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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, 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 (281) 863-3000
THE WOODLANDS, TEXAS 77381 (Registrant's Telephone Number,
(Address of Principal Executive Including Area Code)
Offices and Zip 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. |X|
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 $198.3 million, based on the closing price of
the common stock on the Nasdaq National Market on June 30, 2003 of $6.60 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 8, 2004, 63,312,972 shares of
common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the registrant's definitive proxy statement
relating to the registrant's 2004 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, 2003, 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........................................................................................... 20
3. Legal Proceedings.................................................................................... 21
4. Submissions of Matters to a Vote of Security Holders................................................. 21
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters................................ 22
6. Selected Financial Data.............................................................................. 23
7. Management's Discussion and Analysis of Financial Condition and Results of Operations................ 24
7A. Quantitative and Qualitative Disclosure About Market Risk............................................ 33
8. Financial Statements and Supplementary Data.......................................................... 33
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................. 33
9A. Controls and Procedures.............................................................................. 33
PART III
10. Directors and Executive Officers of the Registrant................................................... 34
11. Executive Compensation............................................................................... 34
12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters....... 34
13. Certain Relationships and Related Transactions....................................................... 34
14. Principal Accounting Fees and Services............................................................... 34
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................... 35
Signatures..................................................................................................... 38
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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 systematically
discovering the physiological and behavioral functions of genes to identify
those that encode potential targets for therapeutic intervention, or drug
targets. We make our discoveries using our proprietary technology to knock out,
or disrupt, the function of genes in mice to model the effects on physiology
that could be expected from prospective drugs directed against those targets.
For targets that we believe have high pharmaceutical value, we engage in
programs for the discovery and development of potential small molecule drugs,
therapeutic antibodies and therapeutic proteins. We focus our discovery efforts
in six therapeutic areas - diabetes and obesity, cardiovascular disease,
psychiatric and neurological disorders, cancer, immune system disorders and
ophthalmic disease - and we have advanced targets into drug discovery programs
in each of these areas with potential for addressing large medical markets.
We make our discoveries using proprietary technology to knock out genes
in mice, analyze the resulting effects on physiology and behavior, and identify
those genes that exhibit a favorable therapeutic profile in mouse models. Using
this information, we select potential targets encoded by the corresponding human
genes for our drug discovery programs. . Our physiology-based approach to
understanding gene function and our use of mouse models in our drug discovery
efforts allow us to make highly-informed decisions throughout the drug discovery
and development process, which we believe will increase our likelihood of
success in discovering breakthrough therapeutics.
The scope of our gene knockout technology, combined with the size and
sophistication of our facilities and our evaluative technologies, provides us
with what we believe to be a significant competitive advantage. We are using
these technologies in our Genome5000 program to discover the physiological and
behavioral functions of 5,000 genes from the human genome that belong to gene
families that we consider to be pharmaceutically important. We have completed
our analysis of more than 30% of these genes, and we expect to complete the
analysis of the remaining genes by the end of 2007. Through February 2004, we
have advanced into drug discovery programs more than 40 targets, each of which
we have validated in living mammals, or in vivo.
We are working both independently and through strategic collaborations
and alliances to commercialize our technology and turn our discoveries into
drugs. We have established multiple collaborations with leading pharmaceutical
and biotechnology companies, as well as research institutes and academic
institutions. We are working with Bristol-Myers Squibb Company to discover and
develop novel small molecule drugs in the neuroscience field. We are working
with Genentech, Inc. to discover the functions of secreted proteins and
potential antibody targets identified through Genentech's internal drug
discovery research. We are also working with Abgenix, Inc. to discover and
develop therapeutic antibodies for drug targets identified in our own research.
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 such companies' own drug discovery efforts.
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.
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OUR DRUG DISCOVERY PROCESS
Our drug discovery process begins with our Genome5000 program, in which
we are using our gene knockout technology to discover the physiological and
behavioral functions of 5,000 human genes through analysis of the corresponding
knockout mouse models. Our Genome5000 efforts are focused on the discovery of
the functions in mammalian physiology of proteins encoded by gene families that
we consider to be pharmaceutically important, such as G-protein coupled, or
GPCRs, and other receptors, kinases, ion channels, other key enzymes and
secreted proteins. We have already completed our physiology- and behavior-based
analysis of more than 30% of these 5,000 genes, and we expect to complete the
analysis of the remaining genes by the end of 2007.
We use knockout mice - mice whose DNA has been altered to disrupt, or
knock out, the function of the altered gene - to discover the physiological and
behavioral effects that result from loss of functioning protein encoded by the
disrupted gene. Historically, the study of such loss of function genetic
alterations in mice has been a very powerful tool for understanding human genes
because of the close similarity of gene function and physiology between mice and
humans. With the genomic sequence of both organisms now available, it is
noteworthy that approximately 99% of all human genes have a counterpart in the
mouse genome. 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 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, in vivo,
the physiological and behavioral functions and pharmaceutical utility of the
genes we have knocked out and the potential drug targets they encode.
We believe that the power of our technology has been described in a
large body of scientific literature which was summarized in a retrospective
analysis that we performed of the 100 best selling drugs of 2001 and their
targets, as modeled by the physiological characteristics of knockout mice. This
analysis was published in the January 2003 issue of Nature Reviews Drug
Discovery, a peer-reviewed scientific journal. In this analysis we concluded
that in most cases there was a direct correlation between the physiological
characteristics, or phenotypes, of knockout mice and the therapeutic effect of
the 100 best-selling drugs of 2001.
We are working to discover potential small molecule drugs, therapeutic
antibodies and therapeutic proteins for those in vivo-validated drug targets
that we consider to have high pharmaceutical value. We have established an
internal small molecule drug discovery program, in which we use our own
sophisticated libraries of drug-like chemical compounds in high-throughput
screening assays to identify "hits," or chemical compounds demonstrating
activity, against these targets. We then employ our industrialized medicinal
chemistry platform to optimize the potency and selectivity of these hits and to
identify lead compounds for potential development. Our compound libraries
include chemical scaffolds and building blocks that we designed based on
analyses of the characteristics of drugs that have proven safe and effective in
the past. When we identify a hit, we can rapidly reassemble these building
blocks to create hundreds or thousands of variations around the structure of the
initial compound, enabling us to accelerate our medicinal chemistry efforts.
In all of our drug discovery programs, we use 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 drug candidates in mice. We
believe that by focusing on the physiological functions and pharmaceutical
utility of genes at the outset of the drug discovery process, we will increase
our likelihood of success in discovering breakthrough treatments for human
disease.
OUR TECHNOLOGY
The scope of our gene knockout and evaluative technologies allows us to
create and analyze knockout mice at a rate and on a scale that we believe is
unmatched by our competitors. Combined with our state-of-the-art facilities,
which are among the largest and most sophisticated of their kind in the world,
these technologies provide us with what we believe to be a significant
competitive advantage. The core elements of our technology platform include our
patented technologies for the generation of knockout mice, 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.
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GENE KNOCKOUT TECHNOLOGIES
Gene Targeting. Our gene targeting technology, which is covered by
eight issued patents that we have licensed, enables us to generate highly
specific alterations in targeted genes. The technology uses a vector to replace
DNA of a gene in a mouse embryonic stem cell through a process known as
homologous recombination to disrupt the function of the targeted gene,
permitting the generation of knockout mice. By using this technology in
combination with one or more additional technologies, we are able 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. We can also use this technology to replace the targeted gene with
its corresponding human gene for use for preclinical research in our therapeutic
discovery programs.
Gene Trapping. Our gene trapping technology, which is covered by six
issued patents that we own, is a high-throughput method of generating knockout
mouse clones that we invented. The technology uses genetically engineered
retroviruses that infect mouse embryonic stem cells in vitro, integrate into the
chromosome of the cell and disrupt the function of the gene into which it
integrates, permitting the generation of knockout mice. This process also
stimulates transcription of a non-protein producing 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 embryonic stem cell clone by DNA sequence from the trapped gene
and to select embryonic stem cell clones by DNA sequence for the generation of
knockout mice.
PHYSIOLOGICAL ANALYSIS TECHNOLOGIES
We employ an integrated platform of advanced medical examinations to
rapidly and systematically discover and catalogue the physiological and
behavioral effects resulting from loss of gene function in the mouse knockouts
we have generated using our gene trapping and gene targeting technologies. These
examinations include many of the most sophisticated diagnostic technologies and
tests currently available, many of which might be found in a major medical
center. The following are included among the many tests we use::
- CAT-scans;
- magnetic resonance imaging, or MRI;
- complete blood cell analysis, including red and white blood
cell counts;
- fluorescently activated cell sorting, or FACS, analysis;
- automated behavior analyses;
- nuclear magnetic resonance, or NMR, analysis; and.
- dual energy X-ray absorptiometry.
Each of these technologies has been adapted specifically for the
analysis of mouse physiology. This state-of-the-art technology platform enables
us to assess the consequences of loss of gene function in a living mammal across
a wide variety of parameters relevant to human disease.
We believe that our medical center approach and the technology platform
that makes it possible provide us with substantial advantages over other
approaches to discover gene function and identify novel drug targets. In
particular, we believe that the comprehensive nature of this approach allows us
to uncover functions within the context of mammalian physiology that might be
missed by more narrowly focused efforts. We also believe our approach is more
likely to reveal those side effects that may be a direct result of inhibiting or
otherwise modulating the drug target. Such target-related side effects might
limit the utility of potential therapeutics directed at the drug target or prove
to be unacceptable in light of the potential therapeutic benefit. We believe
these advantages will contribute to better target selection and, therefore, to
the success of our drug discovery and development efforts.
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
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approach will allow us, at an early stage, to identify and optimize therapeutic
candidates for further preclinical and clinical development that demonstrate in
vivo efficacy and to distinguish side effects caused by a specific compound from
the target-related side effects that we defined using the same comprehensive
series of tests.
PRODUCTION AND ANALYSIS INFRASTRUCTURE
Our facilities, which are among the largest and most sophisticated of
their kind in the world, enable us to capitalize on our gene knockout and
physiological analysis technologies by generating knockout mice and analyzing
the physiological function of genes on an expansive scale. We are able to
generate knockout mice for the large number of genes that we believe may be
pharmaceutically important and analyze the physiology of each of those knockout
mice by utilizing our broad range of medical technologies. Our state-of-the-art
animal facilities, occupying a total of approximately 100,000 square feet, are
designed to allow us to generate and analyze approximately 1,000 knockout mice
per year. 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, or Association for Assessment and
Accreditation of Laboratory Animal Care.
Our facilities also enable us to maintain in-house control over our
entire in vivo validation process, from the generation of embryonic stem cell
clones through the completion of in vivo analysis, in a specific pathogen-free
environment. As part of our Genome5000 program, we have already examined the
physiological functions of more than 1,500 genes and expect to complete our
analysis of an aggregate of 5,000 genes by the end of 2007. We are not aware of
any study approaching either the magnitude or breadth of our Genome5000 program,
and we believe that the investment of significant resources over a period of
several years would be required for any competitor to duplicate our gene
knockout and physiological analysis capabilities. The scope of our gene knockout
technology, combined with the size and sophistication of our facilities and our
evaluative technologies, provides us with what we believe to be a significant
competitive advantage.
MEDICINAL CHEMISTRY TECHNOLOGY
We use solution-phase chemistry to generate diverse libraries of
optically pure compounds that are targeted against the same pharmaceutically
relevant gene families that we address in our Genome5000 program. These
libraries are built using highly robust and scalable organic reactions that
allow us to generate compound collections of great diversity and to specially
tailor the compound collections to address various therapeutic target families.
We design these libraries by analyzing the chemical structures of drugs that
have been proven safe and effective against human disease and using that
knowledge in the design of scaffolds and chemical building blocks for the
generation of large numbers of new drug-like compounds. We can rapidly
reassemble these building blocks to generate optimization libraries when we
identify a hit against one of our in vivo-validated targets, enabling us to
rapidly optimize those hits and accelerate our medicinal chemistry efforts.
Our medicinal chemistry technology is housed in a state-of-the-art
76,000 square foot facility in Hopewell, New Jersey. Our lead optimization
chemistry groups are organized around specific discovery targets and work
closely with their pharmaceutical biology counterparts in our facilities in The
Woodlands, Texas. The medicinal chemists optimize lead compounds in order to
select clinical candidates with the desired absorption, distribution,
metabolism, excretion and physicochemical characteristics. We have the
capability to profile our compounds using the same battery of in vivo assays
that we use to characterize our drug discovery targets. This provides us with
valuable detailed information relevant to the selection of the highest quality
compounds for clinical development.
OMNIBANK LIBRARY AND LEXVISION DATABASE
We have capitalized on these core elements of our technology platform
by developing our OmniBank library of gene knockout clones and our LexVision
database cataloging the functions of certain in vivo-validated drug targets.
OmniBank Library. We have used our gene trapping technology in an
automated process to create our OmniBank library of more than 200,000 frozen
gene knockout embryonic stem cell clones, each identified by DNA sequence in a
relational database. Each OmniBank mouse clone contains a single genetic
mutation that can be used to produce knockout models of gene function. We
estimate that our OmniBank library currently contains embryonic stem cell clones
representing more than half of all genes in the mammalian genome and believe it
is the largest
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library of its kind. We believe our OmniBank library permits us to generate
knockout mice at a significantly higher rate than is possible using other
methods and, therefore, provides us with a significant strategic advantage in
the discovery of in vivo gene function and the identification of novel drug
targets.
LexVision Database. Our LexVision database is a comprehensive,
relational database of in vivo-validated drug targets that catalogs the
physiological functions of genes that we have knocked out using our gene
targeting and gene trapping technologies. Our LexVision collaborators obtain
non-exclusive access to the LexVision database for the discovery of small
molecule drugs. We are committed to include 1,250 in vivo-validated drug targets
in our LexVision database over a period of five years. As of December 31, 2003,
we had deposited a total of 750 such targets in our LexVision database.
RESEARCH AND DEVELOPMENT EXPENSES
In 2003, 2002 and 2001, respectively, we incurred expenses of $82.2
million, $74.9 million and $53.4 million in company-sponsored research and
development activities, including $5.0 million, $5.2 million, and $5.5 million,
respectively, of stock-based compensation expense.
OUR COMMERCIALIZATION STRATEGY
We are working both independently and through strategic collaborations
and alliances with leading pharmaceutical and biotechnology companies, research
institutes and academic institutions to commercialize our technology and turn
our discoveries into drugs. Consistent with this approach, we intend to develop
and commercialize certain of our drug discovery programs internally and retain
exclusive rights to the benefits of such programs and to collaborate with third
parties with respect to the development and commercialization of other drug
discovery programs.
We apply our internal resources to our drug discovery programs in order
to commercialize our technology and turn our discoveries into drugs. As we
advance targets into our drug discovery programs, we allocate our internal
resources in a manner designed to maximize our ability to commercialize
opportunities presented by these programs. Our prioritization and allocation of
internal resources among these programs are based on our expectations regarding
their relative likelihood of success and the relevant medical market, as well as
progress realized in our drug discovery efforts for the program. We revise our
prioritization and resource allocation among programs as necessary in order to
capitalize on new discoveries and opportunities.
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 we do not possess internally or is complementary
to our own. These strategic collaborations, as well as our licenses with
pharmaceutical and biotechnology companies, research institutes and academic
institutions, enable us to generate near-term revenues in exchange for access to
some of our technologies and discoveries for use by these third parties in their
own drug discovery efforts. These collaborations and licenses also offer us the
potential, in many cases, to receive milestone payments and royalties on
products that our collaborators and licensees develop using our technology.
ALLIANCES, COLLABORATIONS AND LICENSES
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:
Bristol-Myers Squibb Company. We established a drug discovery alliance
with Bristol-Myers Squibb in December 2003 to discover, develop and
commercialize small molecule drugs in the neuroscience field. In the alliance,
we are contributing a number of neuroscience drug discovery programs at various
stages of development. We will continue to use our gene knockout technology to
identify additional drug targets with promise in the neuroscience field. For
those targets that are selected for the alliance, we and Bristol-Myers Squibb
will work together, on an exclusive basis, to identify, characterize and carry
out the preclinical development of small molecule drugs, and will share equally
both in the costs and in the work attributable to those efforts. As drugs
resulting from
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the alliance enter clinical trials, Bristol-Myers Squibb will have the first
option to assume full responsibility for clinical development and
commercialization.
We received an upfront payment under the agreement and are entitled to
receive research funding during the initial three years of the agreement. We may
receive additional cash payments if we exceed specified research productivity
levels. We will also receive clinical and regulatory milestone payments for each
drug target for which Bristol-Myers Squibb develops a drug under the alliance
and royalties on sales of drugs commercialized by Bristol-Myers Squibb. The
target discovery portion of the alliance has a term of three years, subject to
Bristol-Myers Squibb's option to extend the discovery portion of the alliance
for an additional two years in exchange for further research funding payments.
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 are using our target validation 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 to the discoveries resulting from the collaboration for
the research, development and commercialization of therapeutic proteins and
antibodies. We will retain certain other rights to those discoveries, including
non-exclusive rights, along with Genentech, for the development and
commercialization of small molecule drugs. We received an up-front payment and
are entitled to receive performance payments for our work in the collaboration
as it is completed. We are also entitled to 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 target validation
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 bears 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 collaboration
period, as extended, expires in July 2004, subject to the right of the parties
to extend the term by mutual agreement for up to three additional one-year
periods.
Incyte Corporation. We established a drug discovery alliance with
Incyte in June 2001 to discover novel therapeutic proteins using our target
validation technologies in the discovery of the functions of secreted proteins
identified in Incyte's LifeSeq(R) Gold database. The alliance agreement provides
that up to 250 secreted proteins will be jointly selected for functional
characterization, and we expect 150 to be selected in the first three years.
Under the alliance agreement, we receive research funding from Incyte during the
term of the collaboration. In addition, 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 collaboration period will terminate on June 27, 2004.
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 annual access fees under this
agreement and are entitled to receive milestone payments and royalties on
products Bristol-Myers Squibb develops using our technology. The collaboration
period extends through December 31, 2005, although either party may terminate
the collaboration period on December 31, 2004.
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Incyte Corporation. 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 annual access fees under this agreement, and are entitled to
receive milestone payments and royalties on products Incyte develops using our
technology. The collaboration period will terminate on June 27, 2004.
TARGET VALIDATION COLLABORATIONS
We have established target validation collaboration agreements with a
number of leading pharmaceutical and biotechnology companies. Under these
collaboration agreements, we generate and, in some cases, analyze knockout mice
for genes requested by the collaborator. In addition, we grant non-exclusive
licenses to the collaborator for use of the knockout mice in its internal drug
discovery programs 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 receive fees for knockout mice under these agreements. In
some cases, these agreements also provide for annual subscription fees, annual
minimum commitments and the potential for royalties on products that our
collaborators discover or develop using our technology.
We are generally not pursuing renewals of these agreements as they
expire, and are entering into new agreements on a very limited basis.
E-BIOLOGY COLLABORATION PROGRAM
We provide access to our OmniBank database through the Internet to
subscribing researchers at academic and non-profit research institutions. Our
bioinformatics software allows subscribers to mine our OmniBank database for
genes of interest, and we permit subscribers to acquire OmniBank knockout mice
or embryonic stem cells on a non-exclusive basis in our e-Biology collaboration
program. We receive fees for knockout mice or embryonic stem cells provided to
collaborators in this program and, with participating institutions, rights to
license inventions or to receive royalties on products discovered using our
materials. In all cases we retain rights to use the same OmniBank knockout mice
in our own gene function research and with commercial collaborators. We have
entered into more than 200 agreements under our e-Biology collaboration program
with researchers at leading institutions throughout the world.
TECHNOLOGY LICENSES AND COMPOUND SALES
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 extend for
the life of the patents. Others have terms of one to three years, in some cases
with provisions for subsequent renewals. 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.
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 human genes and partial human and mouse gene
sequences, 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
7
- various enabling technologies in the fields of mutagenesis,
embryonic stem cell manipulation and transgenic or knockout
mice.
We own or have exclusive rights to six issued United States patents
that are directed to our gene trapping technology, 31 issued United States
patents that are directed to full-length sequences of potential drug targets
identified in our gene discovery programs, and five issued United States patents
that are directed to specific knockout mice and discoveries of the functions of
genes made using knockout mice. We have licenses under 64 additional United
States patents, and corresponding foreign patents and patent applications,
directed to gene targeting, gene trapping and genetic manipulation of mouse
embryonic stem cells. These include patents to which we hold exclusive rights in
certain fields, including a total of eight United States patents directed to the
use of gene targeting technologies known as positive-negative selection and
isogenic DNA targeting, as well as patents directed to the use of site specific
genetic recombination technology known as Cre/lox technology.
We have filed or have exclusive rights to more than 600 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, directed to our gene trapping technology, the DNA
sequences of genes, the uses of specific drug targets, drug discovery assays,
and other products and processes. Collectively, these patent applications are
directed to, 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.
As noted above, we hold rights to a number of these patents and patent
applications under license agreements with third parties. In particular, we
license our gene targeting technologies from GenPharm International, Inc. and
our Cre/lox technology from DuPont Pharmaceuticals Company. Many of these
licenses are nonexclusive, although some are exclusive in specified fields. Most
of the licenses, including those from GenPharm and DuPont, have terms that
extend for the life of the licensed patents. In the case of our license from
GenPharm, the license generally is exclusive in specified fields, subject to
specific rights held by third parties, and we are permitted to grant
sublicenses.
All of our employees, consultants and advisors are required to execute
a proprietary information 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 competition
from entities using traditional knockout mouse technology and other
technologies. Several companies, including Regeneron Pharmaceuticals, 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 do. 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.
8
GOVERNMENT REGULATION
REGULATION OF PHARMACEUTICAL PRODUCTS
The development, manufacture and sale of any pharmaceutical or
biological products developed by us or our collaborators will be subject to
extensive regulation by United States and foreign governmental authorities,
including federal, state and local authorities. In the United States, new drugs
are subject to regulation under the Federal Food, Drug and Cosmetic Act and the
regulations promulgated thereunder, or the FDC Act, and biological products are
subject to regulation both under certain provisions of the FDC Act and under the
Public Health Services Act and the regulations promulgated thereunder, or the
PHS Act. The FDA regulates, among other things, the development, preclinical and
clinical testing, manufacture, safety, efficacy, record keeping, reporting,
labeling, storage, approval, advertising, promotion, sale, distribution and
export of drugs and biologics. The process of obtaining FDA approval has
historically been costly and time-consuming.
The standard process required by the FDA before a pharmaceutical or
biological product may be marketed in the United States includes:
- preclinical laboratory and animal tests performed under the
FDA's current Good Laboratory Practices regulations;
- 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.
Among other things, the FDA reviews an NDA to determine whether a
product is safe and effective for its intended use and a BLA to determine
whether a product is safe, pure and potent and the facility in which it is
manufactured, processed, packed, or held meets standards designed to assure the
product's continued safety, purity and potency.
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. Non-compliance with these requirements can
result in, among other things, total or partial suspension of production,
failure of the government to grant approval for marketing and withdrawal,
suspension or revocation of marketing approvals.
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 take
years to complete. In addition, the FDA may place a clinical trial on hold or
terminate it if, among other reasons, the agency concludes that clinical
subjects are being exposed to an unacceptable health risk. After completion of
clinical trials of a new drug or biologic product, FDA marketing approval of the
NDA or BLA must be obtained. An NDA or BLA, depending on the submission, must
contain, among other things, information on chemistry, manufacturing controls
and potency and purity, non-clinical pharmacology and toxicology, human
pharmacokinetics and bioavailability and clinical data. The process of obtaining
approval 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. The FDA's approval of an NDA or BLA can take years and can be
delayed if questions arise. Limited indications for use or other conditions
could also be placed on any approvals that could restrict the commercial
applications of products.
9
Once the FDA approves a product, a manufacturer must provide certain
updated safety and efficacy information. Product changes as well as certain
changes in a manufacturing process or facility would necessitate additional FDA
review and approval. Other post-approval changes may also necessitate further
FDA review and approval. Additionally, a manufacturer must meet other
requirements including those related to adverse event reporting and record
keeping.
Violations of the FDC Act, the PHS Act or regulatory requirements may
result in agency enforcement action, including voluntary or mandatory recall,
license suspension or revocation, product seizure, fines, injunctions and civil
criminal penalties.
In addition to regulatory approvals that must be obtained in the United
States, a drug or biological 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 or
biological product in a country until the regulatory authorities in that country
have approved an appropriate application. 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 or
biological product must also be approved. The pricing review period often begins
after marketing approval is granted. Even if a foreign regulatory authority
approves a drug or biological 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 adversely affect us in the future.
EMPLOYEES AND CONSULTANTS
We believe that our success will be based on, among other things,
achieving and retaining scientific and technological superiority and identifying
and retaining capable management. We have assembled a highly qualified team of
scientists as well as executives with extensive experience in the biotechnology
industry.
As of March 1, 2004, we employed 637 persons, of whom 136 hold M.D.,
Ph.D. or D.V.M. degrees and another 86 hold other advanced degrees. We believe
that our relationship with our employees is good.
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 $35.2 million for the year ended December 31, 2001, $59.7 million for the
year ended December 31, 2002 and $64.2 million for the year ended December 31,
2003. As of December 31, 2003, we had an accumulated deficit of $213.9 million.
We are unsure when we will become profitable, if ever. The size of our net
losses will depend, in part, on the rate of growth, if any, in our revenues and
on the level of our expenses.
We derive substantially all of our revenues from drug discovery
alliances, subscriptions to our LexVision database and our OmniBank library and
collaborations for the development and, in some cases, analysis of the
10
physiological effects of genes altered in knockout mice and technology licenses,
and will continue to do so for the foreseeable future. Our future revenues from
alliances, database subscriptions and collaborations 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 part, on securing new agreements. Our ability to secure future
revenue-generating agreements will depend upon our ability to address the needs
of our potential future 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. Given the early-stage nature of our operations, we do not currently
derive any revenues from sales of pharmaceuticals.
A large portion of our expenses is 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.
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 alliance, database subscription,
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 products that we successfully develop and
commercially launch; and
- the resources we devote to developing and supporting such
products.
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 products and technologies.
We anticipate that our existing capital resources and the revenues we
expect to derive from drug discovery alliances, subscriptions to our databases,
collaborations for the development and, in some cases, analysis of the
physiological effects of genes altered in knockout mice and technology licenses
will enable us to fund our currently planned operations for at least the next
two years. 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 cannot be certain that additional financing,
whether debt or equity, will be available in amounts or on terms acceptable to
us, if at all. 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, and we may not successfully develop or
commercialize any therapeutics or drug targets that we have identified.
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 developing and commercializing drugs based on
our discoveries, in significant part through collaborations and alliances, is
unproven. Our success will depend upon our ability to successfully develop
potential therapeutics for drug targets we consider to have pharmaceutical
value, whether on our own or through collaborations, and to select an
appropriate commercialization strategy for each potential therapeutic we choose
to pursue.
11
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 develop or commercialize
therapeutics or drug targets that we identify, nor have we advanced any drug
candidates to clinical trials. 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 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. Finally, the information that we learn from
knockout mice may prove not to be useful in identifying
pharmaceutically-important drug targets or safe and effective therapies.
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.
We face significant competition in each of the aspects of our business
from companies such as Human Genome Sciences, Inc., Millennium Pharmaceuticals,
Inc., Exelixis, Inc. and other similar companies that engage in programs for the
discovery and development of drugs utilizing a genetics-based approach to target
discovery and validation.
There are a finite number of genes in the human genome, and we believe
that the majority of such genes have been identified and that virtually all will
be identified within the next few years. We face substantial 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. These alternative approaches may
ultimately prove superior, in some or all respects, to the use of knockout mice.
We also face competition from other companies in our efforts to
discover the functions of genes. The Human Genome Project and a large number of
universities and other not-for-profit institutions, many of which are funded by
the United States and foreign governments, are also conducting research to
discover the functions of genes. Competitors could discover and establish
patents on genes or gene products that we identify as promising drug targets,
which might hinder or prevent our ability to capitalize on such targets.
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 our competitors have substantially greater
financial, scientific and human resources than we do. As a result, our
competitors may succeed in developing products earlier than we do, obtaining
regulatory approvals faster than we do and developing products that are more
effective or safer than any that we may develop.
We rely heavily on our collaborators to develop and commercialize pharmaceutical
products based on genes that we identify as promising candidates for development
as drug targets and our collaborators' efforts may fail to yield pharmaceutical
products on a timely basis, if at all.
It is our strategy to develop drug candidates on our own as well as
developing drug candidates in collaboration with third parties, particularly
when such collaborations enable us to obtain access to technology and expertise
that we do not possess internally or is complementary to our own.
Since we do not currently possess the resources necessary to develop,
obtain approvals for or commercialize potential pharmaceutical products based on
all of the genes that we identify as promising candidates for development as
drug targets, we must enter into collaborative arrangements to develop and
commercialize some of these products. We 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.
12
Some of our existing collaboration agreements contain, and
collaborations that we enter into in the future may contain, exclusivity
agreements or other limitations on our activities. These agreements may have the
effect of limiting our flexibility and may cause us to forego attractive
business opportunities.
Cancellations 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. Failures to renew or cancellations by collaborators could mean
a significant loss of revenues and could harm our reputation in the business and
scientific communities.
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. Conflicts with our collaborators could reduce our ability
to obtain future collaboration agreements and could have a negative impact on
our relationship with existing collaborators, materially impairing 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 events could
harm our product development efforts.
We may be unsuccessful 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 these functions. It will be expensive and will require
significant time for us to develop these capabilities internally. 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,
clinical trials or commercial sales and will rely on third parties to
manufacture our potential products, which may harm or delay our product
development and commercialization efforts.
We currently do not have the manufacturing capabilities or experience
necessary to produce materials for preclinical studies, clinical trials or
commercial sales 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 current Good Manufacturing Practices of the United
States Food and Drug Administration, or FDA, which relate to manufacturing and
quality control activities. 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. In addition, there are a limited number of
manufacturers that operate under the FDA's current Good Manufacturing Practices
and that are capable of producing such materials, and we may experience
difficulty finding manufacturers with adequate capacity for our needs. If we are
unable to contract for the production of sufficient quantity and quality of
materials on acceptable terms, our product development and commercialization
efforts may be delayed. Moreover, noncompliance with the FDA's current Good
Manufacturing Practices can result in, among other things, fines, injunctions,
civil and criminal penalties, product recalls or seizures, suspension of
production, failure to obtain marketing approval and withdrawal, suspension or
revocation of marketing approvals.
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
13
expenditures and may not be achieved in a timely and non-disruptive manner, if
at all, and may absorb significant management attention that would otherwise be
available for ongoing development of our business. If we fail to integrate
acquired businesses, technologies or products effectively or if key employees of
an acquired business leave, the anticipated benefits of the acquisition would be
jeopardized. Moreover, we may never realize the anticipated benefits of any
acquisition, such as increased revenues and earnings or enhanced business
synergies. 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 materially
impair 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 could
negatively impact 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 at will. In addition, 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 intense. Failure to recruit and retain
scientific personnel on acceptable terms could prevent us from achieving our
business objectives.
Because all of our target validation operations are located at a single
facility, the occurrence of a disaster could significantly disrupt our business.
Our OmniBank mouse clone library and its backup 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,
mechanical failure 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.
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 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.
RISKS RELATED TO OUR INDUSTRY
Our ability to patent our inventions 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 or use a particular technology or product. No clear
policy has emerged regarding the scope of protection provided in biotechnology
patents. The biotechnology patent situation outside the United States is
similarly uncertain. Changes in, or different interpretations of, patent laws in
the United States or other countries might allow others to use our inventions or
to develop and commercialize any technologies or products that we may develop
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 patent rights and, as a result, the
protection afforded to our scientific discoveries may be insufficient.
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 use for the gene or gene sequences sufficient to meet the
statutory requirements that an invention have utility and that a patent
application enable one to make and use the invention. While the United States
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 covering any potential human therapeutic products that we may develop.
If required, obtaining such biologic data could delay, add substantial costs to,
or affect our ability to obtain patent protection for such products. 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.
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 United States
Patent and Trademark Office. We believe that these court decisions and the
uncertain position of the United States Patent and Trademark Office present a
significant risk that the United States Patent and Trademark Office will not
issue patents based on patent disclosures limited to partial gene sequences. 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 relating to our drug target
or product candidate discoveries, we may be unable to obtain patents for our
inventions based upon those discoveries and may be blocked from using or
developing some of our technologies and products.
Many other entities have filed or may file patent applications on genes
or gene sequences, uses of those genes or gene sequences, gene products and drug
targets, assays for identifying potential therapeutic products, potential
therapeutic products and methods of treatment which are identical or similar to
some of our filings. Some of these applications attempt to assign biologic
function to the genes and proteins based on predictions of function based upon
similarity to other genes and proteins or patterns of gene expression. There is
the significant possibility that patents claiming the functional uses of such
genes and gene products will be issued to our competitors based on such
information. If any such patents are issued to other entities, we will be unable
to obtain patent protection for the same or similar discoveries that we make.
Moreover, we may be blocked from using or developing some of our existing or
proposed technologies and products, or may be required to obtain a license that
may not be available on reasonable terms, if at all.
15
Alternatively, the United States 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 this event, the
prevailing party may require us or our collaborators to stop using a particular
technology or pursuing a potential product or may require us to negotiate a
license arrangement to do so. We may not be able to obtain a license from the
prevailing party on acceptable terms, or at all.
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. The entire human genome and the entire mouse genome
are now publicly known. These public disclosures might limit the scope of our
claims or make unpatentable subsequent patent applications on partial or
full-length genes or their uses.
Issued or pending patents may not fully protect our discoveries, and our
competitors may be able to commercialize technologies or products similar to
those covered by our issued or pending patents.
Pending patent applications do not provide protection against
competitors because they are not enforceable until they issue as patents. Issued
patents may not provide commercially meaningful protection. If anyone infringes
upon our or our collaborators' patent rights, enforcing these rights may be
difficult, costly and time-consuming and, as a result, it may not be
cost-effective or otherwise expedient to pursue litigation to enforce those
patent rights. Others may be able to design around these patents or develop
unique products providing effects similar to any products that we may develop.
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 United States Patent and Trademark Office or a legal action.
In addition, others may discover uses for genes, drug targets or
therapeutic products other than those covered in our issued or pending patents,
and these other uses may be separately patentable. Even if we have a patent
claim on a particular gene, drug target or therapeutic product, the holder of a
patent covering the use of that gene, drug target or therapeutic product could
exclude us from selling a product that is based on the same use of that product.
We may be involved in patent litigation and other disputes regarding
intellectual property rights and may require licenses from third parties for our
discovery and development and planned commercialization activities. We may not
prevail in any such litigation or other dispute or be able to obtain required
licenses.
Our discovery and development efforts as well as 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 and institutions obtain more patents covering the
sequences, functions and uses of genes and the drug targets they encode. We are
aware that other companies and institutions have conducted research on many of
the same targets that we have identified and have filed patent applications
potentially covering many of the genes and encoded drug targets that are the
focus of our drug discovery programs. In some cases, patents have issued from
these applications. In addition, many companies and institutions 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 engaging in
certain discovery or development activities or from manufacturing and marketing
any resulting therapeutic products. If any of these actions are successful, in
addition to our potential liability for damages, these entities would likely
require us or our collaborators to obtain a license in order to continue
engaging in the infringing activities or to manufacture or market the resulting
therapeutic products or may force us to terminate such activities or
manufacturing and marketing efforts.
We may need to pursue litigation against others to enforce our patents
and intellectual property rights and may be the subject of litigation brought by
third parties to enforce their patent and intellectual property rights. In
addition, we may become involved in litigation based on intellectual property
indemnification undertakings that we have given to certain of our collaborators.
Patent litigation is expensive and requires substantial amounts of management
attention. The eventual outcome of any such litigation is uncertain and involves
substantial risks.
We believe that there will continue to be significant litigation in our
industry regarding patent and other intellectual property rights. We have
expended and many of our competitors have expended and are continuing to expend
significant amounts of time, money and management resources on intellectual
property litigation. If we
16
become involved in future intellectual property litigation, it could consume a
substantial portion of our resources and could negatively affect our results of
operations.
Furthermore, in light of recent United States Supreme Court precedent,
our ability to enforce our patents against state agencies, including state
sponsored universities and research laboratories, is limited by the Eleventh
Amendment to the United States Constitution. In addition, opposition by
academicians and the government may hamper our ability to enforce our patents
against academic or government research laboratories. Finally, enforcement of
our patents may cause our reputation in the academic community to be injured.
We use intellectual property that we license from third parties. If we do not
comply with these licenses, we could lose our rights under them.
We rely, in part, on licenses to use certain technologies that are
important to our business, such as gene targeting and conditional knockout
technologies. 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 abiding by the terms of those licenses and the
licensors not terminating them. We are currently in compliance with all
requirements of these licenses. In many cases, we do not control the filing,
prosecution or maintenance of the patent rights to which we hold licenses and
rely upon our licensors to prosecute infringement of those rights. The scope of
our rights under our licenses may be subject to dispute by our licensors or
third parties.
We have not sought patent protection outside of the United States for some of
our inventions, and some of our licensed patents only provide coverage in the
United States. As a result, our international competitors could be granted
foreign patent protection with respect to our discoveries.
We have decided not to pursue patent protection with respect to some of
our inventions 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, genes or gene sequences, uses of those genes or gene sequences, gene
products and drug targets, assays for identifying potential therapeutic
products, potential therapeutic products and methods of treatment for which we
are seeking United States patent protection. In addition, most of our gene
trapping patents and our licensed gene targeting patents cover only the United
States and do not apply to discovery activities conducted outside of the United
States or, in some circumstances, to importing into the United States products
developed using this technology.
We may be unable to protect our trade secrets.
Significant aspects of our intellectual property are not protected by
patents. As a result, we seek to protect the proprietary nature of this
intellectual property as trade secrets through proprietary information
agreements and other measures. While we have entered into proprietary
information agreements with all of our employees, consultants, advisers 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.
Our efforts to discover, evaluate and validate potential targets for drug
intervention and our drug discovery programs are subject to evolving data and
other risks inherent in the drug discovery process.
We are employing our knockout technology and integrated drug discovery
platform to systematically discover, evaluate and validate potential targets for
drug intervention and to develop drugs to address those targets. The drug
discovery and development process involves significant risks of delay or failure
due, in part, to evolving data and the uncertainties involved with the
applications of new technologies. As we refine and advance our efforts, it is
likely that the resulting data will cause us to change our targets from time to
time and, therefore, that the targets that we believe at any time to be
promising may prove not to be so. These developments can occur at any stage of
the drug discovery and development process.
17
Our industry is subject to extensive and uncertain government regulatory
requirements, which could significantly hinder our ability, or the ability of
our collaborators, to obtain, in a timely manner or at all, government approval
of products based on genes that we identify, or to commercialize such products.
We or our collaborators must obtain approval from the FDA in order to
conduct clinical trials and sell our future product candidates in the United
States and from foreign regulatory authorities in order to conduct clinical
trials and sell our future product candidates in other countries. In order to
obtain regulatory approvals for the commercial sale of any products that we may
develop, we will be required to complete extensive clinical trials in humans to
demonstrate the safety and efficacy of our drug candidates. We or our
collaborators may not be able to obtain authority from the FDA or other
equivalent foreign regulatory agencies to initiate or complete any clinical
trials. In addition, we have limited internal resources for making regulatory
filings and dealing with regulatory authorities.
The results from preclinical testing of a drug candidate that is under
development may not be predictive of results that will be obtained in human
clinical trials. In addition, the results of early human clinical trials may not
be predictive of results that will be obtained in larger scale, advanced stage
clinical trials. A number of companies in the pharmaceutical industry have
suffered significant setbacks in advanced clinical trials, even after achieving
positive results in earlier trials. Negative or inconclusive results from a
preclinical study or a clinical trial could cause us, one of our collaborators
or the FDA to terminate a preclinical study or clinical trial or require that we
repeat it. Furthermore, we, one of our collaborators or a regulatory agency with
jurisdiction over the trials may suspend clinical trials at any time if the
subjects or patients participating in such trials are being exposed to
unacceptable health risks or for other reasons.
Any preclinical or clinical test may fail to produce results
satisfactory to the FDA or foreign regulatory authorities. Preclinical and
clinical data can be interpreted in different ways, which could delay, limit or
prevent regulatory approval. The FDA or institutional review boards at the
medical institutions and healthcare facilities where we sponsor clinical trials
may suspend any trial indefinitely if they find deficiencies in the conduct of
these trials. Clinical trials must be conducted in accordance with the FDA's
current Good Clinical Practices. The FDA and these institutional review boards
have authority to oversee our clinical trials, and the FDA may require large
numbers of test subjects. In addition, we must manufacture, or contract for the
manufacture of, the product candidates that we use in our clinical trials under
the FDA's current Good Manufacturing Practices.
The rate of completion of clinical trials is dependent, in part, upon
the rate of enrollment of patients. Patient accrual is a function of many
factors, including the size of the patient population, the proximity of patients
to clinical sites, the eligibility criteria for the study, the nature of the
study, the existence of competitive clinical trials and the availability of
alternative treatments. Delays in planned patient enrollment may result in
increased costs and prolonged clinical development, which in turn could allow
our competitors to bring products to market before we do and impair our ability
to commercialize our products or potential products.
We or our collaborators may not be able to successfully complete any
clinical trial of a potential product within any specified time period. In some
cases, we or our collaborators may not be able to complete the trial at all.
Moreover, clinical trials may not show our potential products to be both safe
and effective. Thus, the FDA and other regulatory authorities may not approve
any products that we develop for any indication or may limit the approved
indications or impose other conditions.
If our potential products receive regulatory approval, we or our collaborators
will remain subject to extensive and rigorous ongoing regulation.
If we or our collaborators obtain initial regulatory approvals from the
FDA or foreign regulatory authorities for any products that we may develop, we
or our collaborators will be subject to extensive and rigorous ongoing domestic
and foreign government regulation of, among other things, the research,
development, testing, manufacture, labeling, promotion, advertising,
distribution and marketing of our products and product candidates. The failure
to comply with these requirements or the identification of safety problems
during commercial marketing could lead to the need for product marketing
restrictions, product withdrawal or recall or other voluntary or regulatory
action, which could delay further marketing until the product is brought into
compliance. The failure to comply with these requirements may also subject us or
our collaborators to stringent penalties.
18
Moreover, several of our product development areas 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 any products that we may develop could limit our ability to test,
manufacture and, ultimately, commercialize such products.
The uncertainty of pharmaceutical pricing and reimbursement may decrease the
commercial potential of any products that we or our collaborators may develop
and affect our ability to raise capital.
Our ability and the ability of our collaborators to successfully
commercialize pharmaceutical products will 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 United States, 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 United States has increased 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, our ability to
establish corporate collaborations would be impaired. 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 profitable basis.
We use hazardous chemicals and radioactive and biological materials in our
business; any disputes relating to improper handling, storage or disposal of
these materials could be time consuming and costly.
Our research and development processes involve the use of hazardous
materials, including chemicals and radioactive and biological materials. Our
operations also produce hazardous waste products. We cannot eliminate the risk
of accidental contamination or discharge or any resultant injury from these
materials. Federal, state and local laws and regulations govern the use,
manufacture, storage, handling and disposal of these materials. We could be
subject to civil damages in the event of an improper or unauthorized release of,
or exposure of individuals to, these hazardous materials. In addition, claimants
may sue us for injury or contamination that results from our use or the use by
third parties of these materials, and our liability may exceed our total assets.
Compliance with environmental laws and regulations may be expensive, and current
or future environmental regulations may impair our research, development or
production efforts. We do not currently maintain insurance coverage that would
cover these types of environmental liabilities.
We may be sued for product liability.
We or our collaborators may be held liable if any product that we or
our collaborators develop, or any product that 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. Our 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.
19
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 reduce the likelihood of
maintaining 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 76,000 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 embryonic stem cell clones
through the completion of in vivo analysis, in a specific pathogen free
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. Because of the size and
sophistication of our facilities, it would require the investment of significant
resources over an extended period of time for any competitor to develop
facilities with the scale, efficiency and productivity with respect to the
analysis of the functionality of genes that our facilities provide.
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 1.16%, the total lease
payments for our facilities would be approximately $0.8 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
$54.8 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.
In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc.
entered into a lease for a 76,000 square-foot facility in Hopewell, New Jersey.
The term of the lease extends until June 30, 2013. The lease provides for an
escalating yearly base rent payment of $1.3 million in the first year, $2.1
million in years two and three, $2.2 million in years four to six, $2.3 million
in years seven to nine and $2.4 million in years ten and eleven. We are the
guarantor of the obligations of our subsidiary under the lease.
We believe that our facilities are well-maintained, in good operating
condition and acceptable for our current operations.
20
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, 2003.
21
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
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
2003
First Quarter................................................................... $ 5.22 $ 3.16
Second Quarter.................................................................. $ 6.60 $ 4.05
Third Quarter................................................................... $ 7.28 $ 4.50
Fourth Quarter.................................................................. $ 6.14 $ 5.07
As of March 8, 2004, there were approximately 257 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.
22
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data for the years ended December 31, 2003,
2002 and 2001 and the balance sheet data as of December 31, 2003 and 2002 have
been derived from our audited financial statements included elsewhere in this
annual report on Form 10-K. The statements of operations data for the years
ended December 31, 2000 and 1999, and the balance sheet data as of December 31,
2001, 2000 and 1999 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 has 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,
------------ ------------ ------------ ------------- ----------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------- ----------
STATEMENTS OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues........................................... $ 42,838 $ 35,200 $ 30,577 $ 14,459 $ 4,738
Operating expenses:
Research and development, including stock-based
compensation of $5,048 in 2003, $5,155 in
2002, $5,539 in 2001 and $10,883 in 2000...... 82,198 74,859 53,355 31,647 14,646
General and administrative, including stock-based
compensation of $5,067 in 2003, $5,113 in 2002,
$5,231 in 2001 and $9,958 in 2000............. 23,233 23,234 20,861 18,289 2,913
---------- ---------- ---------- ---------- ----------
Total operating expenses........................... 105,431 98,093 74,216 49,936 17,559
---------- ---------- ---------- ---------- ----------
Loss from operations............................... (62,593) (62,893) (43,639) (35,477) (12,821)
Interest and other income, net..................... 1,471 3,223 8,467 9,483 346
---------- ---------- ---------- ---------- ----------
Net loss before cumulative effect of a change in
accounting principle............................. (61,122) (59,670) (35,172) (25,994) (12,475)
Cumulative effect of a change in accounting
principle.......................................... (3,076) - - - -
---------- ---------- ---------- ---------- ----------
Net loss........................................... (64,198) (59,670) (35,172) (25,994) (12,475)
Accretion on redeemable convertible preferred stock - - - (134) (536)
---------- ---------- ---------- ---------- ----------
Net loss attributable to common stockholders....... $ (64,198) $ (59,670) $ (35,172) $ (26,128) $ (13,011)
========== ========== ========== ========== ==========
Net loss per common share basic and diluted:
Net loss before cumulative effect of a change
in accounting principle....................... $ (1.08) $ (1.14) $ (0.70) $ (0.63) $ (0.53)
Cumulative effect of a change in
accounting principle.......................... (0.05) - - - -
---------- ---------- ---------- ---------- ----------
Net loss per common share, basic and diluted....... $ (1.13) $ (1.14) $ (0.70 $ (0.63) $ (0.53)
========== ========== ========== =========== ==========
Shares used in computing net loss per common
share, basic and diluted...................... 56,820 52,263 50,213 41,618 24,530
------------------------------------------------------------
AS OF DECEMBER 31,
------------ ------------ ----------- ------------ ---------
2003 2002 2001 2000 1999
----------- ----------- ---------- ----------- ---------
BALANCE SHEET DATA: (IN THOUSANDS)
Cash, cash equivalents and investments, including
restricted cash and investments of $57,514 in 2003,
$57,710 in 2002, $43,338 in 2001 and $13,879 in 2000. $ 161,001 $ 123,096 $ 166,840 $ 202,680 $ 9,156
Working capital......................................... 139,739 111,833 147,663 194,801 2,021
Total assets............................................ 284,199 201,772 239,990 220,693 22,295
Long-term debt, net of current portion.................. 56,344 4,000 -- 1,834 3,577
Redeemable convertible preferred stock.................. -- -- -- -- 30,050
Accumulated deficit..................................... (213,943) (149,745) (90,075) (54,903) (28,909)
Stockholders' equity (deficit).......................... 166,216 169,902 218,372 207,628 (21,937)
23
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 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 Bristol-Myers Squibb Company to discover and develop novel small
molecule drugs in the neuroscience field; 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 Corporation 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 drug discovery
alliances, subscriptions to our databases, target validation 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, 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
collaborations, alliances and database subscriptions 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 offer subscriptions to our databases or 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 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, 2003, we had an accumulated deficit of $213.9 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,
24
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 target validation 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 target validation 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, 2003 we had net operating loss carryforwards of
approximately $131.8 million. We also had research and development tax credit
carryforwards of approximately $8.1 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 target validation resources
are recognized ratably over the subscription or access period. Payments received
under target validation collaborations are recognized as revenue as we perform
our obligations related to such research to the extent such fees are
non-refundable. Non-refundable upfront fees and annual research funding under
our drug discovery alliances are recognized as revenue on a straight-line basis
over the estimated period of service, generally the contractual research term.
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.
Prior to preclinical development work, we are unable to segregate the
costs related to research performed on drug candidates because the drug
candidate is often not specifically identified until the later stages of our
research. When we begin the formal preclinical process in preparation for filing
an IND, we intend to account on a program by program basis for the costs related
to the development of the identified candidate. To date, we have not advanced
any drug products into formal preclinical development.
GOODWILL IMPAIRMENT
Goodwill is not amortized, but is tested at least annually for
impairment at the reporting unit level. We have determined that the reporting
unit is the single operating segment disclosed in our current financial
statements. Impairment is the condition that exists when the carrying amount of
goodwill exceeds its implied fair value. The
25
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. We
determined that the market capitalization approach is the most appropriate
method of measuring fair value of the reporting unit. Under this approach, fair
value is calculated as the average closing price of our common stock for the 30
days preceding the date that the annual impairment test is performed, multiplied
by the number of outstanding shares on that date. A control premium, which is
representative of premiums paid in the marketplace to acquire a controlling
interest in a company, is then added to the market capitalization to determine
the fair value of the reporting unit. 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 2003.
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 is applicable to agreements entered into in fiscal periods
beginning after June 15, 2003. The adoption of EITF 00-21 did not have a
material impact on our financial statements.
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 No. 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 No. 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. We have elected to continue to follow the intrinsic value
method of accounting as prescribed by Accounting Principles Board Opinion No. 25
(or APB 25), "Accounting for Stock Issued to Employees," to account for employee
stock options.
In January 2003, the FASB issued Interpretation No. 46, or FIN 46,
"Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51."
FIN 46 was revised in December 2003. It 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 applied immediately to variable interest entities
created after January 31, 2003, but was effective for the period ending December
31, 2003 for variable interest entities created before February 1, 2003. We
adopted FIN 46 on December 31, 2003 and determined that the lessor under the
synthetic lease is a variable interest entity as defined by FIN 46, and that we
absorb a majority of the variable interest entity's expected losses.
Accordingly, we consolidated the assets of the variable interest entity, which
were comprised of property and improvements funded under the synthetic lease.
These assets had a carrying value of $54.8 million, net of accumulated
depreciation of $3.1 million on December 31, 2003. We also consolidated the
variable interest entity's debt of $52.3 million and non-controlling interests
of $2.5 million. Additionally, we recorded a cumulative effect of a change in
accounting principle equal to the accumulated depreciation of $3.1 million for
the period from the date the buildings were placed in service under the
synthetic lease through December 31, 2003. These improvements will be
depreciated over their useful lives. Due to our residual value guarantee on the
property, the non-recourse feature of the underlying debt, and certain other
provisions of the lease arrangement, we do not allocate any of the variable
interest entity's depreciation or interest expenses to the non-controlling
interest. As permitted by applicable accounting standards, we had previously
accounted for our involvement with the variable interest entity as an operating
lease.
26
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003 AND 2002
Revenues. Total revenues and dollar and percentage changes as compared
to the prior year are as follows (dollar amounts are presented in millions):
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002
---------------- --------------
Total revenues............................. $ 42.8 $ 35.2
Dollar increase............................ $ 7.6
Percentage increase........................ 22%
- Subscription and license fees - Revenue from
subscriptions and license fees increased 21% to $21.6
million due to additional technology licenses granted
to pharmaceutical and biotechnology companies in
2003.
- Collaborative research - Revenue from collaborative
research increased 24% to $21.2 million primarily due
to increased revenue under our drug discovery
alliances with Genentech and Bristol-Myers Squibb,
offset in part by a decrease in revenues from target
validation collaborations due to the scheduled
conclusion of many of these arrangements.
- Compound libraries and other - Revenue from compound
library sales and other decreased 81% to $46,000 due
to the fact that we are not making our compound
libraries available for purchase, subject to limited
exceptions. We may, however, provide additional
quantities of selected compounds or optimization
services under existing compound sales agreements.
In 2003, Incyte Corporation, Amgen, Inc., Bristol-Myers Squibb Company
and Genentech, Inc. represented 23%, 15%, 14% and 14% of revenues, respectively.
In 2002, Incyte, Bristol-Myers Squibb Company and Millennium Pharmaceuticals,
Inc. represented 28%, 14% and 11% of revenues, respectively.
Research and Development Expenses. Research and development expenses
and dollar and percentage changes as compared to the prior year are as follows
(dollar amounts are presented in millions):
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002
---------------- --------------
Total research and development expense..... $ 82.2 $ 74.9
Dollar increase............................ $ 7.3
Percentage increase........................ 10%
Research and development expenses consist primarily of salaries and
other personnel-related expenses, stock-based compensation expenses, laboratory
supplies, facility and equipment costs, consulting and other services. The
change in 2003 as compared to 2002 resulted primarily from the following costs:
- Personnel - Personnel costs increased 14% to $35.0
million primarily due to increased personnel to
support the expansion of our drug discovery programs,
merit pay increases for employees and increasing
employee benefit costs. Salaries, bonuses, employee
benefits, payroll taxes, recruiting and relocation
costs are included in personnel costs.
- Stock-based compensation - Stock based compensation
expense, primarily relating to option grants made
prior to our April 2000 initial public offering,
decreased 2% to $5.0 million.
- Laboratory supplies - Laboratory supplies expense
increased 5% to $11.1 million due primarily to an
increase in drug discovery activities such as high
throughput screening.
27
- Facilities and equipment - Facility and equipment
costs increased 13% to $19.8 million primarily due to
increased rent resulting from the May 2002 lease of
our facility in Hopewell, New Jersey and increased
property taxes on our facilities in The Woodlands,
Texas. Additionally, depreciation expense increased
as a result of purchases of capital equipment and
leasehold improvements.
- Consulting and other services - Consulting and other
services decreased by 1% to $7.7 million. Consulting
and other services include subscriptions to
third-party databases, technology licenses and legal
and patent fees.
- Other - Other costs increased by 17% to $3.6 million.
General and Administrative Expenses. General and administrative
expenses and dollar and percentage changes as compared to the prior year are as
follows (dollar amounts are presented in millions):
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002
---------------- --------------
Total general and administrative expense... $ 23.2 $ 23.2
Dollar increase............................ $ --
Percentage increase........................ --
General and administrative expenses consist primarily of personnel
costs to support our research activities, stock-based compensation expense,
facility and equipment costs and professional fees, such as legal fees. The
change in 2003 as compared to 2002 resulted primarily from the following costs:
- Personnel - Personnel costs decreased 4% to $10.6
million primarily due to decreased staffing in
overhead departments. Salaries, bonuses, employee
benefits, payroll taxes, recruiting and relocation
costs are included in personnel costs.
- Stock-based compensation - Stock based compensation
expense, primarily relating to option grants made
prior to our April 2000 initial public offering,
decreased 1% to $5.1 million.
- Facilities and equipment - Facility and equipment
costs increased 12% to $3.6 million primarily due to
increased rent resulting from the May 2002 lease of
our facility in Hopewell, New Jersey and increased
property taxes on our facilities in The Woodlands,
Texas.
- Professional fees - Professional fees increased 43%
to $1.6 million primarily due to increased legal
fees.
- Other - Other costs increased 13% to $2.3 million.
Interest and Other Income. Interest and other income decreased 44% to
$1.8 million in 2003 from $3.2 million in 2002. This decrease resulted primarily
from lower average cash and investment balances and lower average interest rates
on our investments.
Net Loss and Net Loss Per Common Share Before Cumulative Effect of a
Change in Accounting Principle. Net loss before a change in accounting principle
increased to $61.1 million in 2003 from $59.7 million in 2002. Net loss per
common share before a change in accounting principle decreased to $1.08 in 2003
from $1.14 in 2002. Net loss before a change in accounting principle includes
stock-based compensation expense of $10.1 million and $10.3 million in 2003 and
2002, respectively.
Change In Accounting Principle. As discussed in "Recent Accounting
Pronouncements" above, we adopted FIN 46 on December 31, 2003 and determined
that the lessor under the synthetic lease is a variable interest entity as
defined by FIN 46, and that we absorb a majority of the variable interest
entity's expected losses. Accordingly, we recorded a cumulative effect of a
change in accounting principle equal to the accumulated depreciation of
28
$3.1 million for the period from the date the buildings were placed in service
under the synthetic lease through December 31, 2003.
Net Loss and Net Loss Per Common Share. Net loss increased to $64.2
million in 2003 from $59.7 million in 2002. Net loss per common share decreased
to $1.13 in 2003 from $1.14 in 2002.
YEARS ENDED DECEMBER 31, 2002 AND 2001
Revenues. Total revenues and dollar and percentage changes as compared
to the prior year are as follows (dollar amounts are presented in millions):
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001
---------------- --------------
Total revenues............................. $ 35.2 $ 30.6
Dollar increase............................ $ 4.6
Percentage increase........................ 15%
- Subscription and license fees - Revenue from
subscriptions and license fees increased 21% to $17.9
million due to subscriptions to our LexVision
database.
- Collaborative research - Revenue from collaborative
research increased 52% to $17.1 million primarily due
to increased revenue from target validation
collaborations and our drug discovery alliance with
Incyte.
- Compound libraries and other - Revenue from compound
library sales and other decreased 95% to $0.2 million
due to the fact that 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. We may, however, provide additional
quantities of selected compounds or optimization
services under existing compound sales agreements.
In 2002, Incyte, Bristol-Myers Squibb and Millennium Pharmaceuticals
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
and dollar and percentage changes as compared to the prior year are as follows
(dollar amounts are presented in millions):
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001
---------------- --------------
Total research and development expense..... $ 74.9 $ 53.4
Dollar increase............................ $ 21.5
Percentage increase........................ 40%
Research and development expenses consist primarily of salaries and
other personnel-related expenses, stock-based compensation expenses, laboratory
supplies, facility and equipment costs, consulting and other services. The
change in 2002 as compared to 2001 resulted primarily from the following costs:
- Personnel - Personnel costs increased 35% to $30.8
million primarily due to increased personnel to
support the expansion of our drug discovery programs,
a full year of medicinal chemistry operations and
merit pay increases for employees. Salaries, bonuses,
employee benefits, payroll taxes, recruiting and
relocation costs are included in personnel costs.
- Stock-based compensation - Stock based compensation
expense, primarily relating to option grants made
prior to our April 2000 initial public offering,
decreased 7% to $5.2 million.
29
- Laboratory supplies - Laboratory supplies expense
increased 28% to $10.6 million due primarily to an
increase in drug discovery activities and a full year
of medicinal chemistry operations.
- Facilities and equipment - Facility and equipment
costs increased 98% to $17.5 million due to increased
rent, maintenance costs and property taxes resulting
from our expansion in 2002 into additional facilities
in The Woodlands, Texas and a full year of medicinal
chemistry operations. Additionally, depreciation
expense increased as a result of purchases of capital
equipment and leasehold improvements.
- Consulting and other services - Consulting and other
services increased by 83% to $7.7 million, primarily
due to increased fees related to third party database
subscriptions. Consulting and other services include
subscriptions to third-party databases, technology
licenses and legal and patent fees.
- Other - Other costs decreased 17% to $3.1 million.
General and Administrative Expenses. General and administrative
expenses and dollar and percentage changes as compared to the prior year are as
follows (dollar amounts are presented in millions):
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001
---------------- --------------
Total general and administrative expense... $ 23.2 $ 20.9
Dollar increase............................ $ 2.3
Percentage increase........................ 11%
General and administrative expenses consist primarily of personnel
costs to support our research activities, stock-based compensation expense,
facility and equipment costs and professional fees, such as legal fees. The
change in 2002 as compared to 2001 resulted primarily from the following costs:
- Personnel - Personnel costs increased 59% to $11.1
million primarily due to increased personnel to
support our research activities and merit pay
increases for employees. Salaries, bonuses, employee
benefits, payroll taxes, recruiting and relocation
costs are included in personnel costs.
- Stock-based compensation - Stock based compensation
expense, primarily relating to option grants made
prior to our April 2000 initial public offering,
decreased 2% to $5.1 million
- Facilities and equipment - Facility and equipment
costs increased 81% to $3.2 million primarily due to
increased rent and property taxes resulting from the
expansion in 2002 into additional facilities in The
Woodlands, Texas.
- Professional fees - Professional fees decreased 73%
to $1.1 million primarily due to a reduction in legal
costs as a result of the September 2001 settlement of
our patent infringement litigation against Deltagen,
Inc.
- Other - Other costs increased 1% to $2.7 million.
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 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. Net loss includes stock-based compensation
expense of $10.3 million and $10.8 million in 2002 and 2001, respectively.
30
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,
2003, we had received net proceeds of $293.1 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 and $50.1 million from our
July 2003 common stock offering. In addition, from our inception through
December 31, 2003, we received $172.2 million in cash payments from database
subscription and technology license fees, drug discovery alliances, target
validation collaborations, sales of compound libraries and reagents and
government grants, of which $131.3 million had been recognized as revenues
through December 31, 2003.
As of December 31, 2003, we had $161.0 million in cash, cash
equivalents and short-term investments (including $57.5 million of restricted
cash and investments), as compared to $123.1 million (including $57.7 million of
restricted cash and investments) as of December 31, 2002. We used cash of $7.7
million in operations in 2003. This consisted primarily of the net loss for the
year of $64.2 million offset by non-cash charges of $10.1 million related to
stock-based compensation expense, $10.2 million related to depreciation expense,
$3.1 million related to the cumulative effect of a change in accounting
principle and $1.2 million related to amortization of intangible assets other
than goodwill; a $29.0 million increase in deferred revenue; and changes in
other operating assets and liabilities of $2.8 million. Financing activities
provided cash of $50.4 million, consisting primarily of the $50.1 million in net
proceeds from our July 2003 common stock offering.
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 year-end LIBOR rate of 1.16%, our total lease
payments would be approximately $0.8 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 $54.8 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 $54.8 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, 2003 and 2002, we maintained
restricted cash and investments of $57.0 million and $57.2 million,
respectively, to collateralize funding for property and improvements under the
synthetic lease of $54.8 million and $55.0 million.
We are considering replacing our synthetic lease agreement covering all
of our facilities in The Woodlands, Texas, and we are currently engaged in
discussions to do so. We expect that any such new arrangement would require us
to maintain substantially lower amounts of restricted cash and investments while
increasing our lease payments with respect to these facilities, as compared to
our synthetic lease agreement.
In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc.
entered into a lease for a 76,000 square-foot facility in Hopewell, New Jersey.
The term of the lease extends until June 30, 2013. The lease provides for an
escalating yearly base rent payment of $1.3 million in the first year, $2.1
million in years two and three, $2.2
31
million in years four to six, $2.3 million in years seven to nine and $2.4
million in years ten and eleven. 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, 2003:
---------------------------------------------------------
PAYMENTS DUE BY PERIOD (IN MILLIONS)
---------------------------------------------------------
LESS THAN MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
--------- ---------- --------- --------- ----------
Long-term debt................................ $ 56.3 $ -- $ 56.3 $ -- $ --
Other long-term liabilities................... 2.5 -- 2.5 -- --
Interest payment obligations.................. 2.6 0.8 1.8 -- --
Operating leases.............................. 22.0 2.2 4.4 4.6 10.8
Obligations under purchase orders............. 1.9 1.9 -- -- --
------ ------ ------ ------ ------
Total..................................... $ 85.3 $ 4.9 $ 65.0 $ 4.6 $ 10.8
====== ====== ====== ====== ======
Our future capital requirements will be substantial and will depend on
many factors, including our ability to obtain 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, target validation collaborations, technology
licenses and drug discovery alliances will be sufficient to fund our operations
at least through the next two years. 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 are exposed to interest rate risk because our synthetic lease
payments fluctuate based upon LIBOR rates. A hypothetical 1% increase in LIBOR
rates would result in $0.5 million of additional interest expense under the
lease.
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.
32
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 LLP 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.
ITEM 9A. CONTROLS AND PROCEDURES
Our chief executive officer and chief financial officer have concluded
that our disclosure controls and procedures (as defined in rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are sufficiently effective
to ensure that the information required to be disclosed by us in the reports we
file under the Securities 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.
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.
33
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," "Executive Officers" and "Code of
Ethics" 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, 2003.
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, 2003.
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, 2003.
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, 2003.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item as to the fees we pay our
principal accountant is hereby incorporated by reference from the information
appearing under the caption "Compensation of Independent Auditors" 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, 2003.
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.................................................... 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 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).
10.7 -- Form of Indemnification Agreement with Officers and Directors (filed as Exhibit 10.7 to the
Company's Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by
reference herein).
10.8 -- 2000 Equity Incentive Plan (filed as Exhibit 10.8 to the Company's Registration
35
Statement on Form S-1 (Registration No. 333-96469) and incorporated by reference herein).
10.9 -- 2000 Non-Employee Directors' Stock Option Plan (filed as Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (Registration No. 333-96469) and incorporated by reference
herein).
10.10 -- 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).
+10.11 -- 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).
+10.12 -- 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).
+10.13 -- 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).
*+10.14 -- Amended and Restated Collaboration and License Agreement, dated November 19, 2003, with Genentech,
Inc.
*+10.15 -- Collaboration and License Agreement, dated December 17, 2003, with Bristol-Myers Squibb Company
10.16 -- 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).
10.17 -- 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).
10.18 -- 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)
*31.1 -- Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2 -- Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1 -- Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
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).
36
EXHIBIT NO. DESCRIPTION
----------- -----------
---------------------
* Filed herewith.
+ Confidential treatment has been requested for a portion of this exhibit. The confidential portions of this
exhibit have been omitted and filed separately with the Securities and Exchange Commission.
(b) Reports on Form 8-K:
On October 30, 2003, we filed a Current Report on Form 8-K dated October 30, 2003 relating to our issuance of a
press release reporting our financial results for the quarter ended September 30, 2003, which press release
included our consolidated balance sheet data and consolidated statements of operations data for the period.
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 12, 2004 By: /s/ ARTHUR T. SANDS
-------------------------------------------------
Arthur T. Sands, M.D., Ph.D.
President and Chief Executive Officer
Date: March 12, 2004 By: /s/ JULIA P. GREGORY
-------------------------------------------------
Julia P. Gregory
Executive Vice President, Corporate Development
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 12, 2004
- ------------------------------------ (Principal Executive Officer)
Arthur T. Sands, M.D., Ph.D.
/S/ JULIA P. GREGORY Executive Vice President, Corporate Development and March 12, 2004
- ------------------------------------ Chief Financial Officer
Julia P. Gregory (Principal Financial and Accounting Officer)
/S/ C. THOMAS CASKEY Chairman of the Board of Directors March 12, 2004
- ------------------------------------
C. Thomas Caskey, M.D.
/S/ SAM L. BARKER Director March 12, 2004
- ------------------------------------
Sam L. Barker, Ph.D.
/S/ PATRICIA M. CLOHERTY Director March 12, 2004
- ------------------------------------
Patricia M. Cloherty
/S/ ROBERT J. LEFKOWITZ Director March 12, 2004
- ------------------------------------
Robert J. Lefkowitz, M.D.
/S/ ALAN S. NIES Director March 12, 2004
- ------------------------------------
Alan S. Nies. M.D.
38
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Lexicon Genetics Incorporated:
We have audited the accompanying consolidated balance sheets of Lexicon Genetics
Incorporated and subsidiary (the Company) as of December 31, 2003 and 2002, and
the related consolidated statements of operations, stockholders' equity and cash
flows for the years 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 audits. The financial
statements of the Company for the year ended December 31, 2001 was 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 adjustment described in Note 4.
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 consolidated financial position of Lexicon Genetics
Incorporated as of December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 3 to the consolidated financial statements, during 2003 the
Company adopted relevant portions of Financial Accounting Standards Board
Interpretation No. 46, "Consolidation of Variable Interest Entities - An
Interpretation of ARB No. 51."
As discussed above, the financial statements of the Company for the year ended
December 31, 2001 were audited by other auditors who have ceased operations. As
described in Note 4, these financial statements have been revised. We audited
the reclassification adjustment described in Note 4 that was applied to revise
the 2001 financial statements. In our opinion, such reclassification adjustment
is appropriate and has been properly applied. However, we were not engaged to
audit, review or apply any procedures to the 2001 financial statements of the
Company other than with respect to such reclassification adjustment and,
accordingly, we do not express an opinion or any other form of assurance on the
2001 financial statements taken as a whole.
/s/ ERNST & YOUNG LLP
Houston, Texas
February 12, 2004
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, 2003. SEE EXHIBIT 23.2 FOR FURTHER
INFORMATION.
F-2
LEXICON GENETICS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
----------------------------------------
AS OF DECEMBER 31,
----------------------------------------
2003 2002
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 81,915 $ 39,362
Restricted cash........................................................ 56,963 29,487
Short-term investments, including restricted investments of $551 and
$28,223, respectively............................................... 22,123 54,247
Accounts receivable, net of allowances of $109 for 2003 and 2002....... 6,571 5,143
Prepaid expenses and other current assets.............................. 3,933 4,893
----------------- -----------------
Total current assets................................................ 171,505 133,132
Property and equipment, net of accumulated depreciation of $31,941 and
$19,768, respectively.................................................. 83,676 37,362
Goodwill................................................................... 25,798 25,798
Intangible assets, net of amortization of $2,960 and $1,760, respectively.. 3,040 4,240
Other assets............................................................... 180 1,240
----------------- -----------------
Total assets........................................................ $ 284,199 $ 201,772
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................................... $ 5,884 $ 4,378
Accrued liabilities.................................................... 4,757 4,161
Current portion of deferred revenue.................................... 21,125 12,760
----------------- -----------------
Total current liabilities........................................... 31,766 21,299
Deferred revenue, net of current portion................................... 26,567 5,887
Long-term debt............................................................. 56,344 4,000
Other long-term liabilities................................................ 3,306 684
----------------- -----------------
Total liabilities................................................... 117,983 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;
62,827 and 52,367 shares issued and outstanding, respectively....... 63 52
Additional paid-in capital............................................. 380,995 330,701
Deferred stock compensation............................................ (899) (11,106)
Accumulated deficit.................................................... (213,943) (149,745)
----------------- -----------------
Total stockholders' equity ......................................... 166,216 169,902
----------------- -----------------
Total liabilities and stockholders' equity.......................... $ 284,199 $ 201,772
================= =================
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,
-------------------------------------------------------
2003 2002 2001
-------------- ------------- -------------
Revenues:
Subscription and license fees.............................. $ 21,550 $ 17,871 $ 14,744
Collaborative research..................................... 21,242 17,088 11,220
Compound libraries and other............................... 46 241 4,613
-------------- ------------- -------------
Total revenues........................................... 42,838 35,200 30,577
Operating expenses:
Research and development, including stock-based
compensation of $5,048, $5,155, and $5,539,
respectively............................................ 82,198 74,859 53,355
General and administrative, including stock-based
compensation of $5,067, $5,113, and $5,231, respectively 23,233 23,234 20,861
-------------- ------------- -------------
Total operating expenses................................. 105,431 98,093 74,216
-------------- ------------- -------------
Loss from operations.......................................... (62,593) (62,893) (43,639)
Interest and other income..................................... 1,796 3,230 8,781
Interest expense.............................................. (325) (7) (314)
-------------- ------------- -------------
Net loss before cumulative effect of a change
in accounting principle.................................... (61,122) (59,670) (35,172)
Cumulative effect of a change in accounting principle......... (3,076) -- --
-------------- ------------- -------------
Net loss .................................................... $ (64,198) $ (59,670) $ (35,172)
============== ============= =============
Net loss per common share basic and diluted:
Net loss before cumulative effect of a
change in accounting principle........................... $ (1.08) $ (1.14) $ (0.70)
Cumulative effect of a change in accounting principle...... (0.05) -- --
-------------- ------------- -------------
Net loss per common share, basic and diluted............... $ (1.13) $ (1.14) $ (0.70)
============== ============= =============
Shares used in computing net loss per common share,
basic and diluted.......................................... 56,820 52,263 50,213
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
----------------------------------------- -------------------------------------------
ACCUMULATED
ADDITIONAL DEFERRED OTHER TOTAL
PAID-IN STOCK ACCUMULATED COMPREHENSIVE STOCKHOLDERS'
COMMON STOCK CAPITAL COMPENSATION DEFICIT LOSS EQUITY
-------------- ---------- ------------- ------------ -------------- ------------
SHARES PAR
VALUE
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
Deferred stock compensation, net of
reversals......................... -- -- (92) 92 -- -- --
Amortization of deferred stock
compensation...................... -- -- -- 10,115 -- -- 10,115
Public offering of common stock,
net of offering costs............. 10,240 10 50,147 -- -- -- 50,157
Exercise of common stock options.... 102 1 239 -- -- -- 240
Exercise of common stock warrants... 118 -- -- -- -- -- --
Net and comprehensive loss.......... -- -- -- -- (64,198) -- (64,198)
------ --- -------- -------- ----------- ----- ---------
Balance at December 31, 2003........ 62,827 $63 $380,995 $ (899) $ (213,943) $ -- $ 166,216
====== === ======== ======== =========== ===== =========
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,
--------------------------------------------------------
2003 2002 2001
------------- ------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................ $ (64,198) $ (59,670) $ (35,172)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation...................................................... 10,215 9,111 5,220
Amortization of intangible assets, other than goodwill............ 1,200 1,200 560
Amortization of deferred stock compensation....................... 10,115 10,268 10,770
Loss on sale of long-term investments............................. -- 197 --
Gain on disposal of property and equipment........................ (18) -- --
Cumulative effect of a change in accounting principle ............ 3,076 -- --
Changes in operating assets and liabilities:
Increase in accounts receivable................................. (1,428) (599) (1,409)
(Increase) decrease in prepaid expenses and other current assets 960 484 (2,531)
(Increase) decrease in other assets............................. 1,060 3,965 (4,919)
Increase in accounts payable and other liabilities.............. 2,257 700 1,089
Increase in deferred revenue.................................... 29,045 5,552 8,402
------------- ------------- -------------
Net cash used in operating activities......................... (7,716) (28,792) (17,990)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment........................... (4,824) (19,766) (13,471)
Proceeds from disposal of property and equipment.............. 48 -- --
(Increase) decrease in restricted cash........................ (27,476) (22,794) 7,186
Purchase of short-term investments............................ (33,313) (91,962) (355,869)
Maturities of short-term investments.......................... 65,437 171,109 387,345
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..... (128) 47,225 13,604
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.............................. 50,397 574 718
Proceeds from debt borrowings....................................... -- 4,000 --
Repayment of debt borrowings........................................ -- -- (3,909)
------------- ------------- -------------
Net cash provided by (used in) financing activities........... 50,397 4,574 (3,191)
-------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents................... 42,553 23,007 (7,577)
Cash and cash equivalents at beginning of year......................... 39,362 16,355 23,932
------------- ------------- -------------
Cash and cash equivalents at end of year............................... $ 81,915 $ 39,362 $ 16,355
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.............................................. $ 4 $ 7 $ 330
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized (loss) and reversal of unrealized loss on long-term
investments...................................................... $ -- $ 437 $ (437)
Issuance (cancellation) of equity securities in connection with
acquisition......................................................... $ -- $ (79) $ 35,216
Deferred stock compensation, net of reversals....................... $ 92 $ 886 $ 958
Retirement of property and equipment................................ $ 1,148 $ 90 $ 181
Property and equipment recorded in connection with consolidation of
variable interest entity.......................................... $ 54,811 $ -- $ --
Long-term debt recorded in connection with consolidation of variable
interest entity................................................... $ (52,344) $ -- $ --
Other long-term liabilities recorded in connection with consolidation
of variable interest entity....................................... $ (2,467) $ -- $ --
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
LEXICON GENETICS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
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
database subscription and collaboration agreements, technology licenses,
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 and Short-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 and short-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.
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 (see Note 9) 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, 2003 and 2002, the
Company maintained restricted cash and investments of $57.5 million and $57.7
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 accounts receivable are unsecured and are
concentrated in 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, 2003, management believes that the Company has no
significant concentrations of credit risk.
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, target validation
collaborations for the development and, in some cases, analysis of the
physiological
F-7
effects of genes altered in knockout mice, technology licenses and compound
library sales. In 2003, Incyte Corporation, Amgen Inc., Bristol-Myers Squibb
Company and Genentech, Inc. represented 23%, 15%, 14% and 14% of revenues,
respectively. In 2002, Incyte, Bristol-Myers Squibb 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.
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 40 years. Maintenance, repairs and minor
replacements are charged to expense as incurred. Significant renewals and
betterments are capitalized.
Impairment of Long-Lived Assets: Under Statement of Financial Accounting
Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal 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 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 2003.
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, target validation 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 target validation resources are
recognized ratably over the subscription or access period. Payments received
under target validation collaborations are recognized as revenue as Lexicon
performs its obligations related to such research to the extent such fees are
non-refundable. Non-refundable upfront fees and annual research funding under
our drug discovery alliances are recognized as revenue on a straight line basis
over the estimated period of service, generally the contractual research term.
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 (SAB) No. 104, "Revenue
Recognition," 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.
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
F-8
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 $10.1 million, $10.3
million and $10.8 million of stock-based compensation during 2003, 2002 and
2001, 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 SFAS No. 123, "Accounting for Stock Based Compensation," had been
applied to all outstanding and unvested awards in each period:
---------------------------------------------------
YEAR ENDED DECEMBER 31,
---------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
(IN THOUSANDS)
Net loss, as reported......................................... $ (64,198) $ (59,670) $ (35,172)
Add: Stock-based employee compensation
expense included in reported net loss...................... 10,115 10,268 10,770
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards............................................. (26,344) (25,913) (20,616)
-------------- ------------- -------------
Pro forma net loss............................................ $ (80,427) $ (75,315) $ (45,018)
============== ============= =============
Net loss per common share, basic and diluted
As reported................................................ $ (1.13) $ (1.14) $ (0.70)
============== ============= =============
Pro forma.................................................. $ (1.42) $ (1.44) $ (0.90)
============== ============= =============
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 and warrants 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 security 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, 2003 or 2002.
3. 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 is
applicable to agreements entered into in fiscal periods beginning after June 15,
2003. The adoption of EITF 00-21 did not have a material impact on the Company's
financial statements.
In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure."
This statement amends SFAS No. 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 No. 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 has elected to
continue to follow the intrinsic value method of accounting as prescribed by APB
Opinion No. 25, "Accounting for Stock Issued to Employees," to account for
employee stock options. The additional disclosures required under SFAS No. 148
are effective for fiscal years ending after December 15, 2002, and have been
provided in Note 2.
In January 2003, the FASB issued Interpretation No. 46, or FIN 46,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51."
FIN 46 was revised in December 2003. It 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 applied immediately to variable interest entities
created after January 31, 2003, but was effective for the period ending December
31, 2003 for variable interest
F-9
entities created before February 1, 2003. The Company adopted FIN 46 on December
31, 2003 and determined that the lessor under the synthetic lease, as discussed
in Note 9, is a variable interest entity as defined by FIN 46, and that the
Company absorbs a majority of the variable interest entity's expected losses.
Accordingly, the Company consolidated the assets of the variable interest
entity, which were comprised of property and improvements funded under the
synthetic lease. These assets had a carrying value of $54.8 million, net of
accumulated depreciation of $3.1 million on December 31, 2003. Such amounts are
included in property and equipment in the accompanying consolidated balance
sheet as of December 31, 2003. The Company also consolidated the variable
interest entity's debt of $52.3 million and non-controlling interests of $2.5
million, which amounts are included in long-term debt and other long-term
liabilities, respectively, in the accompanying consolidated balance sheet as of
December 31, 2003. Additionally, the Company recorded a cumulative effect of a
change in accounting principle equal to the accumulated depreciation of $3.1
million for the period from the date the buildings were placed in service under
the synthetic lease through December 31, 2003. These improvements will be
depreciated over their useful lives. Due to the Company's residual value
guarantee on the property, the non-recourse feature of the underlying debt, and
certain other provisions of the lease arrangement, the Company did not allocate
any of the variable interest entity's depreciation or interest expenses to the
non-controlling interest. The Company had previously accounted for its
involvement with the variable interest entity as an operating lease.
4. RECLASSIFICATION
In the accompanying statement of cash flows for the year ended December 31,
2001, Lexicon has reclassified the amount of restricted cash from cash and cash
equivalents into a separate line item.
5. INVESTMENTS
Investments at December 31, 2003 and 2002 were as follows:
---------------------------------------------------------------
AS OF DECEMBER 31, 2003
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- ------------ -------------
(IN THOUSANDS)
Held-to-maturity:
Certificates of deposit....................... $ 561 $ -- $ -- $ 561
U.S. government agencies...................... 3,500 2 -- 3,502
Corporate debt securities..................... 16,572 -- (13) 16,559
Commercial paper.............................. 1,490 -- (2) 1,488
----------- ----------- ------------ -------------
Total held-to-maturity investments......... $ 22,123 $ 2 $ (15) $ 22,110
=========== =========== ============ =============
----------------------------------------------------------------
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
============= ============ ============ =============
F-10
6. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2003 and 2002 are as follows:
-------------------------------------------------
ESTIMATED AS OF DECEMBER 31,
USEFUL LIVES --------------------------------
IN YEARS 2003 2002
--------------- --------------- -------------
(IN THOUSANDS)
Computers and software................................ 3-5 $ 11,519 $ 10,996
Furniture and fixtures................................ 5-7 7,676 8,595
Laboratory equipment.................................. 3-7 29,847 27,282
Leasehold improvements................................ 3-10 11,765 10,257
Buildings............................................. 15-40 51,246 --
Land.................................................. -- 3,564 --
------------ ------------
Total property and equipment....................... 115,617 57,130
Less: Accumulated depreciation........................ (31,941) (19,768)
------------ ------------
Net property and equipment........................ $ 83,676 $ 37,362
============ ============
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 allowance
should be provided.
The components of Lexicon's deferred tax assets (liabilities) at December 31,
2003 and 2002 are as follows:
---------------------------------
AS OF DECEMBER 31,
---------------------------------
2003 2002
------------- -------------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards............................ $ 46,130 $ 39,887
Research and development tax credits........................ 8,105 7,113
Stock-based compensation.................................... 7,468 5,828
Deferred revenue............................................ 16,685 4,686
Other....................................................... 1,628 1,230
------------- -------------
Total deferred tax assets.............................. 80,016 58,744
Deferred tax liabilities:
Property and equipment...................................... (1,643) (990)
Other....................................................... (59) (138)
------------- -------------
Total deferred tax liabilities......................... (1,702) (1,128)
Less: Valuation allowance..................................... (78,314) (57,616)
------------- -------------
Net deferred tax assets................................ $ -- $ --
============= =============
At December 31, 2003, Lexicon had net operating loss carryforwards of
approximately $131.8 million and research and development tax credit
carryforwards of approximately $8.1 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 2003,
the valuation allowance increased $20.7 million primarily due to the Company's
current year net loss, 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 was no change in the carrying amount of goodwill for the year
ended December 31, 2003. In accordance with SFAS No. 142, the goodwill balance
is not subject to amortization, but is tested at least annually for impairment
at the reporting unit level, which is the Company's single operating segment.
The Company performed an impairment test of goodwill on its annual impairment
assessment date. This test did not result in an impairment of goodwill.
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, 2003 was $1.2 million.
The estimated amortization expense for the next five years is as follows:
----------------------------------
FOR THE YEAR ENDING DECEMBER 31
----------------------------------
(IN THOUSANDS)
2004.................... $ 1,200
2005.................... 1,200
2006.................... 640
2007.................... --
2008.................... --
9. DEBT OBLIGATIONS
Genentech Loan: 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 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
below.
Synthetic Lease Obligation: 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 1.16%, the Company's total lease
payments would be approximately $0.8 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 $54.8
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 purchase the properties would not
materially exceed the $54.8 million funded under the synthetic
F-12
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, 2003 and
2002, the Company maintained restricted cash and investments of $57.0 million
and $57.2 million, respectively, to collateralize funding for property and
improvements under the synthetic lease of $54.8 million and $55.0 million.
Lexicon consolidated the lessor under its synthetic lease upon adoption of FIN
46. See Note 3, "Recent Accounting Pronouncements," for information on the
financial statement impact.
10. COMMITMENTS AND CONTINGENCIES
Operating Lease Obligation: Lexicon's subsidiary leases laboratory and office
space in East Windsor and Hopewell, New Jersey under agreements which expire in
January 2004 and June 2013, respectively. Lexicon is the guarantor of the
obligations of its subsidiary under the Hopewell lease. The Company is required
to maintain restricted investments to collateralize the East Windsor and
Hopewell leases. As of December 31, 2003 and 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 $3.7 million, $2.8
million, and $0.9 million for the years ended December 31, 2003, 2002 and 2001,
respectively. These amounts included rent expense related to the synthetic
lease. Lexicon consolidated the lessor under its synthetic lease upon adoption
of FIN 46 on December 31, 2003. Future payments under the synthetic lease
agreement will be included in interest expense rather than rent expense. The
table below includes non-cancelable future lease payments for the facilities in
New Jersey:
---------------------
FOR THE YEAR ENDING
DECEMBER 31
---------------------
(IN THOUSANDS)
2004....................................................................... $ 2,196
2005....................................................................... 2,191
2006....................................................................... 2,248
2007....................................................................... 2,248
2008....................................................................... 2,309
Thereafter................................................................. 10,921
-----------------
Total........................................................... $ 22,113
=================
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
Common Stock: In July 2003, Lexicon completed the public offering and sale of
10.0 million shares of its common stock at a price of $5.25 per share. In August
2003, the underwriters partially exercised their over-allotment option,
purchasing an additional 240,000 shares. The total net proceeds from the
offering was $50.1 million, after deducting underwriting discounts of $3.2
million and offering expenses of $0.4 million.
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.
F-13
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, 2003, an aggregate of 15,000,000 shares of common stock had
been reserved for issuance, options to purchase 12,669,159 shares were
outstanding and 1,795,078 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 day following 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
following 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.
As of December 31, 2003, an aggregate of 600,000 shares of common stock had been
reserved for issuance, options to purchase 131,000 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.
F-14
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, 2003, an aggregate of 122,649 shares of common stock had been
reserved for issuance, options to purchase 89,012 shares of common stock were
outstanding, options to purchase 10,689 shares of common stock had been
cancelled and 22,948 shares of common stock had been issued upon the exercise of
stock options issued under the Coelacanth Plan.
Stock-Based Compensation: SFAS No. 123, "Accounting for Stock-Based
Compensation," allows companies to adopt one of two methods for accounting for
stock options. Lexicon has elected the method that requires disclosure only of
stock-based compensation. Because of this election, 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 prior to our initial public offering. During the years
ended December 31, 2003, 2002 and 2001, the Company recognized $10.1 million,
$10.3 million and $10.7 million, respectively, in compensation expense relating
to these options. Additionally, during the years ended December 31, 2003 and
2002, the Company reversed approximately $79,000 and $612,000, 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 No. 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 No. 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 2003, 2002 and 2001:
- volatility factors of 92%, 100% and 109%, respectively;
- risk-free interest rates of 3.40%, 4.64%, and 5.03%,
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. The fair values of the issuances were estimated using the Black-Scholes
pricing model with the assumptions noted in the preceding paragraph. 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. The Company reversed
expense of $6,000 for the year ended December 31, 2003 for the decline in fair
value of options issued to non-employee consultants and recognized expense of
$79,000 and $109,000 in the years ended December 31, 2002 and 2001,
respectively.
If vesting continues in accordance with the outstanding individual stock
options, Lexicon expects to record amortization expense for deferred stock
compensation of $0.9 million in 2004.
F-15
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, 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
---------
Granted............................................. 1,897 4.24
Exercised........................................... (102) 2.34
Canceled............................................ (278) 8.92
---------
Balance at December 31, 2003............................ 12,889 6.12
=========
Exercisable at December 31, 2003........................ 9,345 $ 5.73
=========
The weighted average fair values of options granted during the years ended
December 31, 2003, 2002 and 2001 were $3.52, $7.32 and $10.31, respectively. As
of December 31, 2003, 1,004,763 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, 2003:
- ---------------------------------------------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------------------------- ----------------------------------
WEIGHTED AVERAGE
REMAINING WEIGHTED WEIGHTED
RANGE OF OUTSTANDING AS OF CONTRACTUAL AVERAGE EXERCISABLE AS OF AVERAGE
EXERCISE PRICE DECEMBER 31, 2003 LIFE (IN YEARS) EXERCISE PRICE DECEMBER 31, 2003 EXERCISE PRICE
- ------------------- ----------------- ---------------- -------------- ----------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
$0.0003 - $0.22 886 1.9 $ 0.05 886 $ 0.05
1.67 - 2.50 5,509 5.3 2.41 5,419 2.41
3.16 - 4.70 1,534 9.1 3.92 44 4.18
4.76 - 7.00 633 9.1 5.62 145 5.75
7.20 - 10.55 1,994 8.0 9.34 1,035 9.33
10.87 - 16.00 1,715 7.3 12.60 1,268 12.55
16.63 - 22.06 401 6.3 19.51 362 19.51
25.25 - 31.63 35 6.8 27.00 28 27.12
38.00 - 38.50 182 6.7 38.49 158 38.49
--------- --------
12,889 $ 6.12 9,345 $ 5.73
========= ========
Warrants
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. 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 9). The warrant was exercised in 2003 by way of a
cashless exercise, resulting in the issuance of a total of 117,784 shares of
common stock.
F-16
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, 2003,
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, 2003 an aggregate of 12,905,654 shares of common stock were
reserved for issuance upon exercise of outstanding stock options and warrants
and 1,004,763 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 $637,000,
$645,000, and $332,000 in 2003, 2002 and 2001, 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 drug discovery alliances,
target validation collaborations for the development and, in some cases,
analysis of the physiological effects of genes altered in knockout mice,
technology licenses, subscriptions to its databases 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 target
validation 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 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 ending
July 2004, subject to the right of the parties to extend the term for up to
three additional one-year periods.
Bristol-Myers Squibb Company: Lexicon established an alliance with Bristol-Myers
Squibb in December 2003 to discover, develop and commercialize small molecule
drugs in the neuroscience field. Lexicon is contributing a number of drug
discovery programs at various stages of development. Lexicon will continue to
use its gene knockout technology to identify additional drug targets with
promise in the neuroscience field. For those targets that are selected for the
alliance, Lexicon and Bristol-Myers Squibb will work together, on an exclusive
basis, to identify, characterize and carry out the preclinical development of
small molecule drugs, and will share equally both in the costs and in the work
attributable to those efforts. As drugs resulting from the collaboration enter
clinical trials, Bristol-Myers Squibb will have the first option to assume full
responsibility for clinical development and commercialization. Lexicon received
an upfront payment of $36.0 million and is entitled to receive research funding
of $30.0 million in the initial three years of the agreement. Bristol-Myers
Squibb has the option to extend the discovery portion of the alliance for an
additional two years in exchange for further committed research funding
F-17
of up to $50.0 million. Lexicon may receive additional cash payments for
exceeding specified research productivity levels. Lexicon will also receive
clinical and regulatory milestone payments for each drug target for which
Bristol-Myers Squibb develops a drug under the alliance. Lexicon will earn
royalties on sales of drugs commercialized by Bristol-Myers Squibb. The party
with responsibility for the clinical development and commercialization of drugs
resulting from the alliance will bear the costs of those efforts. Revenue
recognized under this agreement was $0.8 million for the year ended December 31,
2003.
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 target validation 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 of $9.0 million and funding under a $4.0 million loan in
2002. The terms of the loan are discussed in Note 9. In addition, Lexicon can
receive up to $24.0 million in performance payments for its work in the
collaboration as it is completed, of which $3.0 million has been received as of
December 31, 2003. Total revenue recognized under this agreement was $6.0
million and $0.1 million for the years ended December 31, 2003 and 2002,
respectively. 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 Corporation. Lexicon established a drug discovery alliance with Incyte in
June 2001 to discover novel therapeutic proteins using the Company's target
validation technologies in the discovery of the functions of secreted proteins
from Incyte's LifeSeq(R) Gold database. Lexicon receives research funding under
the agreement, $15.0 million of which has been received as of December 31, 2003.
Revenue recognized under this agreement was $5.0 million, $5.0 million and $2.5
million for the years ended December 31, 2003, 2002 and 2001, respectively.
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 will terminate in June 2004.
Revenues from drug discovery alliances are included in collaborative research
revenue in the accompanying consolidated statements of operations.
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 annual 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. Revenue recognized under this agreement was $5.0 million, $5.0
million and $4.0 million for the years ended December 31, 2003, 2002 and 2001,
respectively. The agreement, as amended, has a term of five years, although
either party may terminate the agreement after four years.
Incyte Corporation. 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 annual access fees under this agreement, and is
entitled to receive milestone payments and royalties on products Incyte develops
using the Company's technology. Revenue recognized under this agreement was $5.0
million, $5.0 million and $2.5 million for the years ended December 31, 2003,
2002 and 2001, respectively. The agreement will terminate in June 2004.
F-18
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 2003 and 2002.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
---------------------------------------------------------
QUARTER ENDED
---------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------ ----------- ------------- --------------
(UNAUDITED)
2003
Revenues............................................ $ 8,106 $ 8,921 $ 12,111 $ 13,700
Loss from operations................................ $ (17,532) $ (17,852) $ (14,868) $ (12,341)
Net loss before cumulative effect of a change
in accounting principle.......................... $ (17,145) $ (17,619) $ (14,558) $ (11,800)
Cumulative effect of a change in accounting principle -- -- -- (3,076)
----------- ----------- ----------- ------------
Net loss............................................ $ (17,145) $ (17,619) $ (14,558) $ (14,876)
=========== ========== =========== ============
Net loss per common share before cumulative effect
of a change in accounting principle.............. $ (0.33) $ (0.34) $ (0.24) $ (0.19)
Cumulative effect of a change in accounting principle -- -- -- (0.05)
----------- ----------- ----------- ------------
Net loss per common share, basic and diluted........ $ (0.33) $ (0.34) $ (0.24) $ (0.24)
=========== =========== =========== ============
Shares used in computing net loss per common share.. $ 52,371 $ 52,496 $ 59,475 $ 62,794
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-19
EXHIBIT NO. DESCRIPTION
----------- -----------
*+10.14 -- Amended and Restated Collaboration and
License Agreement, dated November 19, 2003, with
Genentech, Inc.
*+10.15 -- Collaboration and License Agreement, dated
December 17, 2003, with Bristol-Myers Squibb
Company
*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)
*31.1 -- Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2 -- Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1 -- 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.