the stock split for all periods presented.
Common Stock: In April 2000, Lexicon completed the initial public offering of
10,000,000 shares of its common stock at an initial public offering price of
$22.00 per share, for net proceeds of $203.2 million, after deducting
underwriting discounts of $15.4 million and offering expenses of $1.4 million.
F-9
42
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Redeemable Convertible Series A Preferred Stock: In May 1998, Lexicon completed
the private placement of 4,244,664 shares of redeemable convertible Series A
preferred stock (Series A Preferred Stock) at a price of $7.50 per share, for
net proceeds of approximately $29.6 million, after deducting placement agent
fees and offering costs of approximately $2.2 million.
The Series A Preferred Stock was convertible into common stock at a conversion
price of $2.50 per share of common stock, and was redeemable on May 7, 2003, for
a sum of the following: (a) the greater of $2.50 per share or the fair market
value of the number of shares of common stock into which a share of Series A
Preferred Stock could then be converted and (b) an amount per share equal to all
declared but unpaid dividends. The Series A Preferred Stock was converted
according to its terms into 12,733,992 shares of common stock upon the April
2000 closing of Lexicon's initial public offering of common stock. Prior to the
conversion, the Series A Preferred Stock was being accreted to its May 7, 2003
redemption value of $31,834,980. The Series A Preferred Stock was not included
as a component of total stockholders' equity (deficit) in the accompanying
financial statements due to its redemption features.
On September 14, 1995, Lexicon entered into a registration rights agreement with
its founding stockholders. The agreement was subsequently extended to other
stockholders and holders of warrants and was amended and restated as of May 7,
1998. As amended and restated, the registration rights agreement provides
holders of registrable securities with the right to require Lexicon to register
the offering of their shares under the Securities Act of 1933, as amended, under
certain circumstances and subject to certain exceptions. Such rights may be
exercised by holders of registrable securities who, in the aggregate, hold (a)
at least 25 percent of the then-outstanding registrable securities that were
originally issued to a director and founding stockholder of Lexicon or (b) 25
percent of the then-outstanding registrable securities issued upon conversion of
the Series A Preferred Stock. The registration rights agreement also provides
holders of registrable securities with the right to include their shares in
offerings registered under the Securities Act of 1933, as amended, for the
account of Lexicon or for the account of other holders of registration rights,
subject to certain exceptions. The registration rights agreement provides that
Lexicon shall pay the expenses associated with all such registrations.
7. STOCK OPTIONS AND WARRANTS
Stock Options: In September 1995, Lexicon's Board of Directors approved the 1995
Stock Option Plan, which was subsequently amended and restated in February 2000
as the 2000 Equity Incentive Plan (the "equity incentive plan"). The equity
incentive plan will terminate in 2010 unless the board terminates it sooner. The
Board of Directors authorized and reserved an aggregate of 11,250,000 shares of
common stock for issuance under the equity incentive plan. The equity incentive
plan provides for the grant of incentive stock options to employees and
nonstatutory stock options to employees, directors and consultants of Lexicon.
The plan also permits the grant of stock bonuses and restricted stock purchase
awards. Incentive stock options will have an exercise price of 100% or more of
the fair market value of our common stock on the date of grant. Nonstatutory
stock options may have an exercise price as low as 85% of fair market value on
the date of grant. The purchase price of other stock awards may not be less than
85% of fair market value. However, the board may award bonuses in consideration
of past services without a purchase payment. Shares may be subject to a
repurchase option in the discretion of the board. The equity incentive plan
provides that it will be administered by the board, or a committee appointed by
the board, which determines recipients and types of options to be granted,
including number of shares under the option and the exercisability of the
shares. On January 1 of each year for ten years, beginning in 2001, the number
of shares reserved for issuance under the equity incentive plan automatically
will be increased by the greater of:
o 5% of Lexicon's outstanding shares on a fully-diluted basis;
or
o that number of shares that could be issued under awards
granted under the equity incentive plan during the prior
12-month period.
F-10
43
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Board of Directors may provide for a lesser increase in the number of shares
reserved under the equity incentive plan for any year.
The total number of shares reserved in the aggregate may not exceed 60,000,000
shares over the ten-year period. As December 31, 2000, options to purchase
8,252,505 shares of common stock were outstanding under the equity incentive
plan and 966,549 options had been exercised.
In February 2000, Lexicon adopted the 2000 Non-Employee Directors' Stock Option
Plan (the "directors' plan") to provide for the automatic grant of options to
purchase shares of common stock to non-employee directors of Lexicon. Lexicon
reserved a total of 600,000 shares of its common stock for issuance under the
directors' plan. Non-employee directors elected after the closing of Lexicon's
initial public offering will receive an initial option to purchase 30,000 shares
of common stock. In addition, on the date of each of Lexicon's annual meetings
of stockholders, beginning with the annual meeting in 2001, each non-employee
director who has been a director for at least six months will automatically be
granted an option to purchase 6,000 shares of common stock. On the day after
each annual meeting of Lexicon's stockholders, for 10 years, starting in 2001,
the share reserve will automatically be increased by a number of shares equal to
the greater of:
o 0.3% of Lexicon's outstanding shares on a fully-diluted basis;
or
o that number of shares that could be issued under options
granted under the directors' plan during the prior 12-month
period.
Options granted under the directors' plan will become vested and exercisable
over a period of five years and will have an exercise price equal to the fair
market value of Lexicon's common stock on the date of grant. The option term is
ten years. As of December 31, 2000, Lexicon had not issued any options under the
directors' plan.
Stock-based Compensation: Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation," allows companies to adopt one of
two methods for accounting for stock options. Lexicon has elected the method
that requires disclosure only of stock-based compensation. Because of this
election, Lexicon is required to account for its employee stock-based
compensation plans under Accounting Principles Board (APB) Opinion No. 25 and
its related interpretations. Accordingly, deferred compensation is recorded for
stock-based compensation grants based on the excess of the estimated fair value
of the common stock on the measurement date over the exercise price. The
deferred compensation is amortized over the vesting period of each unit of
stock-based compensation grant, generally four years. If the exercise price of
the stock-based compensation grants is equal to the estimated fair value of
Lexicon's stock on the date of grant, no compensation expense is recorded.
F-11
44
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
During the years ended December 31, 1999 and 2000, Lexicon recorded
approximately $1.0 million and $54.1 million, respectively, in aggregate
deferred compensation relating to options issued to employees and non-employee
directors. During the years ended December 31, 1999 and 2000, Lexicon recognized
approximately $86,000 and $20.0 million respectively, in compensation expense
relating to these options. Additionally, during the year ended December 31,
2000, Lexicon reversed approximately $1.3 million of deferred compensation and
additional paid in capital for unamortized deferred compensation related to the
forfeiture of nonvested options by terminated employees. Total amortization
expense was revised to the extent amortization had previously been recorded for
nonvested options.
The following pro forma information regarding net loss is required by SFAS No.
123, and has been determined as if Lexicon had accounted for its employee stock
options under the fair-value method as defined by SFAS No. 123. The fair value
of these options was estimated at the date of grant using the Black-Scholes
method and the following assumptions for 1998, 1999 and 2000: volatility factor
ranging from 29% to 67%, risk-free interest rates ranging from 5.13% to 8%,
expected option lives of seven years, three percent expected turnover, and no
dividends.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the vesting period of the options using the
straight-line method. Lexicon's pro forma information follows:
---------------------------------------------------------
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1999 2000
--------------- --------------- ---------------
Net loss
As reported ............................................ $ (7,480,805) $ (12,475,087) $ (25,994,080)
Pro forma .............................................. $ (8,484,922) $ (14,117,799) $ (32,499,268)
Net loss per common share, basic and diluted
As reported ............................................ $ (0.32) $ (0.53) $ (0.63)
Pro forma .............................................. $ (0.36) $ (0.60) $ (0.78)
Lexicon records the fair value of options issued to non-employee consultants,
including Scientific Advisory Board members, at the fair value of the options
issued. Any expense is recognized over the service period or at the date of
issuance if the options are fully vested and no performance obligation exists.
Options to purchase 45,000 and 372,000 shares of common stock were issued to
non-employees in 1999 and 2000, respectively, and during the years ended
December 31, 1999 and 2000, Lexicon recognized approximately $26,000 and
$836,000, respectively, in expense relating to these options. The fair values of
the issuances in 1999 and 2000 were estimated using the Black-Scholes pricing
model with the assumptions noted in the preceding paragraphs, resulting in an
aggregate fair value of approximately $57,000 and $6.4 million, respectively.
Additionally, during the year ended December 31, 2000, Lexicon reversed
approximately $5.6 million of deferred compensation and additional paid in
capital for unamortized deferred expense related to the forfeiture of nonvested
options. Total amortization expense was revised to the extent amortization had
previously been recorded for non-vested options.
If vesting continues in accordance with the outstanding individual stock
options, Lexicon expects to record amortization expense for deferred stock
compensation as follows: $10.9 million during 2001, $10.9 million during 2002,
$10.9 million during 2003 and $900,000 during 2004.
The following is a summary of option activity under the Company's stock option
plans:
------------------------------------
WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
--------------- ---------------
Balance at December 31, 1997 ............................... 2,801,550 $ 0.74
Granted ................................................ 2,128,650 2.48
Exercised .............................................. (68,001) 0.22
Canceled ............................................... (123,225) 1.32
---------------
Balance at December 31, 1998 ............................... 4,738,974 $ 1.51
Granted ................................................ 1,064,700 2.50
Exercised .............................................. (49,506) 0.46
Canceled ............................................... (557,613) 2.03
---------------
Balance at December 31, 1999 ............................... 5,196,555 $ 1.67
Granted ................................................ 4,463,650 6.61
Exercised .............................................. (849,042) 1.31
Canceled ............................................... (558,658) 2.40
---------------
Balance at December 31, 2000 ............................... 8,252,505 $ 4.33
=============== ===============
Exercisable at December 31, 2000 ........................... 3,980,548 $ 1.89
=============== ===============
The weighted average fair values of options granted during the years ended
December 31, 1998, 1999 and 2000 were $1.25, $1.26 and $4.40, respectively. As
of December 31, 2000, 2,630,946 shares of common stock were available for grant
under the Company's stock option plans.
F-12
45
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about stock options outstanding at
December 31, 2000:
- ---------------------------------------------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------------------------- ----------------------------------
WEIGHTED
OUTSTANDING AS AVERAGE WEIGHTED EXERCISABLE AS WEIGHTED
OF REMAINING AVERAGE OF AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICE 2000 LIFE (IN YEARS) PRICE 2000 PRICE
- ------------------- ----------------- ---------------- -------------- ----------------- -------------
$0.0003 - $0.22 1,106,339 4.6 $ 0.08 1,106,339 $ 0.08
0.22 - 1.67 663,810 6.1 1.67 618,562 1.67
1.67 - 2.50 5,555,306 8.4 2.50 2,209,899 2.50
2.50 - 19.80 656,000 9.5 16.63 45,748 19.35
19.80 - 38.50 271,050 9.7 35.99 -- --
--------------- ---------------
8,252,505 $ 4.33 3,980,548 $ 1.89
=============== ===============
Warrants: In connection with certain note purchase agreements in August 1997
(see Note 4), Lexicon issued two warrants to purchase 13,500 shares and 135,000
shares of common stock at an exercise price of $2.50 per share. Management
estimated the value of these warrants at $24,750 and recorded them as deferred
financing costs and additional paid-in capital. The warrant values were
estimated by management taking into consideration the term of the warrant, the
exercise price that was greater than the estimated fair value of the common
stock at issuance and a rate of return of eight percent. Amortization of these
costs is reflected as additional interest expense in the accompanying financial
statements. Both of these warrants were exercised in 2000.
On May 7, 1998, Lexicon issued to the placement agent for the Series A Preferred
Stock private placement a warrant to purchase 605,001 shares of common stock at
an exercise price of $2.50 per share, the warrant may be exercised for cash or
by way of a "cashless" exercise based upon the difference between fair market
value and exercise price. The warrant expires on the fifth anniversary of the
date of issuance. Management estimated the value of this warrant at
approximately $498,000. The warrant values were estimated by management taking
in to consideration the term of the warrant, the exercise price that equaled the
estimated fair value of the common stock at issuance and a rate of return of
eight percent. Upon consummation of the private placement, this amount was
recorded as a reduction of the Series A Preferred Stock balance and an increase
to additional paid-in capital. The value of the warrant, along with the offering
costs associated with the private placement, were accreted back to the Series A
Preferred Stock through the conversion date of the Series A Preferred Stock.
In July 1998, Lexicon issued a warrant to purchase 249,999 shares of common
stock at an exercise price of $2.50 per share, in connection with the grant to
Lexicon of an option to lease additional real property. The warrant expires on
April 15, 2003. Management estimated the value of this warrant at approximately
$196,000. The warrant values were estimated by management taking in to
consideration the term of the warrant, the exercise price that equaled the
estimated fair value of the common stock at issuance and a rate of return of
eight percent. As this warrant has been treated as consideration for the option
to lease certain real property (lease option), Lexicon has recorded the
warrant's value as a long-term asset and additional paid-in capital.
Amortization of the lease option, $17,180 and $41,232 during 1998 and 1999,
respectively, has been recorded as additional lease expense in the accompanying
financial statements. The remaining balance on the lease option was expensed
during 2000 upon Lexicon's completion of a synthetic lease agreement under which
the lessor purchased the optioned real property under an arrangement whereby it
will be leased to Lexicon (see Note 10).
F-13
46
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. BENEFIT PLANS
Lexicon has established an Annual Profit Sharing Incentive Plan (the Profit
Sharing Plan). The purpose of the Profit Sharing Plan is to provide for the
payment of incentive compensation out of the profits of Lexicon to certain of
its employees. Participants in the Profit Sharing Plan are entitled to an annual
cash bonus equal to their proportionate share (based on salary) of 15 percent of
Lexicon's annual pretax income, if any.
Lexicon maintains a defined-contribution savings plan under Section 401(k) of
the Internal Revenue Code. The plan covers substantially all full-time
employees. Participating employees may defer a portion of their pretax earnings,
up to the Internal Revenue Service annual contribution limit. Beginning in 2000,
the Company is required to match employee contributions according to a specified
formula. The matching contributions totaled approximately $160,000 in 2000.
Company contributions vest to employees ratably over four years.
9. COLLABORATION AND LICENSE AGREEMENTS
Merck Genome Research Institute: In March 1997, Lexicon entered into an
agreement with Merck Genome Research Institute (MGRI) under which Lexicon
received an initial cash payment of $4.0 million. A portion of this payment was
recognized as revenue as Lexicon performed its obligations related to such
agreement. In September 2000, Lexicon concluded the agreement with MGRI. In
connection with the conclusion of the MGRI agreement, Lexicon recognized $3.1
million of deferred revenues remaining from the $4.0 million cash payment made
by MGRI when the agreement was signed and an additional $1.0 million of revenue
related to a final, non-refundable cash payment that Lexicon received from MGRI.
Millennium Pharmaceuticals, Inc.: Lexicon established a multi-year functional
genomics agreement in July 1999 for the creation of gene-targeted knockout mice
for use by Millennium in the validation of potential drug targets identified and
selected by Millennium. Lexicon had a separate agreement with Millennium for
access to Lexicon's human gene sequence database that expired in April 2000.
Lexicon substantially expanded its functional genomics agreement with Millennium
in June 2000, increasing the number of knockout mice that it will generate for
Millennium over the remaining term of the agreement, which extends through June
2002.
Bristol-Myers Squibb Company: Lexicon established a LexVision collaboration with
Bristol-Myers Squibb in September 2000, under which Bristol-Myers Squibb has
access to Lexicon's LexVision database and OmniBank library for the discovery of
small molecule drugs. Lexicon could receive between $15 million and $25 million
in access and delivery fees under this agreement, in addition to milestone
payments and royalties on products Bristol-Myers Squibb develops using Lexicon's
technology. The agreement has a term of five years, although either party may
terminate the agreement after three years. During the year ended December 31,
2000, Lexicon recognized $1.0 million of revenue related to $1.25 million due
for the first installment of gene function information provided prior to
December 31, 2000.
10. COMMITMENTS AND CONTINGENCIES
Lease Obligations: Lexicon leases certain equipment under operating leases.
Additionally, in October 2000, the Company entered into a synthetic lease
agreement under which the lessor purchased current laboratory and office space
and animal facility (existing facilities), and agreed to fund the construction
of additional laboratory and office space and a second animal facility (new
facilities). Including the purchase price for the existing facilities, the
synthetic lease provides for funding of up to $45.0 million in property and
improvements. The term of the agreement is six years, which includes the
construction period for the new facilities and a lease period. The Company's
lease payments for the existing facilities began in November 2000 and lease
payments for the new facilities will begin upon completion of construction,
which is expected in the fourth quarter of 2001. At the end of the lease term,
the lease may be extended for one-year terms, up to seven terms, or the Company
may purchase the properties for a price including the outstanding lease balance.
If the Company elects not to renew the lease or purchase the properties, the
Company must arrange the sale of the properties to a third party. Under the sale
option, the Company has guaranteed a percentage of the total original cost as
the residual fair value of the properties. As of
F-14
47
LEXICON GENETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
December 31, 2000, Lexicon had no operating lease for the new facilities;
however, the Company will enter into lease arrangements at construction
completion. Rent expense for all operating leases was approximately $673,000,
$1,111,000 and $1,518,000 for the years ended December 31, 1998, 1999 and 2000,
respectively. Future rental expense under the synthetic lease is subject to
fluctuation based on LIBOR rates. The table below includes future lease payments
for the existing facilities and the anticipated lease payments related to the
new facilities based on a year-end LIBOR rate of 6.4%.
-------------------
FOR THE YEAR ENDING
DECEMBER 31, 2000
-------------------
2001 ...................................................................... $ 795,000
2002 ...................................................................... 3,014,000
2003 ...................................................................... 3,014,000
2004 ...................................................................... 3,014,000
2005 ...................................................................... 3,014,000
Thereafter ................................................................ 2,512,000
---------------
Total .......................................................... $ 15,363,000
===============
Employment Agreements: In December 1998, October 1999, January 2000 and February
2000, Lexicon entered into employment agreements with certain of its corporate
officers. Under the agreements, each officer receives a base salary, subject to
adjustment, with an annual discretionary bonus based upon specific objectives to
be determined by the compensation committee. The employment agreements are
at-will and contain non-competition agreements. The agreements also provide for
a termination clause, which requires either a six or 12-month payment based on
the officer's salary, in the event of termination or change in corporate
control.
F-15
48
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 --- Restated Certificate of Incorporation (filed as
Exhibit 3.1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-96469)
and incorporated by reference herein).
3.2 --- Restated Bylaws (filed as Exhibit 3.2 to the
Company's Registration Statement on Form S-1
(Registration No. 333-96469) and incorporated by
reference herein).
10.1 --- Employment Agreement with Arthur T. Sands, M.D.,
Ph.D. (filed as Exhibit 10.1 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-96469) and incorporated by reference
herein).
10.2 --- Employment Agreement with James R. Piggott, Ph.D.
(filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-96469) and incorporated by reference
herein).
10.3 --- Employment Agreement with Jeffrey L. Wade, J.D.
(filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-96469) and incorporated by reference
herein).
10.4 --- Employment Agreement with Brian P. Zambrowicz,
Ph.D. (filed as Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-96469) and incorporated by reference
herein).
10.5 --- Employment Agreement with Julia P. Gregory (filed
as Exhibit 10.5 to the Company's Registration
Statement on Form S-1 (Registration No. 333-96469)
and incorporated by reference herein).
10.6 --- Employment Agreement with Randall B. Riggs (filed
as Exhibit 10.6 to the Company's Registration
Statement on Form S-1 (Registration No. 333-96469)
and incorporated by reference herein).
10.7 --- Form of Indemnification Agreement with Officers
and Directors (filed as Exhibit 10.7 to the
Company's Registration Statement on Form S-1
(Registration No. 333-96469) and incorporated by
reference herein).
10.8 --- 2000 Equity Incentive Plan (filed as Exhibit 10.8
to the Company's Registration Statement on Form
S-1 (Registration No. 333-96469) and incorporated
by reference herein).
10.9 --- 2000 Non-Employee Directors' Stock Option Plan
(filed as Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-96469) and incorporated by reference
herein).
+10.10 --- LexVision Database and Collaboration Agreement
with Bristol-Myers Squibb, dated September 26,
2000 between Lexicon Genetics Incorporated and
Bristol-Myers Squibb Company (filed as Exhibit
16.1 to the Company's Current Report on Form 8-K
dated September 26, 2000 and incorporated by
reference herein).
10.11 --- Master Loan and Security Agreement dated May 21,
1999, with FINOVA Capital Corporation (filed as
Exhibit 10.12 to the Company's Registration
Statement on Form S-1 (Registration No.
333-964969) and incorporated by reference
herein.).
*10.12 --- Synthetic Lease Financing Facility with First
Security Bank, National Association, the Lenders
and Holders named therein, and Bank of America,
N.A.
*23.1 --- Consent of Arthur Andersen LLP
24.1 --- Power of Attorney (contained in signature page)
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* Filed herewith.
+ Confidential treatment has been requested for a portion of this exhibit. The
confidential portions of this exhibit have been omitted and filed separately
with the Securities and Exchange Commission.
E-1