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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
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
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES AND ZIP CODE)
(281) 863-3000
(REGISTRANT'S TELEPHONE NUMBER,
INCLUDING AREA CODE)
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 [ ]
As of May 6, 2003, 52,495,423 shares of the registrant's common stock,
par value $0.001 per share, were outstanding.
LEXICON GENETICS INCORPORATED
TABLE OF CONTENTS
PAGE
----
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS................................................................. 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2003 (unaudited) and December 31, 2002...................... 3
Consolidated Statements of Operations (unaudited) - Three Months Ended
March 31, 2003 and 2002........................................................................ 4
Consolidated Statements of Cash Flows (unaudited) - Three Months Ended
March 31, 2003 and 2002........................................................................ 5
Notes to Consolidated Financial Statements (unaudited).............................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................................... 16
Item 4. Controls and Procedures............................................................................. 16
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................................................... 17
SIGNATURES................................................................................................... 18
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.
------------
FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-Q 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 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors," that
may cause our or our industry's actual results, levels of activity, performance
or achievements to be materially different from any future results, levels or
activity, performance or achievements expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. We are not under any duty to
update any of the forward-looking statements after the date of this quarterly
report on Form 10-Q to conform these statements to actual results, unless
required by law.
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEXICON GENETICS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
AS OF MARCH 31, AS OF DECEMBER 31,
2003 2002
------------------- ------------------
(UNAUDITED)
ASSETS
------
Current assets:
Cash and cash equivalents............................................ $ 39,177 $ 39,362
Restricted cash...................................................... 44,831 29,487
Short-term investments, including restricted investments of
$12,879 and $28,223, respectively ................................ 23,579 54,247
Accounts receivable, net of allowance for doubtful accounts
of $109........................................................... 3,809 5,143
Prepaid expenses and other current assets............................ 4,590 4,893
---------------- -----------------
Total current assets.............................................. 115,986 133,132
Property and equipment, net of accumulated depreciation
of $22,303 and $19,768, respectively................................. 35,516 37,362
Goodwill................................................................. 25,798 25,798
Intangible assets, net of amortization of $2,060 and $1,760, respectively 3,940 4,240
Other assets............................................................. 727 1,240
---------------- -----------------
Total assets...................................................... $ 181,967 $ 201,772
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable..................................................... $ 2,752 $ 4,378
Accrued liabilities.................................................. 3,534 4,161
Current portion of deferred revenue.................................. 10,503 12,760
---------------- -----------------
Total current liabilities......................................... 16,789 21,299
Deferred revenue, net of current portion................................. 5,137 5,887
Long-term debt........................................................... 4,000 4,000
Other long-term liabilities.............................................. 720 684
---------------- -----------------
Total liabilities................................................. 26,646 31,870
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;
52,374 and 52,367 shares issued and outstanding................... 52 52
Additional paid-in capital........................................... 330,666 330,701
Deferred stock compensation.......................................... (8,507) (11,106)
Accumulated deficit.................................................. (166,890) (149,745)
---------------- -----------------
Total stockholders' equity........................................ 155,321 169,902
---------------- -----------------
Total liabilities and stockholders' equity........................ $ 181,967 $ 201,772
================ =================
The accompanying notes are an integral part of these
consolidated financial statements.
3
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------------
2003 2002
--------------- ---------------
Revenues:
Subscription and license fees.............................. $ 3,102 $ 3,395
Collaborative research..................................... 4,993 4,256
Compound libraries and other............................... 11 5
------------- -------------
Total revenues........................................... 8,106 7,656
Operating expenses:
Research and development, including stock-based
compensation of $1,270 and $1,307, respectively.......... 19,834 16,864
General and administrative, including stock-based
compensation of $1,276 and $1,282, respectively.......... 5,804 5,969
------------- -------------
Total operating expenses............................... 25,638 22,833
------------- -------------
Loss from operations.......................................... (17,532) (15,177)
Interest and other income..................................... 468 1,120
Interest expense.............................................. (81) (2)
-------------- -------------
Net loss .................................................... $ (17,145) $ (14,059)
============= =============
Net loss per common share, basic and diluted.................. $ (0.33) $ (0.27)
Shares used in computing net loss per common share,
basic and diluted.......................................... 52,371 52,126
The accompanying notes are an integral part of these
consolidated financial statements.
4
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------------------
2003 2002
---------------- ----------------
Cash flows from operating activities:
Net loss.............................................................. $ (17,145) $ (14,059)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation........................................................ 2,535 1,920
Amortization of intangible assets, other than goodwill.............. 300 300
Amortization of deferred stock compensation......................... 2,547 2,589
Changes in operating assets and liabilities:
Decrease in accounts receivable................................... 1,334 262
(Increase) decrease in prepaid expenses and other current assets.. 303 (684)
Decrease in other assets.......................................... 513 2,307
Decrease in accounts payable and other liabilities................ (2,217) (113)
Decrease in deferred revenue...................................... (3,007) (1,752)
------------- -------------
Net cash used in operating activities........................... (14,837) (9,230)
Cash flows from investing activities:
Purchases of property and equipment................................... (689) (8,735)
Increase in restricted cash........................................... (15,344) (17,949)
Purchases of short-term investments................................... (15,386) (14,161)
Maturities of short-term investments.................................. 46,054 56,352
------------- -------------
Net cash provided by investing activities......................... 14,635 15,507
Cash flows from financing activities:
Proceeds from issuance of common stock................................ 17 267
------------- -------------
Net cash provided by financing activities......................... 17 267
------------- -------------
Net increase (decrease) in cash and cash equivalents..................... (185) 6,544
Cash and cash equivalents at beginning of period......................... 39,362 16,355
------------- -------------
Cash and cash equivalents at end of period............................... $ 39,177 $ 22,899
============= =============
Supplemental disclosure of cash flow information:
Cash paid for interest................................................ $ 1 $ 2
Supplemental disclosure of non-cash investing and financing activities:
Unrealized loss on long-term investments.............................. $ -- $ (322)
Cancellation of equity securities issued in connection with acquisition $ -- $ (78)
Reversal of deferred stock compensation in connection with
stock options....................................................... $ 52 $ 309
The accompanying notes are an integral part of these
consolidated financial statements.
5
LEXICON GENETICS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Lexicon
Genetics Incorporated (Lexicon or the Company) have been prepared in accordance
with generally accepted accounting principles for interim financial information
and pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC). Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended March 31, 2003 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2003.
The accompanying consolidated financial statements include the accounts
of Lexicon and its subsidiary. Intercompany transactions and balances are
eliminated in consolidation.
For further information, refer to the financial statements and
footnotes thereto included in Lexicon's annual report on Form 10-K for the year
ended December 31, 2002, as filed with the SEC.
2. RECLASSIFICATION
The accompanying statement of cash flows for the three months ended
March 31, 2002, has been revised to reflect the reclassification of restricted
cash from cash and cash equivalents into a separate line item.
3. 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 7). As
of March 31, 2003 and December 31, 2002, the Company maintained restricted cash
and investments of $57.7 million under these agreements.
4. 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 for the three-month period ended March 31, 2002
was $14.4 million, which includes a $0.3 million unrealized loss on long-term
investments. During 2002, Lexicon sold its available-for-sale securities. As a
result there was no difference between net loss and comprehensive loss in the
three-month period ended March 31, 2003.
5. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of
shares of common stock outstanding during the applicable period. Shares
associated with stock options and warrants are not
6
included because they are antidilutive. There are no differences between basic
and diluted net loss per share for all periods presented.
6. STOCK-BASED COMPENSATION
Lexicon's stock-based compensation plans 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 $2.5 million and $2.6 million of stock-based
compensation during the three-month periods ended March 31, 2003 and 2002,
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:
------------------------------------
THREE MONTHS ENDED MARCH 31,
------------------------------------
2003 2002
---------------- ----------------
Net loss, as reported........................................ $ (17,145) $ (14,059)
Add: Stock-based employee compensation
expense included in reported net loss..................... 2,546 2,589
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards............................................ (6,443) (6,150)
------------- -------------
Pro forma net loss........................................... $ (21,042) $ (17,620)
============= =============
Net loss per common share, basic and diluted
As reported............................................... $ (0.33) $ (0.27)
============ =============
Pro forma................................................. $ (0.40) $ (0.34)
============ =============
7. COMMITMENTS AND CONTINGENCIES
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,
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 LIBOR rate
of 1.3% at March 31, 2003 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 amounts funded 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
7
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 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 March 31,
2003 and December 31, 2002, the Company maintained restricted cash and
investments of $57.2 million to collateralize funding for property and
improvements under the synthetic lease of $55.0 million.
Lexicon's subsidiary leases laboratory and office space in East Windsor
and Hopewell, New Jersey under agreements which expire in January 2004 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 March 31, 2003, the Company had $0.5 million in
restricted investments to collateralize standby letters of credit for these
leases.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 and technology licenses, 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
9
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
March 31, 2003, we had an accumulated deficit of $166.9 million. Our losses have
resulted principally from costs incurred in research and development, general
and administrative costs associated with our operations, and non-cash
stock-based compensation expenses associated with stock options granted to
employees and consultants prior to our April 2000 initial public offering.
Research and development expenses consist primarily of salaries and related
personnel costs, material costs, 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. 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.
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 collectability 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 to third parties, 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.
10
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. If
employees and consultants continue to vest in accordance with their individual
stock options, we expect to record amortization expense for deferred stock-based
compensation as follows: $7.6 million during the remaining nine months of 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.
RECENT ACCOUNTING PRONOUNCEMENTS
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 Financial Accounting Standards Board, or 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
11
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 Interpretation, or FIN, No. 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 consolidation of the lessor or restructuring of the synthetic
lease will not have a material adverse effect on our financial condition or
results of operations.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2003 and 2002
Revenues. Total revenues increased 6% to $8.1 million in the three
months ended March 31, 2003 from $7.7 million in the corresponding period in
2002. The increase of $0.4 million was primarily the result of revenues
recognized under our drug discovery alliance with Genentech, entered in December
2002, offset in part by reduced revenues under technology license agreements.
Research and Development Expenses. Research and development expenses
increased 18% to $19.8 million in the three months ended March 31, 2003 from
$16.9 million in the corresponding period in 2002. The increase of $2.9 million
was primarily attributable to increased personnel costs and facilities costs to
support the expansion of our drug discovery programs, the development and
analysis of knockout mice and our other functional genomics research efforts.
Research and development expenses for both three-month periods included $1.3
million 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 decreased 3% to $5.8 million in the three months ended March 31, 2003
from $6.0 million in the corresponding period in 2002. General and
administrative expenses for both three-month periods included $1.3 million 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 to $0.5
million in the three months ended March 31, 2003 from $1.1 million in the
corresponding period in 2002. The decrease resulted from lower average cash and
investment balances and lower average interest rates during the 2003 period.
Net Loss and Net Loss Per Common Share. Net loss increased to $17.1
million in the three months ended March 31, 2003 from $14.1 million in the
corresponding period in 2002. Net loss per common share increased to $0.33 in
the three months ended March 31, 2003 from $0.27 in the corresponding period of
2002. As a complement to reporting net loss and net loss per common share in
accordance with generally accepted accounting principles, or GAAP, Lexicon
provides net loss and net loss per common share excluding non-cash, stock-based
compensation. Lexicon uses these results in
12
establishing budgets and believes it is useful in measuring the performance of
the Company's business. Excluding stock-based compensation expense of $2.5
million and $2.6 million in the three months ended March 31, 2003 and 2002,
respectively, we would have had a net loss of $14.6 million and net loss per
common share of $0.28 in the three months ended March 31, 2003, as compared to a
net loss of $11.5 million and net loss per common share of $0.22 in the
corresponding period in 2002.
Our quarterly operating results have fluctuated in the past and are
likely to do so in the future, and we believe that quarter-to-quarter
comparisons of our operating results are not a good indication of our future
performance.
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 March 31,
2003, 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 March 31, 2003, we received $108.1 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 $96.6 million had been recognized as
revenues through March 31, 2003.
As of March 31, 2003, we had $107.6 million in cash, cash equivalents
and short-term investments (including $57.7 million of restricted cash and
investments), as compared to $123.1 million as of December 31, 2002. We used
cash of $14.8 million in operations in the three months ended March 31, 2003.
This consisted primarily of the net loss for the period of $17.1 million offset
by non-cash charges of $2.5 million related to stock-based compensation expense,
$2.5 million related to depreciation expense and $0.3 million related to
amortization of intangible assets other than goodwill. Investing activities
provided cash of $14.6 million in the three months ended March 31, 2003,
principally as a result of net maturities of short-term investments, offset in
part by an increase in restricted cash.
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 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 LIBOR rate of 1.3% at March 31, 2003, 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 amounts funded 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
13
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 March 31, 2003 and
December 31, 2002, we maintained restricted cash and investments of $57.2
million to collateralize funding for property and improvements under the
synthetic lease of $55.0 million.
In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc.
signed 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 or 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.
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 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 12 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.
14
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.
RISK FACTORS
Our business is subject to certain risks and uncertainties, including
those referenced below:
Risks Related to Our Business
o we have a history of net losses, and we expect to continue to incur net
losses and may not achieve or maintain profitability
o 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
o we will need additional capital in the future and, if it is not
available, we will have to curtail or cease operations
o we are an early-stage company with an unproven business strategy
o 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
o 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
o any cancellation by or conflicts with our collaborators could harm our
business
o we have no experience in developing and commercializing pharmaceutical
products on our own
o we lack the capability to manufacture compounds for preclinical studies
and clinical trials and will rely on third parties to manufacture our
potential products
o we may engage in future acquisitions, which may be expensive and time
consuming and from which we may not realize anticipated benefits
o 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
o we may encounter difficulties in managing our growth, which could
increase our losses
o because all of our functional genomics operations are located at a
single facility, the occurrence of a disaster could significantly
disrupt our business
Risks Related to Our Industry
o our ability to patent our discoveries is uncertain because patent laws
and their interpretation are highly uncertain and subject to change
o our patent applications may not result in enforceable patent rights
15
o 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 function in knockout
mice
o we may be involved in patent litigation and other disputes regarding
intellectual property rights, and can give no assurance that we will
prevail in any such litigation or other dispute
o 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
o our rights to the use of technologies licensed by third parties are not
within our control
o we may be unable to protect our trade secrets
o 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
o the uncertainty of pharmaceutical pricing and reimbursement may
decrease the commercial potential of our products and affect our
ability to raise capital
o security risks in electronic commerce or unfavorable Internet
regulation may deter future use of our products and services
o 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
o we may be sued for product liability
o public perception of ethical and social issues may limit or discourage
the use of our technologies, which could reduce our revenues
For additional discussion of the risks and uncertainties that affect
our business, see "Item 1. Business - Risk Factors" included in our annual
report on Form 10-K for the year ended December 31, 2002, as filed with the
Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Disclosure about Market Risk" under "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations for
quantitative and qualitative disclosures about market risk.
ITEM 4. CONTROLS AND PROCEDURES
Lexicon's chief executive officer and chief financial officer have
concluded that the Company's disclosure controls and procedures (as defined in
Securities Exchange Act of 1934 (the "Exchange Act") Rules 13a-14 (c) and
15d-14(c)) are sufficiently effective to ensure that the information required to
be disclosed by the Company in the reports it files under the Exchange Act 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.
16
Subsequent to the Company's 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.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO. DESCRIPTION
----------- -----------
10.1 -- Consulting Letter Agreement, dated March 31, 2003, with
Robert J. Lefkowitz, M.D.
99.1 -- Certification of CEO and CFO Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
None.
17
SIGNATURES
Pursuant to the requirements 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: May 9, 2003 By: /s/ ARTHUR T. SANDS
-------------------------------------
Arthur T. Sands, M.D., Ph.D.
President and Chief Executive Officer
Date: May 9, 2003 By: /s/ JULIA P. GREGORY
-------------------------------------
Julia P. Gregory
Executive Vice President and
Chief Financial Officer
18
CERTIFICATIONS
I, Arthur T. Sands, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lexicon Genetics
Incorporated;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act 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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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; and
6. The registrant's other certifying officers and I have indicated in
this quarterly 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: May 9, 2003
/s/ Arthur T. Sands
-------------------------------------
Arthur T. Sands, M.D., Ph.D.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
19
CERTIFICATIONS
I, Julia P. Gregory, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lexicon Genetics
Incorporated;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act 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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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; and
6. The registrant's other certifying officers and I have indicated in this
quarterly 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: May 9, 2003
/s/ Julia P. Gregory
----------------------------------
Julia P. Gregory
EXECUTIVE VICE PRESIDENT AND CHIEF
FINANCIAL OFFICER
20
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
10.1 -- Consulting Letter Agreement, dated March 31, 2003, with
Robert J. Lefkowitz, M.D.
99.1 -- Certification of CEO and CFO Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002