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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, 2002
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)
8800 TECHNOLOGY FOREST PLACE
THE WOODLANDS, TEXAS 77381 (281) 863-3000
(Address of Principal Executive (Registrant's Telephone Number,
Offices and Zip Code) 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. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934. Yes |X| No |_|
The aggregate market value of voting stock held by non-affiliates of the
registrant as of the last day of the registrant's most recently completed second
quarter was approximately $124.9 million, based on the closing price of the
common stock on the Nasdaq National Market on June 28, 2002 of $4.12 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 10, 2003, 52,370,730 shares of common
stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the registrant's definitive proxy statement relating
to the registrant's 2003 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, 2002, 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........................................................................................... 22
3. Legal Proceedings.................................................................................... 23
4. Submissions of Matters to a Vote of Security Holders................................................. 23
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters................................ 24
6. Selected Financial Data.............................................................................. 25
7. Management's Discussion and Analysis of Financial Condition and Results of Operations................ 26
7A. Quantitative and Qualitative Disclosure About Market Risk............................................ 32
8. Financial Statements and Supplementary Data.......................................................... 32
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................. 32
PART III
10. Directors and Executive Officers of the Registrant................................................... 33
11. Executive Compensation............................................................................... 33
12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters....... 33
13. Certain Relationships and Related Transactions....................................................... 34
14. Controls and Procedures.............................................................................. 34
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................... 35
Signatures..................................................................................................... 38
The Lexicon name and logo, LexVision(R) and OmniBank(R) are registered
trademarks and Genome5000(TM) and e-Biology(TM) are trademarks of Lexicon
Genetics Incorporated.
In this annual report on Form 10-K, "Lexicon Genetics," "Lexicon," "we,"
"us" and "our" refer to Lexicon Genetics Incorporated.
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 of 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.
PART I
ITEM 1. BUSINESS
OVERVIEW
Lexicon Genetics is a biopharmaceutical company focused on the discovery
of breakthrough treatments for human disease. We are using gene knockout
technology to systematically discover in living mammals, or in vivo, the
physiological functions and pharmaceutical utility of genes. Our gene function
discoveries fuel therapeutic discovery programs in diabetes, obesity,
cardiovascular disease, immune disorders, neurological disease and cancer. We
have established drug discovery alliances and functional genomics collaborations
with leading pharmaceutical and biotechnology companies, research institutes and
academic institutions throughout the world to commercialize our technology and
turn our discoveries into drugs.
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 and
validate, in vivo, the physiological functions and pharmaceutical utility of the
genes we have knocked out and the potential targets for therapeutic
intervention, or drug targets, they encode.
We employ internal resources and drug discovery alliances to discover
potential small molecule drugs, therapeutic antibodies and therapeutic proteins
for in vivo-validated drug targets that we consider to have high pharmaceutical
value. We use our own sophisticated libraries of drug-like chemical compounds
and an industrialized medicinal chemistry platform to identify small molecule
drug candidates for our in vivo-validated drug targets. We have established
alliances with Genentech, Inc. for the discovery of therapeutic proteins and
antibody targets; with Abgenix, Inc. for the discovery and development of
therapeutic antibodies based on our drug target discoveries; and with Incyte
Genomics, Inc. for the discovery and development of therapeutic proteins. In
addition, we have established collaborations and license agreements with many
other leading pharmaceutical and biotechnology companies under which we receive
fees and, in many cases, are eligible to receive milestone and royalty payments,
in return for granting access to some of our technologies and discoveries for
use in their own drug discovery efforts.
We believe that our industrialized approach of discovering and validating
drug targets in vivo, together with our capabilities in small molecule drug
discovery and the integration of our own capabilities with those of our alliance
partners in therapeutic antibody and therapeutic protein discovery, will
significantly increase our likelihood of success in discovering breakthrough
treatments for human disease, and will reduce the risk, time and expense of
discovering and developing therapeutics for new drug targets. Together, we
believe that these factors will provide us with substantial strategic advantages
in the competition to discover and develop genomics-based pharmaceutical
products.
Lexicon Genetics was incorporated in Delaware in July 1995, and commenced
operations in September 1995. Our corporate headquarters are located at 8800
Technology Forest Place, The Woodlands, Texas 77381, and our telephone number is
(281) 863-3000.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made
available free of charge on our corporate website located at
www.lexicon-genetics.com as soon as reasonably practicable after the filing of
those reports with the Securities and Exchange Commission. Information found on
our website should not be considered part of this annual report on Form 10-K.
1
KEY MILESTONES AND ACHIEVEMENTS IN 2002
We made substantial business and technical progress in 2002:
- We continued to advance additional in vivo-validated drug targets
into therapeutic discovery programs, and identified compounds
demonstrating activity in several of our more advanced programs;
- We established an alliance with Genentech for the discovery of
therapeutic proteins and antibody targets;
- We made further progress in our alliances with Abgenix for the
discovery of therapeutic antibodies and with Incyte for the
discovery of therapeutic proteins;
- We granted non-exclusive, internal research-use sublicenses under
our gene targeting patents to Genentech, Biogen, Inc. and Millennium
Pharmaceuticals, Inc.;
- We obtained an additional key patent covering our gene trapping
technology, as well as patents covering nine full-length sequences
of potential drug targets identified in our gene discovery programs;
- We brought on-line our new office, laboratory and animal facilities;
- We substantially increased our rate of productivity in our
Genome5000 program for the discovery of the in vivo functions of
5,000 genes over five years, ending the year having completed the
analysis of the functions of 750 genes; and
- We achieved more than $35 million in revenues, marking our seventh
consecutive year of revenue growth.
We believe we are poised to capitalize on these achievements in 2003 by
further accelerating the pace of our Genome5000 program, substantially expanding
our pipeline of in vivo-validated drug targets, advancing our therapeutic
discovery programs towards clinical development, and establishing additional
drug discovery alliances and functional genomics collaborations to commercialize
our technology and further develop our discoveries.
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 two
to four percent of the genome. The remaining 96% to 98% of DNA in chromosomes
does not code for protein. Although estimates vary as to the total number of
genes within the total of approximately three billion nucleotide base pairs of
"genomic" or "chromosomal" DNA that make up the human genome, it is estimated
that the human genome contains approximately 30,000 genes.
The Human Genome Project and other publicly and privately-funded DNA
sequencing efforts 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 valuable drug targets - are commonly referred to as
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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, and
conducting experiments 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 defining gene 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 resulting physiological, pathological
and behavioral consequences. As mammals, humans and mice have very similar
genomes and share very similar physiology - one of the reasons that mice are
among the most widely used animal model systems in the pharmaceutical industry.
As a result of these similarities, the in vivo analysis of the function of a
gene in knockout mice - mice whose DNA has been altered to disrupt, or "knock
out," the function of the altered gene - enables the predictions to be made
regarding the effects on human physiology of prospective therapeutics that
modulate the corresponding human drug target and, therefore, regarding the
pharmaceutical utility and value of the target for the discovery and development
of such therapeutics.
Genomics-Based Drug Discovery
We believe that genomics represents a significant opportunity for the
discovery and development of breakthrough treatments for human disease. Drugs on
the market today interact with a total of about 120 specific protein targets,
each of which is encoded by a gene. Of those, only 43 represented human host
proteins targeted by one or more of the 100 best-selling drugs of 2001. While
estimates of the total number of potential drug targets encoded within the human
genome vary, some experts believe that genomics research could discover as many
as 5,000 new targets for pharmaceutical development. Our own experience suggests
that the number of new targets with true pharmaceutical value is much lower,
perhaps in the range of 100 to 150 new high-quality targets. This would still be
a substantial increase from the number of targets that fuel the pharmaceutical
industry at present, but demonstrates the importance of selecting the drug
targets with the greatest pharmaceutical utility from the much larger pool of
potential targets. The fact that very little is known about the physiological
functions of most genes, however, presents a major challenge in making these
selections, and for drug discovery research generally, which has traditionally
relied primarily on established drug targets with well-characterized functions.
The magnitude of this challenge is evident in expectations regarding the
productivity of drug discovery research for genomics-based drug targets.
According to the Fruits of Genomics, a 2001 study conducted by McKinsey & Co.
and Lehman Brothers, the average cost of bringing a single drug to market,
estimated at $800 million in 2000, may increase to as much as $1.6 billion by
2005. The primary driver of the increase is the expected change, as a result of
the wealth of potential drug targets generated by the Human Genome Project and
other publicly and privately-funded DNA sequencing efforts, in the proportion of
drug targets in pharmaceutical companies' research pipelines that are
"unprecedented" - that is, drug targets for which therapeutics have not
previously been developed. The study estimates that this increase in
unprecedented drug targets will result in substantially higher rates of failure
in early preclinical biological validation and Phase 2 clinical development.
The chief cause of these failures, we believe, is the advancement of
unprecedented drug targets into expensive screening and therapeutic discovery
programs without an understanding of the in vivo biology and physiological
function of the target. Because target selection decisions drive all subsequent
drug discovery and development spending, and failures account for 75% or more of
the average cost of bringing a drug to market, the quality of target selection
decisions has a disproportionate effect on the overall cost of bringing a drug
to market.
OUR STRATEGY
We believe that the discovery and selection of drug targets that have high
pharmaceutical value - that exhibit favorable therapeutic profiles and address
large medical markets - will be the key determinant of success in genomics-based
drug discovery. The solution to this challenge, we believe, requires redefining
the way drug discovery is conducted by systematically determining the
physiological 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 to discover which potential
targets from the human genome exhibit favorable
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therapeutic profiles and address large medical markets. In addition, we believe
that identifying these drug targets at the very beginning of the drug discovery
process, before committing to expensive screening and therapeutic discovery
programs, will substantially increase the productivity and cost-effectiveness of
our drug discovery efforts relative to other approaches. Together, we believe
that these factors will significantly increase our likelihood of success in
discovering breakthrough treatments for human disease, and will reduce the risk,
time and expense of discovering and developing therapeutics for new drug
targets.
Our principal objective is to establish a leadership position in the
discovery of breakthrough treatments for human disease. The key elements of our
strategy include the following:
- systematically discover, in vivo, the physiological functions and
pharmaceutical utility of 5,000 genes over five years in our
Genome5000 program;
- employ internal resources and drug discovery alliances to discover
potential small molecule drugs, therapeutic antibodies and
therapeutic proteins for in vivo-validated drug targets that we
consider to have high pharmaceutical value;
- develop promising therapeutic candidates through drug development
alliances or with our own resources; and
- generate near-term revenues through collaborations and license
agreements with pharmaceutical and biotechnology companies in return
for granting access to some of our technologies and discoveries for
use in their own drug discovery efforts.
OUR TECHNOLOGY PLATFORM
We have developed, refined and integrated a technology platform that spans
the drug discovery process from gene identification to the discovery and
development of therapeutics, with a focus on the systematic discovery and
validation, in vivo, of the physiological functions and pharmaceutical utility
of genes and the drug targets they encode, and the discovery and development of
therapeutics for our in vivo-validated drug targets. Our technology platform
includes both proprietary and non-proprietary technologies in gene sequencing
and discovery, bioinformatics analysis, expression analysis, gene knockouts,
biological and physiological analysis, chemical compound libraries, assay
development, high-throughput screening and medicinal chemistry.
The core elements of our technology platform include our patented
technologies for the generation of gene knockouts, our integrated platform of
advanced medical technologies for the systematic and comprehensive biological
analysis of in vivo physiology, and our industrialized approach to medicinal
chemistry and the generation of high-quality, drug-like compound libraries.
These core elements of our technology platform are described below.
Gene Knockout Technologies
We have developed and refined gene knockout technologies and expertise to
rapidly and efficiently generate knockout mice for the in vivo analysis of the
physiological functions of thousands of genes. Our patented gene trapping and
gene targeting technologies, our experience in using these technologies and the
scale of our gene knockout operations provide us with substantial advantages
over the methods generally used to generate knockout mice, allowing us to
overcome limitations inherent in such methods that restrict the rate at which
knockout mice may be produced and, therefore, the rate at which the genes in the
mammalian genome may be analyzed.
Gene Targeting. Our gene targeting technology, which is covered by six
issued patents, enables us to generate highly-specific alterations in targeted
genes. The technology uses a vector to replace DNA of a gene in a mouse ES cell
with DNA from the targeting construct in the chromosome of the cell through a
process known as homologous recombination. When used to knock out a gene, the
DNA from the targeting construct disrupts the function of the targeted gene,
permitting the generation of knockout mice.
4
We use our gene targeting technology to knock out the function of the
targeted gene for the analysis of the gene's function. We also use this
technology in combination with one or more additional technologies such as
Cre/lox recombinase technology to generate alterations that selectively disrupt,
or conditionally regulate, the function of the targeted gene for the analysis of
the gene's function in selected tissues, at selected stages in the animal's
development or at selected times in the animal's life. In addition, we can use
this technology to replace the targeted gene with its corresponding human gene,
or ortholog, for use in our therapeutic discovery programs.
We have developed an industrialized approach to gene targeting, and
believe that our experience using this technology and the scale of our gene
targeting operations provide us with substantial advantages in efficiency and
speed relative to others using similar approaches to generate knockout mice.
Gene Trapping. Our gene trapping technology, which is covered by six
issued patents, is a high-throughput method of generating knockout mouse clones
that we invented. The technology uses genetically engineered retroviruses that
infect mouse ES 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. The
gene trap also stimulates transcription of a portion of the trapped gene, using
the cell's own splicing machinery to extract this transcript from the chromosome
for automated DNA sequencing. This allows us to identify and catalogue each ES
cell clone by DNA sequence from the trapped gene, and to select ES cell clones
by DNA sequence for the generation of knockout mice.
We have used our gene trapping technology in an automated process to
create our OmniBank library of more than 200,000 frozen gene knockout ES cell
clones, each identified by DNA sequence in a relational database. Because our
gene trapping vectors are designed to trap genes in a manner largely independent
of their levels of expression, our OmniBank library includes even those genes
that are very rarely expressed. We estimate that our OmniBank library currently
contains gene knockout clones for more than half of all genes in the mammalian
genome.
We believe our OmniBank library, which is by far the largest library of
gene knockout clones in the world, provides us with unparalleled strategic
advantages in the discovery of in vivo gene function. The OmniBank library
permits us to generate knockout mice for in vivo analysis at a significantly
higher rate than is possible using other methods. We have generated many of our
in vivo-validated drug target discoveries that we consider to have high
pharmaceutical value using knockout mice generated from our OmniBank library.
Physiological Analysis Technologies
We have assembled and integrated a technology platform for in vivo
physiological analysis using a medical center approach to genes, enabling us to
systematically define the functions and pharmaceutical utility of the genes we
have knocked out and the potential targets for therapeutic intervention, or drug
targets, they encode.
Gene Function Discovery. 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. These technologies include many of the most
sophisticated diagnostic technologies that might be found in a major medical
center, from CAT-scans and magnetic resonance imaging (MRI) to complete blood
cell analysis, all adapted specifically for the analysis of mouse physiology.
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 analysis is captured in relational databases for our use,
and use by our collaborators, in drug discovery.
We believe that our medical center approach and the technology platform
that makes it possible provide us with substantial advantages over other
approaches to gene function and drug target discovery. We believe that our
comprehensive, unbiased approach allows us to uncover functions within the
context of mammalian physiology that might be missed by more narrowly-focused
efforts directed on the basis of hypotheses as to the gene's likely function,
particularly when these hypotheses are based on expression analyses and other
factors that our experience
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indicates are unreliable predictors of gene function. We also believe our
approach is more likely to uncover target-related side effects that might limit
the utility of potential therapeutics addressing the drug target or prove to be
unacceptable in light of the potential therapeutic benefit. In both these cases,
we believe these advantages will contribute to better target selection and,
therefore, to the success of our drug discovery and development efforts.
Preclinical Analysis of Therapeutic Candidates. We employ the same
physiological analysis technology platform that we use in the discovery of gene
function to analyze the in vivo efficacy and safety profiles of therapeutic
candidates in mice. We believe that this approach will allow us, at an early
stage, to identify and optimize therapeutic candidates for further preclinical
and clinical development that demonstrate superior in vivo efficacy and to
distinguish compound-related effects from the target-related effects that we
defined using the same systematic, comprehensive series of tests. The result, we
believe, will substantially increase our likelihood of success in traditional
preclinical and clinical development, and will reduce the risk, time and expense
of developing our therapeutics for our in vivo-validated drug targets.
Medicinal Chemistry Technology
We acquired state-of-the-art medicinal chemistry capabilities through our
July 2001 acquisition of Coelacanth Corporation, which forms the foundation of
our Lexicon Pharmaceuticals division focused on the discovery and development of
small molecule drugs for our in vivo-validated drug targets. We use
solution-phase chemistry to generate diverse libraries of optically pure
compounds that are targeted against the same categories of drug targets we
address in our Genome 5000 drug target discovery program. We design these
libraries by analyzing the chemical structures of drugs that have been proven
safe and effective against human disease and synthesizing that knowledge in the
design of scaffolds and chemical building blocks for the generation of large
numbers of new drug-like compounds. These building blocks, which we refer to as
"pharmacophoric modules," can rapidly be reassembled to generate optimization
libraries when we identify a hit, or compound demonstrating activity, against
one of our in vivo-validated targets, enabling us to rapidly optimize those hits
and accelerate our medicinal chemistry efforts.
RESEARCH AND DEVELOPMENT PROGRAMS
Genome5000 Drug Target Discovery Program
We are using our industrialized approach to gene targeting and our
OmniBank library of more than 200,000 gene knockout ES cell clones, together
with our integrated platform of advanced physiological analysis technologies, to
systematically discover in living mammals, or in vivo, the functions and
pharmaceutical utility of a total of 5,000 genes over five years in our
Genome5000 program. The Genome5000 program includes the 1,250 drug targets that
we have committed to include in our LexVision database of in vivo-validated drug
targets, as well as the additional drug targets that we are pursuing in internal
programs and drug discovery alliances. We believe that our in vivo validation of
the drug targets discovered in our Genome5000 program provides us and our
collaborators with substantial advantages over competing validation approaches
in the discovery and development of genomics-based pharmaceutical products.
Our Genome5000 efforts are focused on the discovery of the functions in
mammalian physiology of proteins encoded by pharmaceutically important gene
families, such as G-protein coupled (GPCRs) and other receptors, kinases, ion
channels, other key enzymes and secreted proteins. We use bioinformatics
analysis and other resources to prioritize genes for analysis in this program
from a variety of sources, including our own proprietary gene sequence
databases, which encompass hundreds of full-length human gene sequences and more
than 50,000 partial human gene sequences that we discovered using our gene
trapping technology, our OmniBank database and library, Incyte's LifeSeq(R) Gold
Database and the public human genome project.
We have identified in vivo-validated drug targets in each of our internal
disease biology programs, which include programs for the identification of drug
targets with pharmaceutical utility in the discovery of therapeutics for the
treatment of diabetes, obesity, cardiovascular disease, immune disorders,
neurological disease and cancer. We are moving many of these targets forward
into therapeutic discovery and development programs, both on our own and with
collaborators.
6
Therapeutic Discovery Programs
We employ internal resources and drug discovery alliances to discover
potential small molecule drugs, therapeutic antibodies and therapeutic proteins
for in vivo-validated drug targets that we consider to have high pharmaceutical
value. We use our own sophisticated libraries of drug-like chemical compounds
and an industrialized medicinal chemistry platform to identify small molecule
drug candidates for our in vivo-validated drug targets. We have established
alliances with Genentech for the discovery of therapeutic proteins and antibody
targets; with Abgenix for the discovery and development of therapeutic
antibodies based on our drug target discoveries; and with Incyte for the
discovery and development of therapeutic proteins.
Our criteria for advancing in vivo-validated drug targets into therapeutic
discovery and development programs include the following:
- Favorable Therapeutic Profile. The drug target must demonstrate a
favorable therapeutic profile in vivo. Specifically, our in vivo
analysis must suggest that the effect of inhibiting or otherwise
modulating the activity of the drug target in humans would have a
therapeutic effect in treating disease, with an acceptable
target-related side effect profile.
- Novel Function. The function of the drug target must be novel - that
is, we are interested in drug targets whose function was not
generally known to others before we discovered it.
- Large Medical Market. The potential market for therapeutics
addressing the drug target must be substantial. We are interested in
drug targets that are key switches that control human physiology,
addressing large markets such as heart disease, diabetes, depression
and cancer.
Our small molecule drug discovery programs involve the following stages:
- assay development and high throughput screening (HTS) to identify
"hits," or compounds demonstrating activity, against the in
vivo-validated targets;
- medicinal chemistry efforts to optimize the potency and selectivity
of the hits, to identify lead compounds for further development;
- lead optimization and preliminary preclinical analysis;
- formal preclinical studies of optimized leads; and
- clinical development.
Our most advanced projects to date have reached the lead optimization and
preliminary preclinical analysis stage.
As of March 10, 2003, we had advanced more than 15 in vivo-validated drug
targets into therapeutic discovery programs.
Research and Development Expenses
In 2002, 2001 and 2000, respectively, we incurred expenses of $74.9
million, $53.4 million and $31.6 million in company-sponsored research and
development activities, including $5.2 million, $5.5 million and $10.9 million,
respectively, of stock-based compensation expense.
7
COLLABORATIONS AND ALLIANCES
Our collaboration and alliance strategy involves:
- drug discovery alliances to discover and develop therapeutics based
on our drug target discoveries, particularly when the alliance
enables us to obtain access to technology and expertise that is
complementary to our own; and
- functional genomics collaborations with pharmaceutical and
biotechnology companies, research institutions and academic
institutions to generate near-term revenues for granting access to
some of our technologies and discoveries for use in their own drug
discovery efforts, as well as the potential, in many cases, for
milestone payments and royalties on products they develop using our
technology.
In implementing this strategy, we have entered into the drug discovery
alliances and functional genomics collaborations with leading pharmaceutical and
biotechnology companies, research institutions and academic institutions
throughout the world, as described below.
Drug Discovery Alliances
We have entered into the following alliances for the discovery and
development of therapeutics based on our in vivo drug target discovery efforts:
Genentech, Inc. We established a drug discovery alliance with Genentech in
December 2002 to discover novel therapeutic proteins and antibody targets. Under
the alliance agreement, we will use our functional genomics technologies to
discover the functions of secreted proteins and potential antibody targets
identified through Genentech's internal drug discovery research. Genentech will
have exclusive rights in the discoveries resulting from the collaboration for
the research, development and commercialization of therapeutic proteins and
antibodies. We will retain certain other rights in those discoveries, including
rights for the development of small molecule drugs. We received an up-front
payment and will receive performance payments for our work in the collaboration
as it is completed. We will also receive milestone payments and royalties on
sales of therapeutic proteins and antibodies for which Genentech obtains
exclusive rights. The agreement has an expected collaboration term of three
years.
Abgenix, Inc. We established a drug discovery alliance with Abgenix in
July 2000 to discover novel therapeutic antibodies using our functional genomics
technologies and Abgenix's technology for generating fully human monoclonal
antibodies. We and Abgenix expanded and extended the alliance in January 2002,
with the intent of accelerating the selection of in vivo-validated antigens for
antibody discovery and the development and commercialization of therapeutic
antibodies based on those targets. Under the alliance agreement, we and Abgenix
will each have the right to obtain exclusive commercialization rights, including
sublicensing rights, for an equal number of qualifying therapeutic antibodies,
and will each receive milestone payments and royalties on sales of therapeutic
antibodies from the alliance that are commercialized by the other party or a
third party sublicensee. Each party will bear its own expenses under the
alliance. The expanded alliance also provides us with access to Abgenix's
XenoMouse(R) technology for use in some of our own drug discovery programs. The
agreement, as extended, has a term of four years, subject to the right of the
parties to extend the term for up to three additional one-year periods.
Incyte Genomics, Inc. We established a drug discovery alliance with Incyte
in June 2001 to discover novel therapeutic proteins using our functional
genomics technologies in the discovery of the functions of secreted proteins
from Incyte's LifeSeq(R) Gold database. Under the alliance agreement, we and
Incyte will each have the right to obtain exclusive commercialization rights,
including sublicensing rights, for an equal number of qualifying therapeutic
proteins, and will each receive milestone payments and royalties on sales of
therapeutic proteins from the alliance that are commercialized by the other
party or a third party sublicensee. The agreement has a term of five years,
although either party may terminate the agreement after three years.
8
LexVision Collaborations
We have entered into the following collaborations for access to our
LexVision database of in vivo-validated drug targets:
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 receive access fees under this agreement,
and are entitled to receive 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.
Incyte Genomics, Inc. We established a LexVision collaboration with Incyte
in June 2001, under which Incyte has non-exclusive access to our LexVision
database and OmniBank library for the discovery of small molecule drugs. We
receive access fees under this agreement, and are entitled to receive milestone
payments and royalties on products Incyte develops using our technology. The
agreement has a term of five years, although either party may terminate the
agreement after three years.
Functional Genomics Collaborations
We have established functional genomics collaboration agreements with a
number of leading pharmaceutical and biotechnology companies for the generation
and, in some cases, analysis of knockout mice for genes requested by the
collaborator. Under these agreements, we grant non-exclusive licenses to the
collaborator for use in its internal drug discovery programs of the knockout
mice and, if applicable, analysis data that we generate under the agreement.
Some of these agreements also provide for non-exclusive access to our OmniBank
database. 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 that our collaborators discover or develop using
our technology.
We have entered into functional genomics collaboration agreements with the
following companies:
COMPANY DATE OF AGREEMENT END OF ACCESS PERIOD
------- ----------------- --------------------
Amgen, Inc. July 2001 July 2003
Abgenix, Inc. January 2001 January 2004
Tularik Inc. October 2000 October 2003
Wyeth March 2000 March 2003
Boehringer Ingelheim Pharmaceuticals, Inc. February 2000 February 2004
Pharmacia Corp. January 2000 January 2003
Johnson & Johnson Pharmaceutical
Research and Development L.L.C. December 1999 December 2003
N.V. Organon December 1999 December 2002
Millennium Pharmaceuticals, Inc. July 1999 June 2002
Each of these agreements has a specified access period during which the
collaborator may request new projects, although we continue to conduct work and
the agreement remains in effect until the projects requested during the access
period are completed.
We have also entered into functional genomics collaboration agreements
with a number of additional 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
We believe that our OmniBank database and library represent a unique
resource for catalyzing collaborations with researchers at pharmaceutical
companies, biotechnology companies and academic institutions
9
for the discovery of gene function. We provide access to our OmniBank database
through the Internet to subscribing researchers at leading companies and
academic institutions throughout the world. Our bioinformatics software allows
subscribers to mine our OmniBank database for genes of interest, and we permit
subscribers to acquire OmniBank knockout mice or ES cells on a non-exclusive
basis for the determination of gene function under our e-Biology collaboration
program. In this program, we receive fees for OmniBank knockout mice and, with
participating institutions, 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 retain rights to use the same OmniBank knockout mice in our own gene
function research and with commercial collaborators. We have more than 100
agreements under our e-Biology collaboration program with researchers at leading
institutions throughout the world.
TECHNOLOGY LICENSES AND COMPOUND SALES
In addition to collaborations, we have used technology licenses and
compound library sales to generate revenues for the support of our own research
and development efforts.
Technology Licenses. We have granted non-exclusive, internal research-use
sublicenses under certain of our gene targeting patent rights to a total of 12
leading pharmaceutical and biotechnology companies. Many of these agreements
have terms of one to three years, in some cases with provisions for subsequent
renewals. Others extend for as long as the life of the patents. We typically
receive up-front license fees and, in some cases, receive additional license
fees or milestone payments on products that the sublicensee discovers or
develops using our technology.
Compound Library Sales. Our Lexicon Pharmaceuticals subsidiary has entered
into agreements with a total of 29 leading pharmaceutical and biotechnology
companies for non-exclusive access to selected compound libraries. Most of these
agreements were completed by Coelacanth prior to our July 2001 acquisition of
the company. The remainder were completed in 2001 as we wound down Coelacanth's
compound sales efforts in support of our strategic decision to use our compound
libraries principally in our own drug discovery efforts. These agreements
typically provide for our sale of compounds from the selected library for use by
the customer in its own internal drug discovery efforts. Under some of these
agreements, we have agreed to provide additional quantities of selected
compounds or optimization services in exchange for further payments. Subject to
limited exceptions, we do not intend to continue to make our compound libraries
available for purchase in the future.
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:
- 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;
- the utility of genes and the drug targets or therapeutic proteins
they encode based on our discoveries of their biological functions
using knockout mice;
- drug discovery assays for our in vivo-validated targets;
- chemical compounds and their use in treating human diseases and
conditions; and
- various enabling technologies in the fields of mutagenesis, ES cell
manipulation and transgenic or knockout mice.
We own or have exclusive rights to six issued U.S. patents that cover our
gene trapping technology, nine issued U.S. patents that cover full-length
sequences of potential drug targets identified in our gene discovery
10
programs, 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 47 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 to which we hold exclusive
rights in certain fields, including a total of six U.S. patents covering the use
of positive-negative selection and isogenic DNA gene targeting technology, as
well as patents covering the use of Cre/lox technology. We have filed or have
exclusive rights to more than 500 pending patent applications in the United
States Patent and Trademark Office, 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, the
utility of drug targets, drug discovery assays, and other products and
processes. Collectively, these patent applications cover, among other things,
approximately 200 full-length human gene sequences, more than 50,000 partial
human gene sequences, and more than 45,000 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., Millennium Pharmaceuticals, Inc. and Exelixis, Inc.,
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, including Deltagen, Inc. and DNX (a subsidiary
of Xenogen Corporation), and a large number of academic institutions create
knockout mice for third parties using these more traditional 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 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 drugs and biologics. The process of obtaining FDA approval has
historically been costly and time-consuming.
11
The standard process required by the FDA before a pharmaceutical product
may be marketed in the United States includes:
- preclinical tests;
- submission to the FDA of an Investigational New Drug application, or
IND, which must become effective before human clinical trials may
commence;
- adequate and well-controlled human clinical trials to establish the
safety and efficacy of the drug or biologic in our intended
application;
- for drugs, submission of a New Drug Application, or NDA, and, for
biologics, submission of a Biologic License Application, or BLA,
with the FDA; and
- FDA approval of the NDA or BLA prior to any commercial sale or
shipment of the product.
In addition to obtaining FDA approval for each product, each drug or
biologic 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.
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 four to seven 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, one to three years;
if questions arise, approval can take longer.
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.
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.
12
As of March 3, 2003, we employed 579 persons, of whom 123 hold M.D., Ph.D.
or D.V.M. degrees and another 123 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. 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, and in
some cases receive access to our OmniBank database and mice from our OmniBank
library. Most of these 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 AFFILIATION TITLE
- ---- ----------- -----
DISEASE BIOLOGY ADVISORS
Abul K. Abbas, M.D. University of California, San Professor and Chair, Department of Pathology
Francisco
John D. Brunzell, M.D. University of Washington Professor of Medicine, Division of
Metabolism, Endocrinology & Nutrition
Roger D. Cone, Ph.D. Vollum Institute for Advanced Senior Scientist
Biomedical Research
Neal G. Copeland, Ph.D. National Cancer Institute Director, Mouse Cancer Genetics Program
Kenneth H. Gabbay, M.D. Baylor College of Medicine Professor of Pediatrics and Molecular &
Cell Biology, Head, Section of Molecular
Diabetes and Metabolism, Department of
Pediatrics
John M. Harlan, M.D. University of Washington Professor and Head, Division of Hematology
Medicine
Nancy A. Jenkins, Ph.D. National Cancer Institute Senior Investigator, Mouse Cancer Genetics
Program
Jeffrey L. Noebels, M.D., Ph.D. Baylor College of Medicine Professor of Neurology, Neuroscience and
Molecular Genetics
Howard A. 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
Laurence H. Tecott, M.D., Ph.D. University of California, San Associate Professor, Department of
Francisco Psychiatry
MEDICINAL CHEMISTRY ADVISORS
Ronald T. Borchardt, Ph.D. University of Kansas Professor and Chairman, Department of
Pharmaceutical Chemistry
Alan R. Katritsky, Ph.D. University of Florida Professor of Chemistry
David W. C. MacMillan, Ph.D. California Institute of Technology Associate Professor of Chemistry
Nikola Pavletich, Ph.D. Memorial Sloan-Kettering Cancer Head, Structural Biology of Oncogenes and
Center Tumor Suppressors Laboratory, Howard Hughes
Medical Institute Investigator
Chairman, Medical Advisory Board
Alan S. Nies, M.D. Former Senior Vice President, Clinical
Sciences, Merck & Co., Inc.
13
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
$59.7 million for the year ended December 31, 2002. As of December 31, 2002, we
had an accumulated deficit of $149.7 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
LexVision and OmniBank databases, drug discovery alliances, functional genomics
collaborations for the development and, in some cases, analysis of the
physiological effects of genes altered in knockout mice, technology licenses and
compound library sales, and will continue to do so for the foreseeable future.
Our future revenues from database subscriptions, collaborations and alliances
are uncertain because our existing agreements have fixed terms or relate to
specific projects of limited duration. Our future revenues from technology
licenses are uncertain because they depend, in large part, on securing new
agreements. Subject to limited exceptions, we do not intend to continue to make
our compound libraries available for purchase in the future. Our ability to
secure future revenue-generating agreements will depend upon our ability to
address the needs of our potential future subscribers, collaborators and
licensees, and to negotiate agreements that we believe are in our long-term best
interests. We may determine that our interests are better served by retaining
rights to our discoveries and advancing our therapeutic programs to a later
stage, which could limit our near-term revenues.
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 continue to 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 operating results and, in particular, our ability to generate
additional revenues are dependent on many factors, including:
- our ability to establish new database subscriptions, research
collaborations and technology licenses, and the timing of such
arrangements;
- the expiration or other termination of database subscriptions and
research collaborations with our collaborators, which may not be
renewed or replaced;
- the success rate of our discovery efforts leading to opportunities
for new research collaborations and licenses, as well as milestone
payments and royalties;
- the timing and willingness of our collaborators to commercialize
pharmaceutical products that would result in milestone payments and
royalties; and
- general and industry-specific economic conditions, which may affect
our and our collaborators' research and development expenditures.
Because of these and other factors, including the risks and uncertainties
described in this section, our quarterly operating results have fluctuated in
the past and are likely to do so in the future. Due to the likelihood of
14
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, which could result in a
decline in our stock price.
We will 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, alliance,
collaboration and technology license 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. Our capital
requirements will increase substantially to the extent we advance potential
therapeutics into preclinical and clinical development. 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 and revenues we expect
to derive from subscriptions to our databases, drug discovery alliances,
functional genomics collaborations and technology licenses will enable us to
maintain our currently planned operations at least through the next 12 months.
However, we may generate less revenues than we expect, and changes may occur
that would consume available capital resources more rapidly 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.
We are an early-stage company with an unproven business strategy
Our business strategy of using our technology platform and, specifically,
the discovery of the functions of genes using knockout mice to select promising
drug targets and of developing 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 as drug targets,
discover potential therapeutics for drug targets we consider to have
pharmaceutical value, successfully develop such potential therapeutics and
select an appropriate commercialization strategy for each potential therapeutic
we choose to pursue.
Biotechnology and pharmaceutical companies have successfully developed and
commercialized only a limited number of genomics-derived pharmaceutical products
to date. We have not proven our ability to identify genomics-derived
therapeutics or drug targets with commercial potential, or to develop or
commercialize therapeutics or drug targets that we do identify. It is difficult
to successfully select those drug targets with the most potential for commercial
development and to identify potential therapeutics, and we do not know that any
pharmaceutical products based on our drug target discoveries can be successfully
commercialized. In addition, we may experience unforeseen technical
complications in the processes we use to generate gene knockout mice, conduct in
vivo analyses, generate compound libraries, develop screening assays for drug
targets or conduct screening of compounds against those drug targets. These
complications could materially delay or limit the use of those resources,
substantially increase the anticipated cost of generating them or prevent us
from implementing our processes at appropriate quality and throughput levels.
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.
15
We also face competition from other companies in our efforts to discover
the functions of genes. Many of these competitors 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 the
functions of genes. Competitors could discover and establish patents in genes or
gene products that we identify as promising drug targets.
Our ability to use our patent rights to prevent competition in the
creation and use of knockout mice outside of the United States is limited.
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 targeting
and gene trapping technologies may be developed, thereby rendering those
technologies obsolete.
We face significant competition from other companies, as well as from
universities and other not-for-profit institutions, in our drug discovery and
product development efforts. Many of these competitors have substantially
greater financial, scientific and human resources than we do. 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.
We rely heavily on collaborators to develop and commercialize pharmaceutical
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 pharmaceutical 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
pharmaceutical 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 pharmaceutical products.
Some of our agreements provide us with rights to participate in the
commercial development of pharmaceutical products 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 alliance and 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.
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 are also potential competitors
or may 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.
16
We have no experience in developing and commercializing pharmaceutical products
on our own
Our ability to develop and commercialize pharmaceutical 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
pharmaceutical products.
We lack the capability to manufacture compounds for preclinical studies and
clinical trials and will rely on third parties to manufacture our potential
products
We currently do not have the manufacturing capabilities or experience
necessary to produce materials for preclinical studies or clinical trials and
intend to rely on collaborators and third-party contractors to produce such
materials. We will rely on selected manufacturers to deliver materials on a
timely basis and to comply with applicable regulatory requirements, including
the FDA's current Good Manufacturing Practices, or GMP. These manufacturers may
not be able to produce material on a timely basis or manufacture material at the
quality level or in the quantity required to meet our development timelines and
applicable regulatory requirements. If we are unable to contract for production
of sufficient quantity and quality of materials on acceptable terms, our product
development efforts may be delayed.
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 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 93 at December 31, 1998 to
122 at December 31, 1999, 287 at December 31, 2000, 484 at December 31, 2001,
572 at December 31, 2002 and 579 at March 3, 2003. Our ability to manage our
operations and growth effectively requires us to continue to expend funds to
improve our
17
operational, financial and management controls, 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 all of our functional genomics operations are 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, and our
knockout mouse research operations are carried out entirely at the same
facility. While we have developed redundant and emergency backup systems to
protect these resources and the facilities in which they are stored, they may be
insufficient in the event of a severe fire, flood, hurricane, tornado or similar
disaster. If such a disaster significantly damages or destroys the facility in
which these resources are maintained, our business could be disrupted until we
could regenerate the affected resources 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.
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. Our ability to obtain patent
protection based on genes or 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
encoded by such genes, the impact of these guidelines is uncertain and may delay
or negatively affect our patent position. Furthermore, biologic data in addition
to that obtained by our current technologies may be required for issuance of
patents on human therapeutics. If required, obtaining such biologic data could
delay, add substantial 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. 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.
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. 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.
18
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 primarily on the basis of gene sequence information.
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 functions and
pharmaceutical utility that we discover for both new and known genes and
proteins. 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 or patterns of gene expression. 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 may be involved in 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
covering the sequences, functions and uses of genes and the drug targets they
encode. 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.
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.
We believe that there will continue to be significant litigation in our
industry regarding patent and other intellectual property rights. We have 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 future intellectual property 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.
19
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 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 that are
material to our business. We do not own the patents that underlie 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 and
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 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
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 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.
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,
20
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.
The uncertainty of pharmaceutical pricing and reimbursement may decrease the
commercial potential of our products and affect our ability to raise capital
Our ability and the ability of our collaborators to successfully
commercialize pharmaceutical products may depend in part on the extent to which
reimbursement for the cost of such products and related treatment will be
available from government health administration authorities, private health
coverage insurers and other organizations. The pricing, availability of
distribution channels and reimbursement status of newly approved pharmaceutical
products is highly uncertain. As a result, adequate third-party coverage may not
be available for us to maintain price levels sufficient for realization of an
appropriate return on our investment in product discovery and development.
In certain foreign markets, pricing or profitability of healthcare
products is subject to government control. In the U.S., there have been, and we
expect that there will continue to be, a number of federal and state proposals
to implement similar governmental control. In addition, an increasing emphasis
on managed care in the U.S. has and will continue to increase the pressure on
pharmaceutical pricing. While we cannot predict the adoption of any such
legislative or regulatory proposals or the effect such proposals or managed care
efforts may have on our business, the announcement of such proposals or efforts
could harm our ability to raise capital, and the adoption of such proposals or
efforts could harm our results of operations. Further, to the extent that such
proposals or efforts harm other pharmaceutical companies that are our
prospective collaborators, this may reduce our ability to establish corporate
collaborations. In addition, third-party payers are increasingly challenging the
prices charged for medical products and services. We do not know whether
consumers, third-party payers and others will consider any products that we or
our collaborators develop to be cost effective or that reimbursement to the
consumer will be available or will be sufficient to allow us or our
collaborators to sell such products on a competitive basis.
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 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
21
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.
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 knockout mouse technologies. Governmental authorities
could, for ethical, social or other purposes, limit the use of genetic processes
or prohibit the practice of our 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 300,000 square feet of space for our
corporate offices and laboratories in buildings located in The Woodlands, Texas,
a suburb of Houston, Texas, and approximately 118,000 square feet of space for
offices and laboratories near Princeton, New Jersey.
Our facilities in The Woodlands, Texas include two state-of-the art animal
facilities totaling approximately 100,000 square feet. These facilities,
completed in 1999 and 2002, respectively, were custom designed for the
generation and analysis of knockout mice and are accredited by AAALAC
International (Association for Assessment and Accreditation of Laboratory Animal
Care). These facilities enable us to maintain in-house control over our entire
in vivo validation process, from the generation of ES cell clones through the
completion of in vivo analysis, in a specific pathogen free (SPF) environment.
We believe these facilities, which are among the largest and most sophisticated
of their kind in the world, provide us with significant strategic and
operational advantages relative to our competitors.
In October 2000, we entered into a synthetic lease agreement under which
the lessor purchased our existing laboratory and office buildings and animal
facility in The Woodlands, Texas and agreed to fund the construction of an
additional laboratory and office building and a second animal facility. The
synthetic lease agreement was subsequently expanded to include funding for the
construction of a central plant facility. Including the purchase price for our
existing facilities, the synthetic lease, as amended, provides for funding of up
to $55.0 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 the new facilities began upon completion of construction, which occurred at
the end of the first quarter of 2002. Lease payments are subject to fluctuation
based on LIBOR rates. Based on a year-end LIBOR rate of 1.4%, our total lease
payments for our existing facilities and the new facilities would be
approximately $0.9 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 equal to the $55.0 million funded under the synthetic
lease for property and improvements plus the amount of any accrued but unpaid
lease payments. If we elect not to renew the lease or purchase the properties,
we may arrange for the sale of the properties to a third party or surrender the
properties to the lessor. If we
22
elect to arrange for the sale of the properties or surrender the properties to
the lessor, we have guaranteed approximately 86% of the total original cost as
the residual fair value of the properties.
In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc.
entered into a ten-year lease for a 76,000 square-foot facility in Hopewell, New
Jersey. The lease provides for an escalating yearly rent payment of $1.3 million
in the first year, $1.7 million in years two and three, $1.8 million in years
four to six, $2.0 million in years seven to nine and $2.1 million in year ten.
The lease also provides our subsidiary with the option in the second year of the
lease to borrow $2.0 million in tenant improvement funds from the landlord, at
which time rental payments due under the lease will increase as the tenant
improvement allowance is amortized over a ten-year period. We are the guarantor
of the obligations of our subsidiary under the lease. We also lease space in
East Windsor, New Jersey under an agreement that expires in January 2004. Our
aggregate rent expense under the New Jersey leases is approximately $2.5 million
per year.
We believe that our facilities are well-maintained, in good operating
condition and acceptable for our current operations.
ITEM 3. LEGAL PROCEEDINGS
We are not presently a party to any material legal proceedings.
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, 2002.
23
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
--------- --------
2001
First Quarter................................................................... $ 15.00 $ 6.56
Second Quarter.................................................................. $ 12.50 $ 5.69
Third Quarter................................................................... $ 12.75 $ 5.87
Fourth Quarter.................................................................. $ 11.90 $ 7.25
2002
First Quarter................................................................... $ 12.04 $ 7.98
Second Quarter.................................................................. $ 9.00 $ 4.12
Third Quarter................................................................... $ 6.18 $ 3.51
Fourth Quarter.................................................................. $ 5.25 $ 3.35
As of March 10, 2003, there were approximately 253 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.
24
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data for the year ended December 31, 2002 and
the balance sheet data as of December 31, 2002 have been derived from our
audited financial statements included elsewhere in this annual report on Form
10-K that have been audited by Ernst & Young LLP, independent auditors. The
statements of operations data for each of the years ended December 31, 2001 and
2000, and the balance sheet data as of December 31, 2001, 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 who have ceased operations. The statements of operations data for
the years ended December 31, 1999 and 1998, and the balance sheet data as of
December 31, 2000, 1999 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,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- -------- --------
STATEMENTS OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues .................................................. $ 35,200 $ 30,577 $ 14,459 $ 4,738 $ 2,242
Operating expenses:
Research and development, including stock-based
compensation of $5,155 in 2002, $5,539 in 2001
and $10,883 in 2000 .................................. 74,859 53,355 31,647 14,646 8,410
General and administrative, including stock-based
compensation of $5,113 in 2002, $5,231 in 2001
and $9,958 in 2000 ................................... 23,234 20,861 18,289 2,913 2,024
--------- --------- --------- -------- --------
Total operating expenses .................................. 98,093 74,216 49,936 17,559 10,434
--------- --------- --------- -------- --------
Loss from operations ...................................... (62,893) (43,639) (35,477) (12,821) (8,192)
Interest and other income, net ............................ 3,223 8,467 9,483 346 711
--------- --------- --------- -------- --------
Net loss .................................................. (59,670) (35,172) (25,994) (12,475) (7,481)
Accretion on redeemable convertible preferred stock ....... -- -- (134) (536) (357)
--------- --------- --------- -------- --------
Net loss attributable to common stockholders .............. $ (59,670) $ (35,172) $ (26,128) $(13,011) $ (7,838)
========= ========= ========= ======== ========
Net loss per common share, basic and diluted .............. $ (1.14) $ (0.70) $ (0.63) $ (0.53) $ (0.32)
========= ========= ========= ======== ========
Shares used in computing net loss per common share,
basic and diluted ...................................... 52,263 50,213 41,618 24,530 24,445
AS OF DECEMBER 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- -------- --------
BALANCE SHEET DATA: (IN THOUSANDS)
Cash, cash equivalents and investments, including
restricted cash and investments of $57,710 in 2002
$43,338 in 2001 and $13,879 in 2000 ..................... $ 123,096 $ 166,840 $ 202,680 $ 9,156 $ 19,422
Working capital ........................................... 111,833 147,663 194,801 2,021 18,102
Total assets .............................................. 201,772 239,990 220,693 22,295 28,516
Long-term debt, net of current portion .................... 4,000 -- 1,834 3,577 5,024
Redeemable convertible preferred stock .................... -- -- -- 30,050 29,515
Accumulated deficit ....................................... (149,745) (90,075) (54,903) (28,909) (16,434)
Stockholders' equity (deficit) ............................ 169,902 218,372 207,628 (21,937) (9,035)
25
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 a biopharmaceutical company focused on the discovery of
breakthrough treatments for human disease. We are using gene knockout technology
to systematically discover the physiological functions of genes in living
mammals, or in vivo. 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
and validate which genes, when knocked out, result in a favorable medical
profile with pharmaceutical utility. We then pursue those genes and the proteins
they encode as potential targets for therapeutic intervention in our drug
discovery programs.
We employ internal resources and drug discovery alliances to discover
potential small molecule drugs, therapeutic antibodies and therapeutic proteins
for in vivo-validated drug targets that we consider to have high pharmaceutical
value. We use our own sophisticated libraries of drug-like chemical compounds
and an industrialized medicinal chemistry platform to identify small molecule
drug candidates for our in vivo-validated drug targets. We have established
alliances with Genentech, Inc. for the discovery of therapeutic proteins and
antibody targets; with Abgenix, Inc. for the discovery and development of
therapeutic antibodies based on our drug target discoveries; and with Incyte
Genomics, Inc. for the discovery and development of therapeutic proteins. In
addition, we have established collaborations and license agreements with many
other leading pharmaceutical and biotechnology companies under which we receive
fees and, in many cases, are eligible to receive milestone and royalty payments,
for access to some of our technologies and discoveries for use in their own drug
discovery efforts.
We derive substantially all of our revenues from subscriptions to our
databases, drug discovery alliances, functional genomics collaborations for the
development and, in some cases, analysis of the physiological effects of genes
altered in knockout mice, technology licenses and compound library sales. To
date, we have generated a substantial portion of our revenues from a limited
number of sources.
Our operating results and, in particular, our ability to generate
additional revenues are dependent on many factors, including our success in
establishing research collaborations, technology licenses and new database
subscriptions, expirations of our research collaborations and database
subscriptions, the success rate of our discovery efforts leading to
opportunities for new research collaborations and licenses, as well as milestone
payments 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. Our future revenues from database subscriptions, collaborations
and alliances are uncertain because our existing agreements have fixed terms or
relate to specific projects of limited duration. Our future revenues from
technology licenses are uncertain because they depend, in large part, on
securing new agreements. Subject to limited exceptions, we do not intend to
continue to make our compound libraries available for purchase in the future.
Our ability to secure future revenue-generating agreements will depend upon our
ability to address the needs of our potential future subscribers, collaborators
and licensees, and to negotiate agreements that we believe are in our long-term
best interests. We may determine that our interests are better served by
retaining rights to our discoveries and advancing our therapeutic programs to a
later stage, which could limit our near-term revenues. Because of these and
other factors, our quarterly operating results have fluctuated in the past and
are likely to do so in the future, and we do not believe that quarter-to-quarter
comparisons of our operating results are a good indication of our future
performance.
Since our inception, we have incurred significant losses and, as of
December 31, 2002, we had an accumulated deficit of $149.7 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,
26
material costs, facility costs, depreciation on property and equipment, legal
expenses resulting from intellectual property prosecution and other expenses
related to our drug discovery and LexVision programs, the development and
analysis of knockout mice and our other functional genomics research efforts,
and the development of compound libraries. 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., which was
settled in September 2001. In connection with the expansion of our drug
discovery programs 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.
As of December 31, 2002, we had net operating loss carryforwards of
approximately $114.0 million. We also had research and development tax credit
carryforwards of approximately $7.1 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 Revenue
Code of 1986 and similar state provisions. The annual limitation may result in
the expiration of net operating losses and credits before utilization.
CRITICAL ACCOUNTING POLICIES
Revenue Recognition
We recognize revenues when persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, the price is fixed and
determinable, and collectibility is reasonably assured. Payments received in
advance under these arrangements are recorded as deferred revenue until earned.
Fees for access to our databases and other functional genomics resources
are recognized ratably over the subscription or access period. Collaborative
research payments are recognized as revenue as we perform our obligations
related to such research to the extent such fees are non-refundable.
Milestone-based fees are recognized upon completion of specified milestones
according to contract terms. Non-refundable technology license fees are
recognized as revenue upon the grant of the license when performance is complete
and there is no continuing involvement.
Revenues recognized from multiple element contracts are allocated to each
element of the arrangement based on the relative fair value of the elements. The
determination of fair value of each element is based on objective evidence. When
revenues for an element are specifically tied to a separate earnings process,
revenue is recognized when the specific performance obligation associated with
the element is completed. When revenues for an element are not specifically tied
to a separate earnings process, they are recognized ratably over the term of the
agreement.
A change in our revenue recognition policy or changes in the terms of
contracts under which we recognize revenues could have an impact on the amount
and timing of our recognition of revenues.
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. 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
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 as research and development expense or general and
administrative expense, as appropriate, over the vesting period of the
individual stock options for which it was recorded, generally four years.
27
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 of $10.2 million during 2003 and $0.9 million during
2004. The amount of stock-based compensation expense to be recorded in future
periods may decrease if unvested stock options for which deferred stock-based
compensation has been recorded are subsequently canceled or forfeited or may
increase if additional stock options are granted to individuals other than
employees or directors.
Goodwill Impairment
Goodwill is not amortized, but is tested at least annually for impairment
at the reporting unit level. Impairment is the condition that exists when the
carrying amount of goodwill exceeds its implied fair value. The first step in
the impairment process is to determine the fair value of the reporting unit and
then compare it to the carrying value, including goodwill. If the fair value
exceeds the carrying value, no further action is required and no impairment loss
is recognized. Additional impairment assessments may be performed on an interim
basis if we encounter events or changes in circumstances that would indicate
that, more likely than not, the carrying value of goodwill has been impaired.
There was no impairment of goodwill in 2002.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board, or FASB issued
Interpretation, or FIN, No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 elaborates on the existing disclosure requirements for most
guarantees, including residual value guarantees issued in conjunction with
operating lease agreements. It also clarifies that at the time a company issues
a guarantee, the company must recognize an initial liability for the fair value
of the obligation it assumes under that guarantee and must disclose that
information in its interim and annual financial statements. The initial
recognition and measurement provisions apply on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002. Our adoption of FIN 45 will not have a material
impact on our results of operations and financial position.
In November 2002, the Emerging Issues Task Force, or EITF, reached a
consensus on EITF Issue No. 00-21, "Accounting for Revenue Arrangements with
Multiple Deliverables." This consensus requires that revenue arrangements with
multiple deliverables be divided into separate units of accounting if the
delivered items have value to the customer on a standalone basis, there is
objective and reliable evidence of fair value of the undelivered items and, if
the arrangement includes a general right of return, performance of the
undelivered item is considered probable and substantially in our control. The
final consensus will be applicable to agreements entered into in fiscal periods
beginning after June 15, 2003, with early adoption permitted.
In December 2002, the FASB issued Statement of Financial Accounting
Standards, or SFAS, No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure." This statement amends SFAS 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this statement amends the disclosure
requirements of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
accounting for employee compensation and the effect of the method used on
reported results. The Company is currently evaluating whether to adopt the fair
value based method.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." FIN 46 requires that unconsolidated variable interest
entities be consolidated by their primary beneficiaries. A primary beneficiary
is the party that absorbs a majority of the entity's expected losses or residual
benefits. FIN 46 applies immediately to variable interest entities created after
January 31, 2003 and to existing variable interest entities in the periods
beginning after June 15, 2003. We are evaluating whether the adoption of FIN 46
will require us to consolidate the lessor under our synthetic lease. If such
consolidation is required, our balance sheet will reflect as assets additional
property and equipment approximating the $55.0 million funded under the
synthetic lease for property and improvements, less accumulated depreciation,
and a similar amount as a liability. In addition, we will be required to
depreciate such improvements over their useful lives. We may, however, elect to
restructure or replace the synthetic lease prior to the adoption of FIN 46,
whether or not such consolidation would be required. We believe that the
28
consolidation of the lessor, if required, will not have a material adverse
effect on our financial condition or results of operations.
RESULTS OF OPERATIONS
Years Ended December 31, 2002 and 2001
Revenues. Total revenues increased 15% to $35.2 million in 2002 from $30.6
million in 2001. The increase of $4.6 million was primarily attributable to a
$5.9 million increase in revenues from functional genomics collaborations and
our drug discovery alliance with Incyte and a $3.1 million increase in revenues
from database subscription and technology license fees, offset in part by a $4.4
million decrease in compound libraries and other revenue. We did not make our
compound libraries available for purchase in 2002 and, subject to limited
exceptions, do not intend to make our compound libraries available for purchase
in the future.
In 2002, Incyte, Bristol-Myers Squibb Company and Millennium
Pharmaceuticals, Inc. represented 28%, 14% and 11% of revenues, respectively. In
2001, Incyte, Bristol-Myers Squibb and Merck & Co., Inc. represented 16%, 13%
and 12% of revenues, respectively.
Research and Development Expenses. Research and development expenses
increased 40% to $74.9 million in 2002 from $53.4 million in 2001. The increase
of $21.5 million was primarily attributable to increased personnel and facility
costs to support the expansion of our drug discovery programs, including a full
year of medicinal chemistry operations, the development and analysis of knockout
mice and our other functional genomics research efforts. Research and
development expenses for 2002 and 2001 included $5.2 million and $5.5 million,
respectively, of stock-based compensation primarily relating to option grants
made prior to our April 2000 initial public offering.
General and Administrative Expenses. General and administrative expenses
increased 11% to $23.2 million in 2002 from $20.9 million in 2001. The increase
of $2.3 million was due primarily to additional personnel costs offset by a
reduction in legal costs as a result of the September 2001 settlement of our
patent infringement litigation against Deltagen, Inc. General and administrative
expenses for 2002 and 2001 included $5.1 million and $5.2 million, respectively,
of stock-based compensation primarily relating to option grants made prior to
our April 2000 initial public offering.
Interest and Other Income. Interest and other income decreased 63% to $3.2
million in 2002 from $8.8 million in 2001. This decrease resulted from lower
cash and investment balances and lower average interest rates during 2002.
Net Loss and Net Loss Per Common Share. Net loss attributable to common
shareholders increased to $59.7 million in 2002 from $35.2 million in 2001. Net
loss per common share increased to $1.14 in 2002 from $0.70 in 2001. Excluding
stock-based compensation expense of $10.3 million and $10.8 million in 2002 and
2001, respectively, we would have had a net loss of $49.4 million and net loss
per common share of $0.95 in 2002, as compared to a net loss of $24.4 million
and net loss per common share of $0.49 in 2001.
Years Ended December 31, 2001 and 2000
Revenues. Total revenues increased 111% to $30.6 million in 2001 from
$14.5 million in 2000. The increase of $16.1 million was primarily attributable
to a $10.2 million increase in revenues from database subscription and
technology license fees, a $1.7 million increase in revenues from functional
genomics collaborations and our drug discovery alliance with Incyte and revenues
of $4.5 million from compound library sales, offset in part by a $0.3 million
decrease in other revenue.
In 2001, Incyte, Bristol-Myers Squibb and Merck represented 16%, 13% and
12% of revenues, respectively. In 2000, the Merck Genome Research Institute and
Millennium represented 35% and 14% of revenues, respectively.
29
Research and Development Expenses. Research and development expenses
increased 69% to $53.4 million in 2001 from $31.6 million in 2000. The increase
of $21.8 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 programs, the development and
analysis of knockout mice and our other functional genomics research efforts,
offset in part by lower stock-based compensation in 2001. Research and
development expenses for 2001 and 2000 included $5.5 million and $10.9 million,
respectively, of stock-based compensation primarily relating to option grants
made prior to our April 2000 initial public offering.
General and Administrative Expenses. General and administrative expenses
increased 14% to $20.9 million in 2001 from $18.3 million in 2000. The increase
of $2.6 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, offset in part by lower
stock-based compensation in 2001. General and administrative expenses for 2001
and 2000 included $5.2 million and $10.0 million, respectively, of stock-based
compensation primarily relating to option grants made prior to our April 2000
initial public offering.
Interest and Other Income. Interest income decreased 11% to $8.8 million
in 2001 from $9.9 million in 2000. This decrease resulted from lower cash and
investment balances and lower average interest rates on our investments.
Net Loss and Net Loss Per Common Share. Net loss attributable to common
stockholders increased to $35.2 million in 2001 from $26.1 million in 2000. Net
loss per common share increased to $0.70 in 2001 from $0.63 in 2000. Excluding
stock-based compensation expense of $10.8 million and $20.8 million in 2001 and
2000, respectively, 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 $24.4 million and net loss per common
share of $0.49 in 2001, as compared to a net loss of $5.2 million and net loss
per common share of $0.11 in 2000.
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, collaboration and license agreements, equipment financing
arrangements and leasing arrangements. From our inception through December 31,
2002, we had received net proceeds of $242.7 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, 2002, we received $101.7 million in cash payments
from database subscription and technology license fees, drug discovery
alliances, functional genomics collaborations, sales of compound libraries and
reagents and government grants, of which $88.5 million had been recognized as
revenues through December 31, 2002.
As of December 31, 2002, we had $123.1 million in cash, cash equivalents
and short-term and long-term investments (including $57.7 million of restricted
cash and investments), as compared to $166.8 million (including $43.3 million of
restricted cash and investments) as of December 31, 2001. We used cash of $28.8
million in operations in 2002. This consisted primarily of the net loss for the
year of $59.7 million offset by non-cash charges of $10.3 million related to
stock-based compensation expense, $9.1 million related to depreciation expense
and $1.2 million related to amortization of intangible assets other than
goodwill; a $5.6 million increase in deferred revenue; and changes in other
operating assets and liabilities of $4.5 million. Investing activities provided
cash of $47.2 million in 2002, principally as a result of net maturities of
short-term investments and the sale of long-term investments, offset by an
increase in restricted cash and purchases of property and equipment. We received
cash of $4.6 million in financing activities in 2002, consisting principally of
proceeds from a $4.0 million loan and stock option exercises.
In October 2000, we entered into a synthetic lease agreement under which
the lessor purchased our existing laboratory and office buildings and animal
facility in The Woodlands, Texas and agreed to fund the construction of an
additional laboratory and office building and a second animal facility. The
synthetic lease agreement was subsequently expanded to include funding for the
construction of a central plant facility for the distribution of utilities and
related services among our facilities. Including the purchase price for our
existing facilities, the
30
synthetic lease, as amended, provided for funding of up to $55.0 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 the new
facilities began upon completion of construction, which occurred at the end of
the first quarter of 2002. Lease payments are subject to fluctuation based on
LIBOR rates. Based on a year-end LIBOR rate of 1.4%, our total lease payments
would be approximately $0.9 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 equal to the $55.0 million funded under
the synthetic lease for property and improvements plus the amount of any accrued
but unpaid lease payments. If we elect not to renew the lease or purchase the
properties, we may arrange for the sale of the properties to a third party or
surrender the properties to the lessor. If we elect to arrange for the sale of
the properties or surrender the properties to the lessor, we have guaranteed
approximately 86% of the total original cost as the residual fair value of the
properties. We are required to maintain restricted cash or investments to
collateralize borrowings made under the synthetic lease agreement. In addition,
we have agreed to maintain cash and investments of at least $12.0 million in
excess of our restricted cash and investments. If our cash and investments fall
below that level, we may be required to seek a waiver of that agreement or to
purchase the properties or arrange for their sale to a third party. Because our
cost to purchase the properties would not materially exceed the $55.0 million
funded under the synthetic lease for property and improvements and would likely
be less than the amount of restricted cash and investments we are required to
maintain under the synthetic lease, we believe that any requirement that we do
so would not have a material adverse effect on our financial condition. As of
December 31, 2002 and 2001, we maintained restricted cash and investments of
$57.2 million and $43.3 million, respectively, to collateralize funding for
property and improvements under the synthetic lease of $55.0 million and $41.7
million.
In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc.
entered into a ten-year lease for a 76,000 square-foot facility in Hopewell, New
Jersey. The lease provides for an escalating yearly rent payment of $1.3 million
in the first year, $1.7 million in years two and three, $1.8 million in years
four to six, $2.0 million in years seven to nine and $2.1 million in year ten.
The lease also provides our subsidiary with the option in the second year of the
lease to borrow $2.0 million in tenant improvement funds from the landlord, at
which time rental payments due under the lease will increase as the tenant
improvement allowance is amortized over a ten-year period. We are the guarantor
of the obligations of our subsidiary under the lease.
In December 2002, we borrowed $4.0 million under a note agreement with
Genentech. The proceeds of the loan are to be used to fund research efforts
under our alliance with Genentech for the discovery of therapeutic proteins and
antibody targets. The note matures on or before December 31, 2005, but we may
prepay it at any time. We may repay the note, at our option, in cash, in shares
of our common stock valued at the then-current market value, or in a combination
of cash and shares, subject to certain limitations. The note accrues interest at
an annual rate of 8%, compounded quarterly.
Including the lease and debt obligations described above, we had incurred
the following contractual obligations as of December 31, 2002:
PAYMENTS DUE BY PERIOD (IN MILLIONS)
-------------------------------------------------
LESS MORE
THAN 1 1-3 3-5 THAN 5
CONTRACTUAL OBLIGATIONS TOTAL YEAR YEARS YEARS YEARS
----- ---- ----- ----- -----
Long-term debt .............................................. $ 4.0 -- $ 4.0 -- --
Capital lease obligations ................................... -- -- -- -- --
Operating leases ............................................ 22.7 3.5 5.6 4.7 8.9
Other long-term liabilities reflected on our
balance sheet under GAAP ................................ 0.7 -- -- 0.3 0.4
----- ----- ----- ----- -----
Total ................................................... $27.4 $ 3.5 $ 9.6 $ 5.0 $ 9.3
===== ===== ===== ===== =====
Our future capital requirements will be substantial and will depend on
many factors, including our ability to obtain database subscription, alliance,
collaboration and technology license 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. 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 expect to devote substantial capital resources
to continue our research and development efforts, to expand our support and
product development
31
activities, and for other general corporate activities. We believe that our
current unrestricted cash and investment balances and revenues we expect to
derive from subscriptions to our databases, functional genomics collaborations,
technology licenses and drug discovery alliances will be sufficient to fund our
operations at least through the next 12 months. During or after this period, if
cash generated by operations is insufficient to satisfy our liquidity
requirements, we will need to sell additional equity or debt securities,
restructure or replace our synthetic lease to reduce the required amount of
restricted cash and investments, 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.
DISCLOSURE ABOUT MARKET RISK
We are exposed to limited market and credit risk on our cash equivalents
which have maturities of three months or less. We maintain a short-term
investment portfolio which consists of U.S. government agency debt obligations,
investment grade commercial paper, corporate debt securities and certificates of
deposit that mature three to twelve months from the time of purchase, which we
believe are subject to limited market and credit risk. We currently do not hedge
interest rate exposure or hold any derivative financial instruments in our
investment portfolio.
We have operated primarily in the United States and substantially 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
15 in Part IV of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On March 26, 2002, the Board of Directors and its audit committee
dismissed Arthur Andersen LLP as our independent public accountants and engaged
Ernst & Young LLP to serve as our independent auditors for the fiscal year
ending December 31, 2002, subject to stockholder ratification.
Arthur Andersen's report on our consolidated financial statements for the
fiscal year ended December 31, 2001 did not contain an adverse opinion or
disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit
scope or accounting principles.
During the fiscal year ended December 31, 2001 and through the date of the
Board of Directors' decision, there were no disagreements with Arthur Andersen
on any matter of accounting principle or practice, financial statement
disclosure, or auditing scope or procedure which, if not resolved to Arthur
Andersen's satisfaction, would have caused them to make reference to the subject
matter in connection with their report on our consolidated financial statements
for such year; and there were no reportable events as defined in Item
304(a)(1)(v) of Regulation S-K.
During the fiscal year ended December 31, 2001 and through the date of the
Board of Directors' decision, we did not consult Ernst & Young with respect to
the application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
our consolidated financial statements, or any other matters or reportable events
as set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K.
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item as to our directors and executive
officers is hereby incorporated by reference from the information appearing
under the captions "Election of Directors" and "Executive Officers" in our
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 our fiscal year on December
31, 2002.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item as to our management is hereby
incorporated by reference from the information appearing under the captions
"Executive Compensation" and "Election of Director - Director Compensation" in
our 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 our fiscal year on December 31, 2002.
Notwithstanding the foregoing, in accordance with the instructions to Item 402
of Regulation S-K, the information contained in our 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 AND
RELATED STOCKHOLDER MATTERS
The information required by this Item as to the ownership by management
and others of our securities is hereby incorporated by reference from the
information appearing under the caption "Stock Ownership of Certain Beneficial
Owners and Management" in our 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 our fiscal year on
December 31, 2002.
EQUITY COMPENSATION PLAN INFORMATION
The following table presents aggregate summary information as of December
31, 2002 regarding the common stock that may be issued upon exercise of options,
warrants and rights under all of our existing equity compensation plans,
including our 2000 Equity Incentive Plan, 2000 Non-Employee Directors' Stock
Option Plan and Coelacanth Corporation 1999 Stock Option Plan.
(a) (b) (c)
WEIGHTED
AVERAGE
EXERCISE PRICE NUMBER OF SECURITIES
NUMBER OF SECURITIES PER SHARE OF REMAINING AVAILABLE FOR
TO BE ISSUED UPON OUTSTANDING FUTURE ISSUANCE UNDER EQUITY
EXERCISE OF OPTIONS, COMPENSATION PLANS (EXCLUDING
OUTSTANDING OPTIONS, WARRANTS AND SECURITIES REFLECTED IN
PLAN CATEGORY WARRANTS AND RIGHTS RIGHTS COLUMN (a))
- ------------------------------- ------------------------ --------------- -----------------------------
Equity compensation plans
approved by security
holders (1) ................. 11,282,188 $6.5006 2,124,606 (3)(4)(5)
Equity compensation plans
not approved by security
holders (2) ................. 89,979 2.6807 --
---------- ------- ---------
Total..................... 11,372,167 $6.4704 2,124,606
- ----------
(1) Consists of shares of our common stock issued or remaining available for
issuance under our 2000 Equity Incentive Plan and 2000 Non-Employee
Directors' Stock Option Plan.
(2) Consists of shares of our common stock issuable upon the exercise of
options granted under the Coelacanth Corporation 1999 Stock Option Plan,
which we assumed in connection with our July 2001 acquisition of
Coelacanth Corporation.
(3) Includes 1,605,106 shares available for future issuance under our 2000
Equity Incentive Plan, some or all of which may be awarded as stock
bonuses.
33
(4) Our 2000 Equity Incentive Plan provides that on each January 1, the number
of shares available for issuance under the plan will be automatically
increased by the greater of (i) five percent of our outstanding shares on
a fully-diluted basis or (ii) the number of shares that could be issued
under awards granted under the plan during the prior year. Our Board of
Directors may provide for a lesser increase in the number of shares
available for issuance under the plan.
(5) Our 2000 Non-Employee Directors' Stock Option Plan provides that on the
day following each annual meeting of stockholders, the number of shares
available for issuance under the plan will be automatically increased by
the greater of (i) 0.3% of our outstanding shares on a fully-diluted basis
or (ii) the number of shares that could be issued under options granted
under the plan during the prior year. Our Board of Directors may provide
for a lesser increase in the number of shares available for issuance under
the plan.
Coelacanth Corporation 1999 Stock Option Plan
We assumed the Coelacanth Corporation 1999 Stock Option Plan and the
outstanding stock options under the plan in connection with our July 2001
acquisition of Coelacanth. We will not grant any further options under the plan.
As outstanding options under the plan expire or terminate, the number of shares
authorized for issuance under the plan will be correspondingly reduced.
The purpose of the plan was to provide an opportunity for employees,
directors and consultants of Coelacanth to acquire a proprietary interest, or
otherwise increase their proprietary interest, in Coelacanth as an incentive to
continue their employment or service. Both incentive and nonstatutory options
are outstanding under the plan. Most outstanding options vest over time and
expire ten years from the date of grant. The exercise price of options awarded
under the plan was determined by the plan administrator at the time of grant. In
general, incentive stock options have an exercise price of 100% or more of the
fair market value of Coelacanth common stock on the date of grant and
nonstatutory stock options have an exercise price as low as 85% of fair market
value on the date of grant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item as to certain business relationships
and transactions with our management and other related parties is hereby
incorporated by reference to such information appearing under the captions
"Certain Transactions" and "Compensation Committee Interlocks and Insider
Participation" in our 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 our fiscal year on December
31, 2002.
ITEM 14. CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer have concluded
that our disclosure controls and procedures (as defined in Securities Exchange
Act of 1934 Rules 13a-14(c) and 15d-14(c)) are sufficiently effective to ensure
that the information required to be disclosed by us in the reports we file under
the Securities Exchange Act of 1934 is gathered, analyzed and disclosed with
adequate timeliness, accuracy and completeness, based on an evaluation of such
controls and procedures conducted within 90 days prior to the date hereof.
Subsequent to our evaluation, there were no significant changes in
internal controls or other factors that could significantly affect internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
34
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report:
1. Consolidated Financial Statements
PAGE
----
Report of Independent Auditors...................................................... F-1
Report of Independent Public Accountants............................................ F-2
Consolidated Balance Sheets......................................................... F-3
Consolidated Statements of Operations............................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)........................... F-5
Consolidated Statements of Cash Flows............................................... F-6
Notes to Consolidated Financial Statements.......................................... F-7
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 -- Employment Agreement with Alan Main, Ph.D. (filed as
Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 2001 and
incorporated by reference herein).
35
EXHIBIT NO. DESCRIPTION
----------- -----------
10.8 -- Employment Agreement with David Boulton (filed as
Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 2001 and
incorporated by reference herein).
10.9 -- 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).
10.10 -- 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).
10.11 -- 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).
10.12 -- Coelacanth Corporation 1999 Stock Option Plan (filed
as Exhibit 99.1 to the Company's Registration
Statement on Form S-8 (Registration No. 333-66380) and
incorporated by reference herein).
+10.13 -- LexVision Database and Collaboration Agreement, dated
September 26, 2000, with Bristol-Myers Squibb Company
(filed as Exhibit 10.1 to the Company's Current Report
on Form 8-K dated September 26, 2000 and incorporated
by reference herein).
+10.14 -- LexVision Database and Collaboration Agreement, dated
June 27, 2001, with Incyte Genomics, Inc. (filed as
Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the period ended June 30, 2001 and
incorporated by reference herein).
+10.15 -- Therapeutic Protein Alliance Agreement, dated June 27,
2001, with Incyte Genomics, Inc. (filed as Exhibit
10.3 to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 2001 and incorporated by
reference herein).
*+10.16 -- Collaboration and License Agreement, dated December
17, 2002, with Genentech, Inc.
10.17 -- Synthetic Lease Financing Facility with First Security
Bank, National Association, the Lenders and Holders
named therein, and Bank of America, N.A. (filed as
Exhibit 10.12 to the Company's Annual Report on Form
10-K for the year ended December 31, 2000 and
incorporated by reference herein).
10.18 -- Lease Agreement, dated October 21, 1998, between
Coelacanth Chemical Corporation and ARE-279 Princeton
Road, LLC. (filed as Exhibit 10.18 to the Company's
Annual Report on Form 10-K for the year ended December
31, 2001 and incorporated by reference herein).
10.19 -- Lease Agreement, dated May 23, 2002, between Lexicon
Pharmaceuticals (New Jersey), Inc. and Townsend
Property Trust Limited Partnership (filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 2002 and incorporated by
reference herein).
21.1 -- Subsidiaries (filed as Exhibit 21.1 to the Company's
Annual Report on Form 10-K for the year ended December
31, 2001 and incorporated by reference herein).
*23.1 -- Consent of Ernst & Young LLP
*23.2 -- Information regarding consent of Arthur Andersen LLP
*24.1 -- Power of Attorney (contained in signature page)
36
EXHIBIT NO. DESCRIPTION
----------- -----------
99.1 -- Letter to the Securities and Exchange Commission
regarding Audit Assurances (filed as Exhibit 99.1 to
the Company's Annual Report on Form 10-K for the year
ended December 31, 2001 and incorporated by reference
herein).
*99.2 -- Certification of CEO and CFO Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
----------
* 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:
None.
37
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 17, 2003 By: /s/ ARTHUR T. SANDS
---------------------------------------
Arthur T. Sands, M.D., Ph.D.
President and Chief Executive Officer
Date: March 17, 2003 By: /s/ JULIA P. GREGORY
---------------------------------------
Julia P. Gregory
Executive Vice President and
Chief Financial Officer
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 or her
attorney-in-fact, to sign any amendments to this Form 10-K, 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 or her 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 17, 2003
- ------------------------------ (Principal Executive Officer)
Arthur T. Sands, M.D., Ph.D.
/S/ JULIA P. GREGORY Executive Vice President and March 17, 2003
- ------------------------------ Chief Financial Officer
Julia P. Gregory (Principal Financial and Accounting Officer)
/S/ C. THOMAS CASKEY
- ------------------------------
C. Thomas Caskey, M.D. Chairman of the Board of Directors March 17, 2003
/S/ SAM L. BARKER
- ------------------------------
Sam L. Barker, Ph.D. Director March 17, 2003
/S/ PATRICIA M. CLOHERTY
- ------------------------------
Patricia M. Cloherty Director March 17, 2003
/S/ ROBERT J. LEFKOWITZ
- ------------------------------
Robert J. Lefkowitz, M.D. Director March 17, 2003
/S/ WILLIAM A. MCMINN
- ------------------------------
William A. McMinn Director March 17, 2003
38
CERTIFICATIONS
I, Arthur T. Sands, certify that:
1. I have reviewed this annual report on Form 10-K of Lexicon Genetics
Incorporated;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Securities Exchange Act of 1934 Rules 13a-14 and 15d-14)
for the registrant and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls.
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 17, 2003
/s/ ARTHUR T. SANDS
-------------------------------------
Arthur T. Sands, M.D., Ph.D.
President and Chief Executive Officer
39
I, Julia P. Gregory, certify that:
1. I have reviewed this annual report on Form 10-K of Lexicon Genetics
Incorporated;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in the Securities Exchange Act of 1934 Rules 13a-14 and
15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls.
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 17, 2003
/s/ JULIA P. GREGORY
--------------------------------
Julia P. Gregory
Executive Vice President and
Chief Financial Officer
40
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Lexicon Genetics Incorporated:
We have audited the accompanying consolidated balance sheet of Lexicon Genetics
Incorporated and subsidiary (the Company) as of December 31, 2002, and the
related consolidated statement of operations, stockholders' equity (deficit) and
cash flow for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit. The financial
statements of the Company as of December 31, 2001 and 2000, and for the years
then ended were audited by other auditors who have ceased operations and whose
report dated February 22, 2002 expressed an unqualified opinion on those
statements before the reclassification adjustments and conforming disclosures
described in Note 4.
We conducted our audit 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 audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Lexicon Genetics
Incorporated as of December 31, 2002, and the consolidated results of its
operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.
As discussed above, the financial statements of the Company as of December 31,
2001 and 2000, and for the years then ended were audited by other auditors who
have ceased operations. As described in Note 4, these financial statements have
been revised. We audited the reclassification adjustments and conforming
disclosures described in Note 4 that were applied to revise the 2001 and 2000
financial statements. In our opinion, such reclassification adjustments and
conforming disclosures are appropriate and have been properly applied. However,
we were not engaged to audit, review or apply any procedures to the 2001 and
2000 financial statements of the Company other than with respect to such
reclassification adjustments and conforming disclosures and, accordingly, we do
not express an opinion or any other form of assurance on the 2001 and 2000
financial statements taken as a whole.
/s/ ERNST & YOUNG LLP
Houston, Texas
February 13, 2003
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Lexicon Genetics Incorporated:
We have audited the accompanying consolidated balance sheets of Lexicon Genetics
Incorporated (a Delaware corporation) and subsidiary as of December 31, 2001 and
2000, and the related consolidated statements of operations, stockholders'
equity (deficit) and cash flows for each of the three years in the period ended
December 31, 2001. These financial statements are the responsibility of Lexicon
Genetics Incorporated'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
and subsidiary as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
ARTHUR ANDERSEN LLP
Houston, Texas
February 22, 2002
THIS IS A COPY OF THE REPORT ISSUED BY ARTHUR ANDERSEN LLP, LEXICON'S FORMER
INDEPENDENT PUBLIC ACCOUNTANTS, IN CONNECTION WITH THE COMPANY'S ANNUAL REPORT
ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001. THIS REPORT HAS NOT BEEN
REISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH LEXICON'S ANNUAL REPORT ON
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002. SEE EXHIBIT 23.2 FOR FURTHER
INFORMATION.
F-2
LEXICON GENETICS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
AS OF DECEMBER 31,
------------------------------
2002 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ............................................................ $ 39,362 $ 16,355
Restricted cash ...................................................................... 29,487 6,693
Short-term investments, including restricted investments
of $28,223 and $36,645, respectively .............................................. 54,247 133,394
Accounts receivable, net of allowance for doubtful accounts
of $109 and $211, respectively .................................................... 5,143 4,544
Prepaid expenses and other current assets ............................................ 4,893 5,456
--------- ---------
Total current assets .............................................................. 133,132 166,442
Property and equipment, net of accumulated depreciation
of $19,768 and $10,747, respectively ................................................. 37,362 26,707
Long-term investments .................................................................... -- 10,398
Goodwill ................................................................................. 25,798 25,798
Intangible assets, net of amortization of $1,760 and $560, respectively .................. 4,240 5,440
Other assets ............................................................................. 1,240 5,205
--------- ---------
Total assets ...................................................................... $ 201,772 $ 239,990
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................................................... $ 4,378 $ 3,168
Accrued liabilities .................................................................. 4,161 5,016
Current portion of deferred revenue .................................................. 12,760 10,595
--------- ---------
Total current liabilities ......................................................... 21,299 18,779
Deferred revenue, net of current portion ................................................. 5,887 2,500
Long-term debt ........................................................................... 4,000 --
Other long-term liabilities .............................................................. 684 339
--------- ---------
Total liabilities ................................................................. 31,870 21,618
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 5,000 shares authorized;
no shares issued and outstanding .................................................. -- --
Common stock, $.001 par value; 120,000 shares authorized;
52,367 and 52,022 shares issued and outstanding, respectively ..................... 52 52
Additional paid-in capital ........................................................... 330,701 331,092
Deferred stock compensation .......................................................... (11,106) (22,260)
Accumulated deficit .................................................................. (149,745) (90,075)
Accumulated other comprehensive loss ................................................. -- (437)
--------- ---------
Total stockholders' equity ........................................................ 169,902 218,372
--------- ---------
Total liabilities and stockholders' equity ........................................ $ 201,772 $ 239,990
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------------
2002 2001 2000
-------- -------- --------
Revenues:
Subscription and license fees .......................................... $ 17,871 $ 14,744 $ 4,579
Collaborative research ................................................. 17,088 11,220 9,505
Compound libraries and other ........................................... 241 4,613 375
-------- -------- --------
Total revenues ....................................................... 35,200 30,577 14,459
Operating expenses:
Research and development, including stock-based
compensation of $5,155, $5,539 and $10,883, respectively ............. 74,859 53,355 31,647
General and administrative, including stock-based
compensation of $5,113, $5,231 and $9,958, respectively .............. 23,234 20,861 18,289
-------- -------- --------
Total operating expenses ............................................. 98,093 74,216 49,936
-------- -------- --------
Loss from operations ...................................................... (62,893) (43,639) (35,477)
Interest and other income ................................................. 3,230 8,781 9,905
Interest expense .......................................................... (7) (314) (422)
-------- -------- --------
Net loss .................................................................. (59,670) (35,172) (25,994)
Accretion on redeemable convertible preferred stock ....................... -- -- (134)
-------- -------- --------
Net loss attributable to common stockholders .............................. $(59,670) $(35,172) $(26,128)
======== ======== ========
Net loss per common share, basic and diluted .............................. $ (1.14) $ (0.70) $ (0.63)
======== ======== ========
Shares used in computing net loss per common share,
basic and diluted ...................................................... 52,263 50,213 41,618
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
ACCUMULATED TOTAL
COMMON STOCK ADDITIONAL DEFERRED OTHER STOCKHOLDERS'
------------------- PAID-IN STOCK ACCUMULATED COMPREHENSIVE EQUITY
SHARES PAR VALUE CAPITAL COMPENSATION DEFICIT LOSS (DEFICIT)
------ --------- ---------- ------------ ----------- ------------- -------------
Balance at December 31, 1999 ....... 24,540 $24 $ 7,863 $ (915) $ (28,909) $ -- $ (21,937)
Initial public offering of
common stock ..................... 10,000 10 203,175 -- -- -- 203,185
Accretion on redeemable convertible
preferred stock to redemption
value ............................ -- -- (134) -- -- -- (134)
Conversion of redeemable convertible
preferred stock to common stock .. 12,734 13 30,171 -- -- -- 30,184
Deferred stock compensation, net of
reversals ........................ -- -- 53,563 (53,563) -- -- --
Amortization of deferred stock
compensation ..................... -- -- -- 20,841 -- -- 20,841
Exercise of common stock options ... 849 1 1,111 -- -- -- 1,112
Exercise of common stock warrants .. 149 -- 371 -- -- -- 371
Net loss ........................... -- -- -- -- (25,994) -- (25,994)
------- --- --------- -------- --------- ----- ---------
Balance at December 31, 2000 ....... 48,272 48 296,120 (33,637) (54,903) -- 207,628
Deferred stock compensation, net of
reversals......................... -- -- (958) 958 -- -- --
Deferred stock compensation of
options assumed in acquisition ... -- -- -- (351) -- -- (351)
Amortization of deferred stock
compensation ..................... -- -- -- 10,770 -- -- 10,770
Common stock issued in connection
with acquisition ................. 2,919 3 35,213 -- -- -- 35,216
Exercise of common stock options ... 419 1 717 -- -- -- 718
Exercise of common stock warrants .. 412 -- -- -- -- -- --
Net loss ........................... -- -- -- -- (35,172) -- (35,172)
Unrealized loss on long-term
investments ...................... -- -- -- -- -- (437) (437)
---------
Comprehensive loss ................. -- -- -- -- -- -- (35,609)
------- --- --------- -------- --------- ----- ---------
Balance at December 31, 2001 ....... 52,022 52 331,092 (22,260) (90,075) (437) 218,372
Deferred stock compensation, net of
reversals......................... -- -- (985) 985 -- -- --
Issuance of restricted stock ....... 18 -- 99 (99) -- -- --
Amortization of deferred stock
compensation ..................... -- -- -- 10,268 -- -- 10,268
Cancellation of equity securities
in connection with acquisition ... (7) -- (79) -- -- -- (79)
Exercise of common stock options ... 330 -- 574 -- -- -- 574
Exercise of common stock warrants .. 4 -- -- -- -- -- --
Net loss ........................... -- -- -- -- (59,670) -- (59,670)
Reversal of unrealized loss on
sale of long-term investments .... -- -- -- -- -- 437 437
---------
Comprehensive loss ................. -- -- -- -- -- -- (59,233)
------- --- --------- -------- --------- ----- ---------
Balance at December 31, 2002 ....... 52,367 $52 $ 330,701 $(11,106) $(149,745) $ -- $ 169,902
======= === ========= ======== ========= ===== =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ........................................................................ $ (59,670) $ (35,172) $ (25,994)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation .................................................................. 9,111 5,220 2,621
Amortization of intangible assets, other than goodwill ........................ 1,200 560 --
Amortization of deferred stock compensation ................................... 10,268 10,770 20,841
Loss on sale of long-term investments ......................................... 197 -- --
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable .................................. (599) (1,409) 577
(Increase) decrease in prepaid expenses and other current assets ............ 484 (2,531) (460)
(Increase) decrease in other assets ......................................... 3,965 (4,919) 97
Increase in accounts payable and other liabilities .......................... 700 1,089 4,354
Increase (decrease) in deferred revenue ..................................... 5,552 8,402 (3,538)
--------- --------- ---------
Net cash used in operating activities ..................................... (28,792) (17,990) (1,502)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment ............................................. (19,766) (13,471) (7,709)
(Increase) decrease in restricted cash .......................................... (22,794) 7,186 (13,879)
Purchase of short-term investments .............................................. (91,962) (355,869) (269,847)
Maturities of short-term investments ............................................ 171,109 387,345 112,108
Purchase of long-term investments ............................................... -- (10,835) --
Sale of long-term investments ................................................... 10,638 -- --
Payment of transaction costs, net of cash acquired .............................. -- (752) --
--------- --------- ---------
Net cash provided by (used in) investing activities ....................... 47,225 13,604 (179,327)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on capital lease obligations ................................. -- -- (133)
Proceeds from debt borrowings ................................................... 4,000 -- --
Repayment of debt borrowings .................................................... -- (3,909) (1,462)
Proceeds from issuance of common stock .......................................... 574 718 204,330
--------- --------- ---------
Net cash provided by (used in) financing activities ....................... 4,574 (3,191) 202,735
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ............................... 23,007 (7,577) 21,906
Cash and cash equivalents at beginning of year ..................................... 16,355 23,932 2,026
--------- --------- ---------
Cash and cash equivalents at end of year ........................................... $ 39,362 $ 16,355 $ 23,932
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest .......................................................... $ 7 $ 330 $ 422
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Unrealized loss on long-term investments ........................................ $ -- $ (437) $ --
Reversal of unrealized loss on sale of long-term investments .................... $ 437 $ -- $ --
Conversion of redeemable convertible preferred stock into common stock .......... $ -- $ -- $ 30,184
Conversion of related party note payable into common stock ...................... $ -- $ -- $ 338
Issuance of equity securities in connection with acquisition .................... $ -- $ 35,216 $ --
Cancellation of equity securities in connection with acquisition ................ $ (79) $ -- $ --
Deferred stock compensation, net of reversals ................................... $ 985 $ 958 $ (53,563)
Deferred stock compensation in connection with issuance of
restricted stock .............................................................. $ (99) $ -- $ --
Retirement of property and equipment ............................................ $ 90 $ 181 $ --
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
LEXICON GENETICS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. ORGANIZATION AND OPERATIONS
Lexicon Genetics Incorporated (Lexicon or the Company) is a Delaware corporation
incorporated on July 7, 1995. Lexicon was organized to discover the functions
and pharmaceutical utility of genes and use those gene function discoveries in
the discovery and development of pharmaceutical products for the treatment of
human disease.
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, equipment financing arrangements and
leasing arrangements. The Company'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 the Company's future
success.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The accompanying consolidated financial statements
include the accounts of Lexicon and its subsidiary. Intercompany transactions
and balances are eliminated in consolidation.
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, Short-term Investments and Long-term Investments:
Lexicon considers all highly-liquid investments with original maturities or
auction-based interest rate reset dates of three months or less to be cash
equivalents. Management determines the appropriate classification of its cash
equivalents, short-term investments and long-term investments at the time of
purchase. Short-term investments consist of U.S. government agency debt
obligations, investment grade commercial paper, corporate debt securities and
certificates of deposit that have maturities of three to twelve months from the
date of purchase. Short-term investments are classified as held-to-maturity
securities in the accompanying financial statements. Held-to-maturity securities
are carried at amortized cost. Long-term investments at December 31, 2001
consist of a U.S. government agency debt obligation with a maturity greater than
twelve months from the time of purchase. Long-term investments are classified as
available-for-sale securities and, accordingly, are stated at fair value based
upon quoted market prices of the securities. Unrealized gains and losses on such
securities are reported as other comprehensive income (loss), which is a
separate component of stockholders' equity. In 2002, the Company sold its
available-for-sale securities. As a result, there is no unrealized gain (loss)
as of December 31, 2002.
Restricted Cash and Investments: Lexicon is required to maintain restricted cash
or investments to collateralize borrowings made under the synthetic lease
agreement under which it leases its office and laboratory facilities in The
Woodlands, Texas as well as to collateralize standby letters of credit for the
leases on its office and laboratory facilities in East Windsor and Hopewell, New
Jersey (see Note 10). As of December 31, 2002 and 2001, the Company maintained
restricted cash and investments of $57.7 million and $43.3 million,
respectively, under these agreements.
Concentration of Credit Risk: Lexicon's cash equivalents, short-term investments
and trade receivables represent potential concentrations of credit risk. The
Company minimizes potential concentrations of risk in cash equivalents and
short-term investments by placing investments in high-quality financial
instruments. The Company's customers are primarily pharmaceutical and
biotechnology companies located in the United States and Europe. The Company has
not experienced any significant credit losses to date and, at December 31, 2002,
management believes that the Company has no significant concentrations of credit
risk.
F-7
Segment Information and Significant Customers: Lexicon operates in one business
segment, which primarily focuses on the discovery of the functions and
pharmaceutical utility of genes and the use of those gene function discoveries
in the discovery and development of pharmaceutical products for the treatment of
human disease. Substantially all of the Company's revenues have been derived
from subscriptions to its databases, drug discovery alliances, functional
genomics collaborations for the development and, in some cases, analysis of the
physiological effects of genes altered in knockout mice, technology licenses and
compound library sales. In 2002, Incyte Genomics, Inc., Bristol-Myers Squibb
Company and Millennium Pharmaceuticals, Inc. represented 28%, 14% and 11% of
revenues, respectively. In 2001, Incyte, Bristol-Myers Squibb and Merck & Co.,
Inc. represented 16%, 13% and 12% of revenues, respectively. In 2000, the Merck
Genome Research Institute and Millennium represented 35% and 14% of 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 ten years. Maintenance, repairs and minor
replacements are charged to expense as incurred. Significant renewals and
betterments are capitalized.
Impairment of Long-Lived Assets: Long-lived assets and certain identifiable
intangible assets to be held and used are reviewed for impairment when events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. Determination of recoverability is based on an estimate of
undiscounted future cash flows resulting from the use of the asset and its
eventual disposition. In the event that such cash flows are not expected to be
sufficient to recover the carrying amount of the assets, the assets are written
down to their estimated fair values.
Goodwill Impairment: Under Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangible Assets," goodwill is not amortized, but
is tested at least annually for impairment at the reporting unit level.
Impairment is the condition that exists when the carrying amount of goodwill
exceeds its implied fair value. The first step in the impairment process is to
determine the fair value of the reporting unit and then compare it to the
carrying value, including goodwill. If the fair value exceeds the carrying
value, no further action is required and no impairment loss is recognized.
Additional impairment assessments may be performed on an interim basis if the
Company encounters events or changes in circumstances that would indicate that,
more likely than not, the carrying value of goodwill has been impaired. There
was no impairment of goodwill in 2002.
Revenue Recognition: Revenues are recognized when persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
price is fixed and determinable and collectibility is reasonably assured.
Payments received in advance under these arrangements are recorded as deferred
revenue until earned. Revenues are earned from database subscriptions, drug
discovery alliances, functional genomics collaborations for the development and,
in some cases, analysis of the physiological effects of genes altered in
knockout mice, technology licenses and compound library sales.
Fees for access to databases and other functional genomics resources are
recognized ratably over the subscription or access period. Collaborative
research payments are recognized as revenue as Lexicon performs its obligations
related to such research to the extent such fees are non-refundable.
Milestone-based fees are recognized upon completion of specified milestones
according to contract terms. Non-refundable technology license fees are
recognized as revenue upon the grant of the license when performance is complete
and there is no continuing involvement. Compound library sales are recognized as
revenue upon shipment.
Revenues recognized from multiple element contracts are allocated to each
element of the arrangement based on the relative fair values of the elements.
The determination of fair value of each element is based on objective evidence.
In accordance with Staff Accounting Bulletin No. 101 "Revenue Recognition in
Financial Statements," when revenues for an element are specifically tied to a
separate earnings process, revenue is recognized when the specific performance
obligation associated with the element is completed. When revenues for an
element are not specifically tied to a separate earnings process, they are
recognized ratably over the term of the agreement.
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. 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.
F-8
Stock-based Compensation: As further discussed in Note 12, Lexicon has three
stock-based compensation plans, which are accounted for under the recognition
and measurement provisions of Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees, and Related Interpretations." Under
the intrinsic value method described in APB Opinion No. 25, no compensation
expense is recognized if the exercise price of the employee stock option equals
the market price of the underlying stock on the date of grant. Lexicon
recognized $10.3 million, $10.8 million and $20.8 million of stock-based
compensation during 2002, 2001 and 2000, respectively, which was primarily
related to option grants made prior to Lexicon's April 2000 initial public
offering. The following table illustrates the effect on net loss and net loss
per share if the fair value recognition provisions of Financial Accounting
Standards Board (FASB) No. 123 "Accounting for Stock Based Compensation," had
been applied to all outstanding and unvested awards in each period:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Net loss, as reported .................................................. $(59,670) $(35,172) $(25,994)
Add: Stock-based employee compensation
expense included in reported net loss ............................... 10,268 10,770 20,841
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards ...................................................... (25,913) (20,616) (27,346)
-------- -------- --------
Pro forma net loss ..................................................... $(75,315) $(45,018) $(32,499)
======== ======== ========
Net loss per common share, basic and diluted
As reported ......................................................... $ (1.14) $ (0.70) $ (0.63)
======== ======== ========
Pro forma ........................................................... $ (1.44) $ (0.90) $ (0.78)
======== ======== ========
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.
Comprehensive Loss: Comprehensive loss is comprised of net loss and unrealized
gains and losses on long-term investments, which are considered
available-for-sale securities. Comprehensive loss is reflected in the
consolidated statements of stockholders' equity. During 2002, Lexicon sold its
available-for-sale securities for $10.6 million, resulting in a realized loss of
$197,000 reflected in its net loss for the year. As a result, there is no
accumulated other comprehensive loss as of December 31, 2002.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation (FIN) No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45
elaborates on the existing disclosure requirements for most guarantees,
including residual value guarantees issued in conjunction with operating lease
agreements. It also clarifies that at the time a company issues a guarantee, the
company must recognize an initial liability for the fair value of the obligation
it assumes under that guarantee and must disclose that information in its
interim and annual financial statements. The initial recognition and measurement
provisions apply on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
adoption of FIN 45 will not have a material impact on Lexicon's results of
operations and financial position. See Note 10 regarding disclosures on residual
value guarantees and Lexicon's exposure related to its synthetic lease and
standby letters of credit related to other operating leases.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on
EITF Issue No. 00-21 "Accounting for Revenue Arrangements with Multiple
Deliverables." This issue requires that revenue arrangements with multiple
deliverables be divided into separate units of accounting if the deliverables
meet the following criteria: the delivered items have value to the customer on a
standalone basis; there is objective and reliable evidence of fair value of the
undelivered items; and, if the arrangement includes a general right of return,
performance of the undelivered item is considered probable and substantially in
control of Lexicon. The final consensus will be applicable to agreements entered
into in fiscal periods beginning after June 15, 2003 with early adoption
permitted.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." This statement amends SFAS 123,
"Accounting for Stock-Based Compensation," to provide
F-9
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company is currently evaluating whether to adopt
the fair value based method. The additional disclosures required under SFAS 148
are effective for fiscal years ending after December 15, 2002, and have been
provided in Note 2.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." FIN 46 requires that unconsolidated variable interest entities be
consolidated by their primary beneficiaries. A primary beneficiary is the party
that absorbs a majority of the entity's expected losses or residual benefits.
FIN 46 applies immediately to variable interest entities created after January
31, 2003 and to existing variable interest entities in the periods beginning
after June 15, 2003. The Company is evaluating whether the adoption of FIN 46
will require the consolidation of the lessor under its synthetic lease,
discussed in Note 10. If such consolidation is required, the Company's balance
sheet will reflect as assets additional property and equipment approximating the
$55.0 million funded under the synthetic lease for property and improvements,
less accumulated depreciation, and a similar amount as a liability. In addition,
the Company will be required to depreciate such improvements over their useful
lives. The Company may, however, elect to restructure or replace the synthetic
lease prior to the adoption of FIN 46, whether or not such consolidation would
be required.
4. RECLASSIFICATIONS AND CONFORMING DISCLOSURES
In the accompanying balance sheet as of December 31, 2001, Lexicon has
reclassified the amount of restricted cash from cash and cash equivalents into a
separate line item. The accompanying statements of cash flows for the years
ended December 31, 2001 and 2000 have also been revised to reflect this
reclassification. Additionally, Lexicon included disclosures at December 31,
2001 in a table in Note 5 to conform the prior year information to the current
year presentation.
5. INVESTMENTS
Investments at December 31, 2002 and 2001 were as follows:
AS OF DECEMBER 31, 2002
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
(IN THOUSANDS)
Held-to-maturity:
Certificates of deposit $ 6,091 $ -- $ -- $ 6,091
U.S. government agencies 7,036 5 -- 7,041
Corporate debt securities 13,719 8 (3) 13,724
Commercial paper 26,127 -- -- 26,127
Other debt securities 1,274 7 -- 1,281
--------- -------- -------- ---------
Total held-to-maturity investments $ 54,247 $ 20 $ (3) $ 54,264
========= ======== ======== =========
AS OF DECEMBER 31, 2001
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
(IN THOUSANDS)
Held-to-maturity:
Certificates of deposit $ 11,221 $ -- $ -- $ 11,221
U.S. government agencies 24,125 23 (16) 24,132
Corporate debt securities 33,568 107 (26) 33,649
Commercial paper 64,480 6 -- 64,486
--------- -------- -------- ---------
Total held-to-maturity investments $ 133,394 $ 136 $ (42) $ 133,488
========= ======== ======== =========
Available-for-sale:
U.S. government agencies $ 10,835 $ -- $ (437) $ 10,398
--------- -------- -------- ---------
Total available-for-sale investments $ 10,835 $ -- $ (437) $ 10,398
========= ======== ======== =========
F-10
6. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2002 and 2001 are as follows:
ESTIMATED AS OF DECEMBER 31,
USEFUL LIVES -------------------------
IN YEARS 2002 2001
------------ -------- --------
(IN THOUSANDS)
Computers and software ........................ 3-5 $ 10,996 $ 8,659
Furniture and fixtures ........................ 5-7 8,595 5,044
Laboratory equipment .......................... 3-7 27,282 17,000
Leasehold improvements ........................ 3-10 10,257 6,751
-------- --------
Total property and equipment ............... 57,130 37,454
Less: Accumulated depreciation ................ (19,768) (10,747)
-------- --------
Net property and equipment ................ $ 37,362 $ 26,707
======== ========
7. 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, 2002 and 2001 are as follows:
AS OF DECEMBER 31,
--------------------------
2002 2001
-------- --------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards ............................... $ 39,887 $ 14,535
Research and development tax credits ........................... 7,113 4,607
Stock-based compensation ....................................... 5,828 4,307
Accrued expenses and other ..................................... 5,916 5,550
-------- --------
Total deferred tax assets ................................. 58,744 28,999
Deferred tax liabilities:
Property and equipment ......................................... (990) (341)
Other .......................................................... (138) (18)
-------- --------
Total deferred tax liabilities ............................ (1,128) (359)
Less: Valuation allowance ........................................ (57,616) (28,640)
-------- --------
Net deferred tax assets ................................... $ -- $ --
======== ========
At December 31, 2002, Lexicon had net operating loss carryforwards of
approximately $114.0 million and research and development tax credit
carryforwards of approximately $7.1 million available to reduce future income
taxes. These carryforwards will begin to expire in 2011. A change in ownership,
as defined by federal income tax regulations, could significantly limit the
Company's ability to utilize its carryforwards. Based on the federal tax law
limits and the Company's cumulative loss position, Lexicon concluded it was
appropriate to establish a full valuation allowance for its net deferred tax
assets until an appropriate level of profitability is sustained. During 2002,
the valuation allowance increased $29.0 million primarily due to the Company's
current year net loss, the acquired net operating loss carryforwards from the
purchase of Coelacanth Corporation, and the current year research tax credits.
8. GOODWILL AND OTHER INTANGIBLE ASSETS
On July 12, 2001, Lexicon completed the acquisition of Coelacanth Corporation in
a merger. Coelacanth, now Lexicon Pharmaceuticals (New Jersey), Inc., forms the
core of Lexicon Pharmaceuticals, the division of the
F-11
Company responsible for small molecule compound discovery. The results of
Lexicon Pharmaceuticals (New Jersey), Inc. are included in the Company's results
of operations for the period subsequent to the acquisition.
Goodwill, associated with the acquisition, of $25.8 million, which represents
the excess of the $36.0 million purchase price over the fair value of the
underlying net identifiable assets, was assigned to the consolidated entity,
Lexicon. There were no changes in the carrying amount of goodwill for the year
ended December 31, 2002. In accordance with SFAS 142, the goodwill balance is
not subject to amortization, but is tested at least annually for impairment. The
Company performed an impairment test of goodwill upon adoption of SFAS 142 and
on its annual impairment assessment date. This comparison did not result in an
impairment of goodwill at either assessment date.
Other intangible assets represent Coelacanth's technology platform, which
consists of its proprietary ClickChem(TM) reactions, novel building blocks and
compound sets, automated production systems, high throughput ADMET (Absorption,
Distribution, Metabolism, Excretion and Toxicity) capabilities and its know-how
and trade secrets. The Company expects to amortize the value assigned to other
intangible assets on a straight-line basis over an estimated life of five years.
The amortization expense for the year ended December 31, 2002 was $1.2 million.
The estimated amortization expense for the next five years is as follows:
FOR THE YEAR ENDING DECEMBER 31
-------------------------------
(IN THOUSANDS)
2003.................... $ 1,200
2004.................... 1,200
2005.................... 1,200
2006.................... 640
2007.................... $ --
9. DEBT OBLIGATIONS
On December 31, 2002, Lexicon borrowed $4.0 million under a note agreement with
Genentech, Inc. The proceeds of the loan are to be used to fund research efforts
under the alliance agreement with Genentech discussed in Note 14. The note
matures on or before December 31, 2005, but the Company may prepay it at any
time. The Company may repay the note, at its option, in cash, in shares of
common stock valued at the then-current market price, or in a combination of
cash and shares, subject to certain limitations. The note accrues interest at an
annual rate of 8%, compounded quarterly. The note is subordinated in right of
payment to borrowings made under Lexicon's synthetic lease, which is discussed
in Note 10.
10. COMMITMENTS AND CONTINGENCIES
Lease Obligations: In October 2000, Lexicon entered into a synthetic lease
agreement under which the lessor purchased the Company's existing laboratory and
office buildings and animal facility in The Woodlands, Texas and agreed to fund
the construction of an additional laboratory and office building and a second
animal facility. The synthetic lease agreement was subsequently expanded to
include funding for the construction of a central plant facility. Including the
purchase price for the Company's existing facilities, the synthetic lease, as
amended, provides for funding of up to $55.0 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 the new facilities
began upon completion of construction, which occurred at the end of the first
quarter of 2002. Lease payments are subject to fluctuation based on LIBOR rates.
Based on a year-end LIBOR rate of 1.4% the Company's total lease payments would
be approximately $0.9 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 the Company
may purchase the properties for a price equal to the $55.0 million funded under
the synthetic lease for property and improvements plus the amount of any accrued
but unpaid lease payments. If the Company elects not to renew the lease or
purchase the properties, it may arrange for the sale of the properties to a
third party or surrender the properties to the lessor. If the Company elects to
arrange for the sale of the properties or surrender the properties to the
lessor, it has guaranteed approximately 86% of the total original cost as the
residual fair value of the properties. The Company is required to maintain
restricted cash or investments to collateralize borrowings made under the
synthetic lease agreement. In addition, Lexicon has agreed to maintain cash and
investments of at least $12.0 million in excess of the Company's restricted cash
and investments. If the Company's cash and investments fall below that level,
the Company may be required to seek a waiver of that agreement or to purchase
the properties or arrange for their sale to a third party. Because the Company's
cost to
F-12
purchase the properties would not materially exceed the $55.0 million funded
under the synthetic lease for property and improvements and would likely be less
than the amount of restricted cash and investments it is required to maintain
under the synthetic lease, the Company believes that any requirement that it do
so would not have a material adverse effect on its financial condition. As of
December 31, 2002 and 2001, the Company maintained restricted cash and
investments of $57.2 million and $43.3 million, respectively, to collateralize
funding for property and improvements under the synthetic lease of $55.0 million
and $41.7 million.
Lexicon's subsidiary leases laboratory and office space in East Windsor, New
Brunswick and Hopewell, New Jersey under agreements which expire in January
2004, January 2003 and May 2012, respectively. The Hopewell lease is a ten-year
lease for a 76,000 square-foot facility in New Jersey. The lease provides for an
escalating yearly rent payment of $1.3 million in the first year, $1.7 million
in years two and three, $1.8 million in years four to six, $2.0 million in years
seven to nine and $2.1 million in year ten. The lease also provides an option in
the second year of the lease to borrow $2.0 million in tenant improvement funds
from the landlord, at which time rental payments due under the lease will
increase as the tenant improvement allowance is amortized over a ten-year
period. Lexicon is the guarantor of the obligations of its subsidiary under the
lease. The Company is required to maintain restricted investments to
collateralize the East Windsor and Hopewell leases. As of December 31, 2002, the
Company had $0.5 million in restricted investments to collateralize standby
letters of credit for these leases. Additionally, Lexicon leases certain
equipment under operating leases.
Rent expense for all operating leases was approximately $2.8 million, $0.9
million, and $1.5 million for the years ended December 31, 2002, 2001 and 2000,
respectively. The table below includes non-cancelable future lease payments for
the facilities in The Woodlands, Texas based on a year-end LIBOR rate of 1.4%,
as well as future lease payments for the facilities in New Jersey:
FOR THE YEAR ENDING
DECEMBER 31
---------------------
(IN THOUSANDS)
2003................................... $ 3,479
2004................................... 2,796
2005................................... 2,805
2006................................... 2,769
2007................................... 1,904
Thereafter............................. 8,953
---------------
Total....................... $ 22,706
===============
Employment Agreements: Lexicon has 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.
11. 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.
Redeemable Convertible Series A Preferred Stock: Lexicon's redeemable
convertible Series A preferred stock, originally issued in a private placement
in May 1998, was converted according to its terms into 12,733,992 shares of
common stock upon the April 2000 closing of the Company'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 $31.8 million. The
Series A preferred stock was not included as a component of total stockholders'
equity (deficit) due to its redemption features.
F-13
12. STOCK OPTIONS AND WARRANTS
Stock Options
2000 Equity Incentive Plan: In September 1995, Lexicon adopted 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 of Directors terminates it sooner.
The Equity Incentive Plan provides that it will be administered by the Board of
Directors, or a committee appointed by the Board of Directors, which determines
recipients and types of options to be granted, including number of shares under
the option and the exercisability of the shares. The Equity Incentive Plan is
presently administered by the Compensation Committee of the Board of Directors.
The Equity Incentive Plan provides for the grant of incentive stock options to
employees and nonstatutory stock options to employees, directors and consultants
of the Company. The plan also permits the grant of stock bonuses and restricted
stock purchase awards. Incentive stock options 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 plan administrator 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 plan
administrator.
The Board of Directors initially authorized and reserved an aggregate of
11,250,000 shares of common stock for issuance under the Equity Incentive Plan.
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:
- 5% of Lexicon's outstanding shares on a fully-diluted basis; or
- that number of shares that could be issued under awards granted
under the Equity Incentive Plan during the prior 12-month period;
provided that 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 of December 31, 2002, an aggregate of 14,500,000 shares of common stock had
been reserved for issuance, options to purchase 11,201,000 shares were
outstanding and 1,693,000 shares had been issued upon the exercise of stock
options issued under the Equity Incentive Plan.
2000 Non-Employee Directors' Stock Option Plan: 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 the Company. Under the Directors'
Plan, non-employee directors first elected after the closing of the Company's
initial public offering receive an initial option to purchase 30,000 shares of
common stock. In addition, on the date of each of the Company'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 is automatically
granted an option to purchase 6,000 shares of common stock. Initial option
grants become vested and exercisable over a period of five years and annual
option grants become vested over a period of 12 months from the date of grant.
Options granted under the Directors' Plan have an exercise price equal to the
fair market value of the Company's common stock on the date of grant and term of
ten years from the date of grant.
The Board of Directors initially authorized and reserved a total of 600,000
shares of its common stock for issuance under the Directors' Plan. 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:
- 0.3% of the Company's outstanding shares on a fully-diluted basis;
or
- that number of shares that could be issued under options granted
under the Directors' Plan during the prior 12-month period;
provided that the Board of Directors may provide for a lesser increase in the
number of shares reserved under the Directors' Plan for any year.
F-14
As of December 31, 2002, an aggregate of 600,000 shares of common stock had been
reserved for issuance, options to purchase 81,000 shares were outstanding and no
options had been exercised under the Directors' Plan.
Coelacanth Corporation 1999 Stock Option Plan: Lexicon assumed the Coelacanth
Corporation 1999 Stock Option Plan (the "Coelacanth Plan") and the outstanding
stock options under the plan in connection with our July 2001 acquisition of
Coelacanth Corporation. The Company will not grant any further options under the
plan. As outstanding options under the plan expire or terminate, the number of
shares authorized for issuance under the plan will be correspondingly reduced.
The purpose of the plan was to provide an opportunity for employees, directors
and consultants of Coelacanth to acquire a proprietary interest, or otherwise
increase their proprietary interest, in Coelacanth as an incentive to continue
their employment or service. Both incentive and nonstatutory options are
outstanding under the plan. Most outstanding options vest over time and expire
ten years from the date of grant. The exercise price of options awarded under
the plan was determined by the plan administrator at the time of grant. In
general, incentive stock options have an exercise price of 100% or more of the
fair market value of Coelacanth common stock on the date of grant and
nonstatutory stock options have an exercise price as low as 85% of fair market
value on the date of grant.
As of December 31, 2002, an aggregate of 123,000 shares of common stock had been
reserved for issuance, options to purchase 90,000 shares of common stock were
outstanding, options to purchase 10,000 shares of common stock had been
cancelled and 23,000 shares of common stock had been issued upon the exercise of
stock options issued under the Coelacanth Plan.
Stock-based Compensation: SFAS 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, the Company is required to account for
its employee stock-based compensation plans under 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 the
Company's stock on the date of grant, no compensation expense is recorded.
During the year ended December 31, 2000, Lexicon recorded $54.1 million in
aggregate deferred compensation relating to options issued to employees and
non-employee directors. During the years ended December 31, 2002, 2001 and 2000,
the Company recognized $10.3 million, $10.7 million and $20.0 million,
respectively, in compensation expense relating to these options. Additionally,
during the years ended December 31, 2002 and 2001, the Company reversed
approximately $612,000 and $1.4 million, respectively, 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 pro forma information regarding net loss required by SFAS 123 has been
included in Note 2. The information has been determined as if Lexicon had
accounted for its employee stock options under the fair-value method as defined
by SFAS 123. 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. The fair value of these options was estimated at the
date of grant using the Black-Scholes method and the following weighted-average
assumptions for 2002, 2001 and 2000:
- volatility factors ranging from 109% to 67%;
- risk-free interest rates of 4.64%, 5.03% and 5.13%, respectively;
- expected option lives of seven years;
- three percent expected turnover; and
- no dividends.
Lexicon records the fair value of options issued to non-employee consultants,
including Scientific Advisory Panel 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.
No options were issued to non-
F-15
employee consultants in 2002. Options to purchase 34,000 and 372,000 shares of
common stock were issued to non-employee consultants in 2001 and 2000,
respectively. The Company recognized expense relating to options issued to
non-employee consultants of $79,000, $109,000 and $836,000 in the years ended
December 31, 2002, 2001 and 2000, respectively. The fair values of the issuances
in 2001 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 $471,000 and $6.4 million, respectively. Additionally,
the Company reversed $373,000 deferred compensation and additional paid-in
capital for unamortized deferred expense primarily related to the forfeiture of
nonvested options in the year ended December 31, 2002. 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: $10.2 million during 2003 and $884,000 during 2004.
Stock Option Activity: The following is a summary of option activity under
Lexicon's stock option plans:
WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- --------------
(IN THOUSANDS)
Balance at December 31, 1999............................ 5,197 $ 1.67
Granted............................................. 4,464 6.61
Exercised........................................... (849) 1.31
Canceled............................................ (559) 2.40
---------
Balance at December 31, 2000............................ 8,253 4.33
---------
Granted............................................. 2,493 11.31
Exercised........................................... (419) 1.71
Canceled............................................ (224) 9.17
---------
Balance at December 31, 2001............................ 10,103 6.04
---------
Granted............................................. 2,200 8.68
Exercised........................................... (330) 1.74
Canceled............................................ (601) 9.70
---------
Balance at December 31, 2002............................ 11,372 6.47
---------
Exercisable at December 31, 2002........................ 7,282 $ 4.77
=========
The weighted average fair values of options granted during the years ended
December 31, 2002, 2001 and 2000 were $7.32, $10.31 and $4.40, respectively. As
of December 31, 2002, 2,125,000 shares of common stock were available for grant
under Lexicon's stock option plans.
Stock Options Outstanding: The following table summarizes information about
stock options outstanding at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------------- --------------------------------------
WEIGHTED AVERAGE
REMAINING WEIGHTED WEIGHTED
RANGE OF OUTSTANDING AS OF CONTRACTUAL AVERAGE EXERCISABLE AS OF AVERAGE
EXERCISE PRICE DECEMBER 31, 2002 LIFE (IN YEARS) EXERCISE PRICE DECEMBER 31, 2002 EXERCISE PRICE
- -------------- ----------------- ---------------- -------------- ----------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
$0.0003 - $0.22 893 2.9 $ 0.05 893 $ 0.05
1.67 - 2.50 5,609 6.3 2.41 4,882 2.40
3.35 - 4.99 151 9.5 4.24 18 4.83
5.10 - 7.63 337 9.2 6.33 57 7.07
7.81 - 11.70 2,797 8.8 9.91 592 10.46
11.74 - 16.69 997 8.1 14.05 465 14.15
18.13 - 25.25 384 7.3 20.16 251 20.09
28.69 - 38.50 204 7.7 38.07 124 37.99
------ -----
11,372 $ 6.47 7,282 $ 4.77
====== =====
Warrants
In connection with certain note purchase agreements in August 1997, 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
F-16
the value of these warrants at approximately $25,000 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 for the year ended December 31, 2000. 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 provided that the exercise
price could be paid in cash or by way of a "cashless" exercise based upon the
difference between fair market value and exercise price. 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. This warrant was exercised in 2001 by way of a
cashless exercise, resulting in the issuance of a total of 412,648 shares of
common 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
the Company of an option to lease additional real property. The warrant expires
on April 15, 2003. Amortization of the remaining balance of $155,000 on the
lease option was expensed in 2000 upon the Company's completion of a synthetic
lease agreement under which the lessor purchased the optioned real property
under an arrangement providing for its lease to the Company (see Note 10).
In connection with the acquisition of Coelacanth in July 2001, Lexicon assumed
Coelacanth's outstanding warrants to purchase 25,169 shares of common stock. The
warrants expire on March 31, 2009. The fair value of the warrants was included
in the total purchase price for the acquisition. As of December 31, 2002,
warrants to purchase 16,483 shares of common stock, with an exercise price of
$11.93 per share, remained outstanding.
Aggregate Shares Reserved for Issuance
As of December 31, 2002, an aggregate of 11,639,000 shares of common stock were
reserved for issuance upon exercise of outstanding stock options and warrants
and 2,124,000 additional shares were available for future grants under Lexicon's
stock option plans.
13. 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 the Company 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 the Company'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 was required to match employee contributions according to a
specified formula. The matching contributions totaled approximately $645,000,
$332,000 and $160,000 in 2002, 2001 and 2000, respectively. Company
contributions are vested based on the employee's years of service, with full
vesting after four years of service.
14. COLLABORATION AND LICENSE AGREEMENTS
Lexicon derives substantially all of its revenues from subscriptions to its
databases, drug discovery alliances, functional genomics collaborations for the
development and, in some cases, analysis of the physiological effects of genes
altered in knockout mice, technology licenses and compound library sales.
Drug Discovery Alliances: Lexicon has entered into the following alliances for
the discovery and development of therapeutics based on its in vivo drug target
discovery efforts:
Abgenix, Inc. Lexicon established a drug discovery alliance with Abgenix in July
2000 to discover novel therapeutic antibodies using the Company's functional
genomics technologies and Abgenix's technology for generating fully human
monoclonal antibodies. Lexicon and Abgenix expanded and extended the alliance in
January 2002, with the intent of accelerating the selection of in vivo-validated
antigens for antibody discovery and the development and commercialization of
therapeutic antibodies based on those targets. Under the alliance agreement, the
Company and
F-17
Abgenix will each have the right to obtain exclusive commercialization rights,
including sublicensing rights, for an equal number of qualifying therapeutic
antibodies, and will each receive milestone payments and royalties on sales of
therapeutic antibodies from the alliance that are commercialized by the other
party or a third party sublicensee. Each party will bear its own expenses under
the alliance. The expanded alliance also provides us with access to Abgenix's
XenoMouse(R) technology for use in some of our own drug discovery programs. The
agreement, as extended, has a term of four years, subject to the right of the
parties to extend the term for up to three additional one-year periods.
Genentech, Inc. Lexicon established a drug discovery alliance with Genentech in
December 2002 to discover novel therapeutic proteins and antibody targets. Under
the alliance agreement, Lexicon will use its functional genomics technologies to
discover the functions of secreted proteins and potential antibody targets
identified through Genentech's internal drug discovery research. Genentech will
have exclusive rights in the discoveries resulting from the collaboration for
the research, development and commercialization of therapeutic proteins and
antibodies. Lexicon will retain certain other rights in those discoveries,
including rights for the development of small molecule drugs. Lexicon received
an upfront payment and funding under a loan in 2002, and will receive
performance payments for its work in the collaboration as it is completed. The
terms of the loan are discussed in Note 9. Lexicon will also receive milestone
payments and royalties on sales of therapeutic proteins and antibodies for which
Genentech obtains exclusive rights. The agreement has an expected collaboration
term of three years.
Incyte Genomics, Inc. Lexicon established a drug discovery alliance with Incyte
in June 2001 to discover novel therapeutic proteins using the Company's
functional genomics technologies in the discovery of the functions of secreted
proteins from Incyte's LifeSeq(R) Gold database. Under the alliance agreement,
the Company and Incyte will each have the right to obtain exclusive
commercialization rights, including sublicensing rights, for an equal number of
qualifying therapeutic proteins, and will each receive milestone payments and
royalties on sales of therapeutic proteins from the alliance that are
commercialized by the other party or a third party sublicensee. The agreement
has a term of five years, although either party may terminate the agreement
after three years.
LexVision Collaborations: Lexicon has entered into the following collaborations
for access to the Company's LexVision database of in vivo-validated drug
targets:
Bristol-Myers Squibb Company. Lexicon established a LexVision collaboration with
Bristol-Myers Squibb in September 2000, under which Bristol-Myers Squibb has
non-exclusive access to the Company's LexVision database and OmniBank library
for the discovery of small molecule drugs. The Company receives access fees
under this agreement, and is entitled to receive milestone payments and
royalties on products Bristol-Myers Squibb develops using the Company's
technology. The agreement has a term of five years, although either party may
terminate the agreement after three years.
Incyte Genomics, Inc. Lexicon established a LexVision collaboration with Incyte
in June 2001, under which Incyte has non-exclusive access to the Company's
LexVision database and OmniBank library for the discovery of small molecule
drugs. The Company receives access fees under this agreement, and is entitled to
receive milestone payments and royalties on products Incyte develops using the
Company's technology. The agreement has a term of five years, although either
party may terminate the agreement after three years.
15. SELECTED QUARTERLY FINANCIAL DATA
The table below sets forth certain unaudited statements of operations data, and
net loss per common share data, for each quarter of 2002 and 2001.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED
---------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(UNAUDITED)
2002
Revenues ................................................. $ 7,656 $ 9,411 $ 8,013 $ 10,120
Loss from operations ..................................... (15,177) (15,640) (17,491) (14,585)
Net loss ................................................. (14,059) (14,940) (16,809) (13,862)
Net loss per common share, basic and diluted ............. (0.27) (0.29) (0.32) (0.26)
Shares used in computing net loss per common share ....... 52,126 52,250 52,314 52,357
F-18
QUARTER ENDED
---------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
(UNAUDITED)
2001
Revenues ................................................. $ 3,311 $ 3,502 $ 13,493 $ 10,271
Loss from operations ..................................... (10,823) (12,236) (7,955) (12,625)
Net loss ................................................. (8,008) (9,939) (6,220) (11,005)
Net loss per common share, basic and diluted ............. (0.17) (0.20) (0.12) (0.21)
Shares used in computing net loss per common share ....... 48,343 48,865 51,500 51,955
F-19
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 -- Employment Agreement with Alan Main, Ph.D. (filed as
Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 2001 and
incorporated by reference herein).
EXHIBIT NO. DESCRIPTION
----------- -----------
10.8 -- Employment Agreement with David Boulton (filed as
Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 2001 and
incorporated by reference herein).
10.9 -- 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).
10.10 -- 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).
10.11 -- 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).
10.12 -- Coelacanth Corporation 1999 Stock Option Plan (filed
as Exhibit 99.1 to the Company's Registration
Statement on Form S-8 (Registration No. 333-66380) and
incorporated by reference herein).
+10.13 -- LexVision Database and Collaboration Agreement, dated
September 26, 2000, with Bristol-Myers Squibb Company
(filed as Exhibit 10.1 to the Company's Current Report
on Form 8-K dated September 26, 2000 and incorporated
by reference herein).
+10.14 -- LexVision Database and Collaboration Agreement, dated
June 27, 2001, with Incyte Genomics, Inc. (filed as
Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the period ended June 30, 2001 and
incorporated by reference herein).
+10.15 -- Therapeutic Protein Alliance Agreement, dated June 27,
2001, with Incyte Genomics, Inc. (filed as Exhibit
10.3 to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 2001 and incorporated by
reference herein).
*+10.16 -- Collaboration and License Agreement, dated December
17, 2002, with Genentech, Inc.
10.17 -- Synthetic Lease Financing Facility with First Security
Bank, National Association, the Lenders and Holders
named therein, and Bank of America, N.A. (filed as
Exhibit 10.12 to the Company's Annual Report on Form
10-K for the year ended December 31, 2000 and
incorporated by reference herein).
10.18 -- Lease Agreement, dated October 21, 1998, between
Coelacanth Chemical Corporation and ARE-279 Princeton
Road, LLC. (filed as Exhibit 10.18 to the Company's
Annual Report on Form 10-K for the year ended December
31, 2001 and incorporated by reference herein).
10.19 -- Lease Agreement, dated May 23, 2002, between Lexicon
Pharmaceuticals (New Jersey), Inc. and Townsend
Property Trust Limited Partnership (filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 2002 and incorporated by
reference herein).
21.1 -- Subsidiaries (filed as Exhibit 21.1 to the Company's
Annual Report on Form 10-K for the year ended December
31, 2001 and incorporated by reference herein).
*23.1 -- Consent of Ernst & Young LLP
*23.2 -- Information regarding consent of Arthur Andersen LLP
*24.1 -- Power of Attorney (contained in signature page)
EXHIBIT NO. DESCRIPTION
----------- -----------
99.1 -- Letter to the Securities and Exchange Commission
regarding Audit Assurances (filed as Exhibit 99.1 to
the Company's Annual Report on Form 10-K for the year
ended December 31, 2001 and incorporated by reference
herein).
*99.2 -- Certification of CEO and CFO Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
----------
* 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.