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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
COMMISSION FILE NUMBER: 000-30111
LEXICON GENETICS INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0474169
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
8800 TECHNOLOGY FOREST PLACE
THE WOODLANDS, TEXAS 77381
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES AND ZIP CODE)
(281) 863-3000
(REGISTRANT'S TELEPHONE NUMBER,
INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
As of April 28, 2004, 63,337,622 shares of the registrant's common
stock, par value $0.001 per share, were outstanding.
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LEXICON GENETICS INCORPORATED
TABLE OF CONTENTS
PAGE
----
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS................................................................. 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2004 (unaudited) and December 31, 2003...................... 3
Consolidated Statements of Operations (unaudited) - Three Months Ended
March 31, 2004 and 2003........................................................................ 4
Consolidated Statements of Cash Flows (unaudited) - Three Months Ended
March 31, 2004 and 2003........................................................................ 5
Notes to Consolidated Financial Statements (unaudited).............................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................................... 17
Item 4. Controls and Procedures............................................................................. 17
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................................................... 17
SIGNATURES................................................................................................... 19
The Lexicon name and logo, LexVision(R) and OmniBank(R) are registered
trademarks and Genome5000(TM) and e-Biology(TM) are trademarks of Lexicon
Genetics Incorporated.
FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements.
These statements relate to future events or our future financial performance. We
have attempted to identify forward-looking statements by terminology including
"anticipate," "believe," "can," "continue," "could," "estimate," "expect,"
"intend," "may," "plan," "potential," "predict," "should" or "will" or the
negative of these terms or other comparable terminology. These statements are
only predictions and involve known and unknown risks, uncertainties and other
factors, including the risks outlined under "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors," that
may cause our or our industry's actual results, levels of activity, performance
or achievements to be materially different from any future results, levels or
activity, performance or achievements expressed or implied by these
forward-looking statements.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. We are not under any duty to
update any of the forward-looking statements after the date of this quarterly
report on Form 10-Q to conform these statements to actual results, unless
required by law.
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEXICON GENETICS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
AS OF MARCH 31, AS OF DECEMBER 31,
2004 2003
---------------- ------------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents............................................ $ 51,192 $ 81,915
Restricted cash...................................................... 56,963 56,963
Short-term investments, including restricted investments of
$551 in 2004 and 2003 ............................................ 37,270 22,123
Accounts receivable, net of allowance for doubtful accounts
of $109 for 2004 and 2003......................................... 3,181 6,571
Prepaid expenses and other current assets............................ 3,444 3,933
---------------- -----------------
Total current assets.............................................. 152,050 171,505
Property and equipment, net of accumulated depreciation
of $34,732 and $31,941, respectively................................. 82,146 83,676
Goodwill................................................................. 25,798 25,798
Intangible assets, net of amortization of $3,260 and $2,960, respectively 2,740 3,040
Other assets............................................................. 202 180
---------------- -----------------
Total assets...................................................... $ 262,936 $ 284,199
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................... $ 3,820 $ 5,884
Accrued liabilities.................................................. 3,811 4,757
Current portion of deferred revenue.................................. 19,896 21,125
---------------- -----------------
Total current liabilities......................................... 27,527 31,766
Deferred revenue, net of current portion................................. 22,857 26,567
Long-term debt........................................................... 56,344 56,344
Other long-term liabilities.............................................. 3,426 3,306
---------------- -----------------
Total liabilities................................................. 110,154 117,983
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;
63,326 and 62,827 shares issued and outstanding................... 63 63
Additional paid-in capital........................................... 382,189 380,995
Deferred stock compensation.......................................... (61) (899)
Accumulated deficit.................................................. (229,409) (213,943)
---------------- -----------------
Total stockholders' equity........................................ 152,782 166,216
---------------- -----------------
Total liabilities and stockholders' equity........................ $ 262,936 $ 284,199
================ =================
The accompanying notes are an integral part of these financial statements.
3
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
--------------------------------
2004 2003
------------- -------------
Revenues:
Subscription and license fees.............................. $ 3,548 $ 3,102
Collaborative research..................................... 8,294 4,993
Compound libraries and other............................... -- 11
------------- -------------
Total revenues........................................... 11,842 8,106
Operating expenses:
Research and development, including stock-based
compensation of $419 and $1,270, respectively............ 22,401 19,834
General and administrative, including stock-based
compensation of $411 and $1,276, respectively............ 5,044 5,804
------------- -------------
Total operating expenses............................... 27,445 25,638
------------- -------------
Loss from operations.......................................... (15,603) (17,532)
Interest and other income..................................... 428 468
Interest expense.............................................. (291) (81)
-------------- -------------
Net loss...................................................... $ (15,466) $ (17,145)
============= =============
Net loss per common share, basic and diluted.................. $ (0.25) $ (0.33)
Shares used in computing net loss per common share,
basic and diluted.......................................... 63,065 52,371
The accompanying notes are an integral part of these financial statements.
4
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
---------------------------------
2004 2003
------------- -------------
Cash flows from operating activities:
Net loss.............................................................. $ (15,466) $ (17,145)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation........................................................ 2,821 2,535
Amortization of intangible assets, other than goodwill.............. 300 300
Amortization of deferred stock compensation......................... 830 2,547
Changes in operating assets and liabilities:
Decrease in accounts receivable................................... 3,390 1,334
Decrease in prepaid expenses and other current assets............. 489 303
(Increase) decrease in other assets............................... (22) 513
Decrease in accounts payable and other liabilities................ (2,890) (2,217)
Decrease in deferred revenue...................................... (4,939) (3,007)
------------- -------------
Net cash used in operating activities........................... (15,487) (14,837)
Cash flows from investing activities:
Purchases of property and equipment................................... (1,291) (689)
Increase in restricted cash........................................... -- (15,344)
Purchases of investments.............................................. (18,983) (15,386)
Maturities of investments............................................. 3,836 46,054
------------- -------------
Net cash (used in) provided by investing activities............... (16,438) 14,635
Cash flows from financing activities:
Proceeds from issuance of common stock................................ 1,202 17
------------- -------------
Net cash provided by financing activities......................... 1,202 17
------------- -------------
Net decrease in cash and cash equivalents................................ (30,723) (185)
Cash and cash equivalents at beginning of period......................... 81,915 39,362
------------- -------------
Cash and cash equivalents at end of period............................... $ 51,192 $ 39,177
============= =============
Supplemental disclosure of cash flow information:
Cash paid for interest................................................ $ 206 $ 1
Supplemental disclosure of non-cash investing and financing activities:
Deferred stock compensation, net of reversals......................... $ 7 $ 52
Retirement of property and equipment.................................. $ 30 $ --
The accompanying notes are an integral part of these financial statements.
5
LEXICON GENETICS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Lexicon
Genetics Incorporated (Lexicon or the Company) have been prepared in accordance
with generally accepted accounting principles for interim financial information
and pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC). Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended March 31, 2004 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2004.
The accompanying consolidated financial statements include the accounts
of Lexicon and its subsidiary. Intercompany transactions and balances are
eliminated in consolidation.
For further information, refer to the financial statements and
footnotes thereto included in Lexicon's annual report on Form 10-K for the year
ended December 31, 2003, as filed with the SEC.
2. 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
5), 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 6). As of March 31, 2004 and December 31, 2003, the Company maintained
restricted cash and investments of $57.5 million under these agreements. The
Company refinanced the synthetic lease in April 2004 (See Note 7).
3. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of
shares of common stock outstanding during the applicable period. Shares
associated with stock options and warrants are not included because they are
antidilutive. There are no differences between basic and diluted net loss per
share for all periods presented.
4. STOCK-BASED COMPENSATION
Lexicon's stock-based compensation plans are accounted for under the
recognition and measurement provisions of Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees, and Related
Interpretations." Under the intrinsic value method described in APB Opinion No.
25, no compensation expense is recognized if the exercise price of the employee
stock option equals the market price of the underlying stock on the date of
grant. Lexicon recognized $0.8 million and $2.5 million of stock-based
compensation during the three-month periods ended March 31, 2004 and 2003,
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
6
fair value recognition provisions of Financial Accounting Standards Board (FASB)
No. 123 "Accounting for Stock Based Compensation," had been applied to all
outstanding and unvested awards in each period:
THREE MONTHS ENDED MARCH 31,
---------------------------------
2004 2003
------------- -------------
Net loss, as reported..................................... $ (15,466) $ (17,145)
Add: Stock-based employee compensation
expense included in reported net loss.................. 830 2,546
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards......................................... (4,882) (6,443)
-------------- -------------
Pro forma net loss........................................ $ (19,518) $ (21,042)
============== =============
Net loss per common share, basic and diluted
As reported............................................ $ (0.25) $ (0.33)
============== =============
Pro forma.............................................. $ (0.31) $ (0.40)
============== =============
5. 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. 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 additional facilities. Including
the purchase price for the Company's existing facilities, the synthetic lease,
as amended, provided funding of $54.8 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. 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 lease for
property and improvements and would likely be less than the amount of restricted
cash and investments it is required to maintain under the synthetic lease, the
Company believes that any requirement that it do so would not have a material
adverse effect on its financial condition. As of March 31, 2004 and December 31,
2003, the Company maintained restricted cash and
7
investments of $57.0 million to collateralize funding for property and
improvements under the synthetic lease of $54.8 million. Lexicon adopted
Financial Accounting Standards Board Interpretation No. 46, or FIN 46,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51"
on December 31, 2003. Lexicon determined that the lessor under the synthetic
lease 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 variable interest entity. Subsequent
to March 31, 2004, Lexicon purchased the facilities subject to the synthetic
lease as discussed in Note 7.
6. COMMITMENTS AND CONTINGENCIES
Lexicon's subsidiary leases a 76,000 square-foot laboratory and office
space in Hopewell, New Jersey under an agreement which expires in June 2013. The
lease provides for an escalating yearly 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. Lexicon is the guarantor of the obligations of its subsidiary under the
lease. Lexicon's subsidiary leased a facility in East Windsor, New Jersey. The
lease agreement expired in January 2004. The Company is required to maintain
restricted investments to collateralize these leases. As of March 31, 2004, the
Company had $551,000 in restricted investments to collateralize standby letters
of credit for these leases.
7. SUBSEQUENT EVENT
In April 2004, Lexicon purchased its facilities in The Woodlands from
the lessor under the synthetic lease. In connection with such purchase, Lexicon
repaid the $54.8 million funded under the synthetic lease with proceeds from a
$34.0 million third-party mortgage financing and $20.8 million in cash. The
mortgage has a ten-year term with a 20-year amortization and bears interest at a
fixed rate of 8.23%. As a result of the refinancing, all restrictions on the
cash and investments that had secured the obligations under the synthetic lease
were lifted, leaving a total of $551,000 in restricted investments.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a biopharmaceutical company focused on the discovery of
breakthrough treatments for human disease. We are using gene knockout technology
to systematically discover the physiological functions of genes in living
mammals, or in vivo. We generate our gene function discoveries using knockout
mice - mice whose DNA has been altered to disrupt, or "knock out," the function
of the altered gene. Our patented gene trapping and gene targeting technologies
enable us to rapidly generate these knockout mice by altering the DNA of genes
in a special variety of mouse cells, called embryonic stem 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
9
revenues. Because of these and other factors, our quarterly operating results
have fluctuated in the past and are likely to do so in the future, and we do not
believe that quarter-to-quarter comparisons of our operating results are a good
indication of our future performance.
Since our inception, we have incurred significant losses and, as of
March 31, 2004, we had an accumulated deficit of $229.4 million. Our losses have
resulted principally from costs incurred in research and development, general
and administrative costs associated with our operations, and non-cash
stock-based compensation expenses associated with stock options granted to
employees and consultants prior to our April 2000 initial public offering.
Research and development expenses consist primarily of salaries and related
personnel costs, material costs, facility costs, depreciation on property and
equipment, legal expenses resulting from intellectual property prosecution and
other expenses related to our drug discovery and LexVision programs, the
development and analysis of knockout mice and our other 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. In connection with the expansion of our drug discovery programs and
our target validation research efforts, we expect to incur increasing research
and development costs. As a result, we will need to generate significantly
higher revenues to achieve profitability.
CRITICAL ACCOUNTING POLICIES
Revenue Recognition
We recognize revenues when persuasive evidence of an arrangement
exists, delivery has occurred or services have been rendered, the price is fixed
and determinable, and 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
10
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 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.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2004 and 2003
Revenues. Total revenues and dollar and percentage changes as compared
to the corresponding period in the prior year are as follows (dollar amounts are
presented in millions):
THREE MONTHS ENDED MARCH 31
---------------------------
2004 2003
------- ------
Total revenues........................... $ 11.8 $ 8.1
Dollar increase.......................... $ 3.7
Percentage increase...................... 46%
- Subscription and license fees - Revenue from subscriptions and
license fees increased 14% to $3.5 million due to increased
technology license fees.
- Collaborative research - Revenue from collaborative research
increased 66% to $8.3 million primarily due to increased
revenue under our neuroscience alliance with Bristol-Myers
Squibb Company, which was entered into in December 2003. This
was offset in part by a decrease in revenues from target
validation collaborations due to the scheduled conclusion of
many of these arrangements.
11
Research and Development Expenses. Research and development expenses
and dollar and percentage changes as compared to the corresponding period in the
prior year are as follows (dollar amounts are presented in millions):
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2003
-------- -------
Total research and development expense... $ 22.4 $ 19.8
Dollar increase.......................... $ 2.6
Percentage increase...................... 13%
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 2004 as compared to 2003 resulted primarily from the following costs:
- Personnel - Personnel costs increased 23% to $10.4 million
primarily due to increased personnel to support the expansion
of our drug discovery programs, merit-based 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 67% to $0.4 million.
All deferred stock compensation relating to these options was
fully amortized as of January 31, 2004 when these options
became fully vested.
- Laboratory supplies - Laboratory supplies expense increased
36% to $3.5 million due primarily to increased purchases of
media and compounds related to our drug discovery activities.
- Facilities and equipment - Facilities and equipment costs
increased 5% to $5.1 million primarily due to depreciation
expense on our facilities in The Woodlands, Texas. On December
31, 2003, we consolidated the lessor under our synthetic lease
related to these facilities. Accordingly, depreciation expense
on those facilities is now included in our operating expenses.
- Consulting and other services - Consulting and other services
increased 7% to $1.8 million primarily due to third-party
research costs. Consulting and other services include
subscriptions to third-party databases, technology licenses,
legal and patent fees and third-party research.
- Other - Other costs increased by 17% to $1.2 million.
General and Administrative Expenses. General and administrative
expenses and dollar and percentage changes as compared to the corresponding
period in the prior year are as follows (dollar amounts are presented in
millions):
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2003
------- -------
Total general and administrative expense. $ 5.0 $ 5.8
Dollar decrease.......................... $ 0.8
Percentage decrease...................... 13%
12
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 2004 as compared to 2003 resulted primarily from the following costs:
- Personnel - Personnel costs increased 3% to $2.9 million
primarily due to merit-based pay increases and increased
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 68% to $0.4 million.
All deferred stock compensation relating to these options was
fully amortized as of January 31, 2004 when these options
became fully vested.
- Facilities and equipment - Facilities and equipment costs
decreased 13% to $0.8 million.
- Professional fees - Professional fees increased 31% to $0.3
million.
- Other - Other costs increased 12% to $0.6 million.
Interest and Other Income. Interest and other income decreased to $0.4
million in the three months ended March 31, 2004 from $0.5 million in the
corresponding period in 2003.
Net Loss and Net Loss Per Common Share. Net loss decreased to $15.5
million in the three months ended March 31, 2004 from $17.1 million in the
corresponding period in 2003. Net loss per common share decreased to $0.25 in
the three months ended March 31, 2004 from $0.33 in the corresponding period in
2003. Net loss includes stock-based compensation expense of $0.8 million and
$2.5 million in the three months ended March 31, 2004 and 2003, respectively.
Our quarterly operating results have fluctuated in the past and are
likely to do so in the future, and we believe that quarter-to-quarter
comparisons of our operating results are not a good indication of our future
performance.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations from inception primarily through sales
of common and preferred stock, contract and milestone payments to us under our
collaboration, license and database subscription agreements, equipment financing
arrangements and leasing arrangements. From our inception through March 31,
2004, we had received net proceeds of $294.3 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 March
31, 2004, we received $182.5 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 $143.2 million had been recognized as revenues through March 31, 2004.
As of March 31, 2004, we had $145.4 million in cash, cash equivalents
and short-term investments (including $57.5 million of restricted cash and
investments), as compared to $161.0 million (including $57.5 million of
restricted cash and investments) as of December 31, 2003. We used cash of $15.5
million in operations in the three months ended March 31, 2004. This consisted
primarily of the net loss for the period of $15.5 million offset by non-cash
charges of $2.8 million related to depreciation expense, $0.8 million related to
stock-based compensation expense, and $0.3 million related to
13
amortization of intangible assets other than goodwill; a $4.9 million decrease
in deferred revenue; and changes in other operating assets and liabilities of
$1.0 million. Investing activities used cash of $16.4 million in the three
months ended March 31, 2004, principally as a result of net purchases of
short-term investments. We received cash of $1.2 million in financing activities
consisting of proceeds from stock option exercises.
In October 2000, we entered into a synthetic lease agreement under
which the lessor purchased our existing laboratory and office buildings and
animal facility in The Woodlands, Texas and agreed to fund the construction of
additional facilities. Including the purchase price for our existing facilities,
the synthetic lease, as amended, provided funding of $54.8 million in property
and improvements. We consolidated the lessor under our synthetic lease upon
adoption of Financial Accounting Standards Board Interpretation No. 46 on
December 31, 2003. In April 2004, we purchased our facilities in The Woodlands
from the lessor under the synthetic lease. In connection with such purchase, we
repaid the $54.8 million funded under the synthetic lease with proceeds from a
$34.0 million third-party mortgage financing and $20.8 million in cash. The
mortgage has a ten-year term with a 20-year amortization and bears interest at a
fixed rate of 8.23%. As a result of the refinancing, all restrictions on the
cash and investments that had secured our obligations under the synthetic lease
were eliminated, leaving a total of $551,000 in restricted investments related
to our New Jersey facilities.
In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc.
signed a ten-year lease for a 76,000 square-foot facility in Hopewell, New
Jersey. The 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.
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.
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
drug discovery alliances, technology licenses and target validation
collaborations 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 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.
14
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 at the time of
purchase. 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 within twelve months,
which we believe are subject to limited market and credit risk. We currently do
not hedge interest rate exposure or hold any derivative financial instruments in
our investment portfolio.
We have operated primarily in the United States and substantially all
sales to date have been made in U.S. dollars. Accordingly, we have not had any
material exposure to foreign currency rate fluctuations.
RISK FACTORS
Our business is subject to certain risks and uncertainties, including
those referenced 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 will need additional capital in the future and, if it is not
available, we will have to curtail or cease operations
- any sale of additional equity securities in the future may be dilutive
to our stockholders
- we are an early-stage company, and we may not successfully develop or
commercialize any therapeutics or drug targets that we have identified
- 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 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
- we rely on several key collaborators for a significant portion of our
revenues, the loss of any of which would negatively impact our business
to the extent such losses are not offset by additional collaborators
- cancellations by or conflicts with our collaborators could harm our
business
- we may be unsuccessful in developing and commercializing pharmaceutical
products on our own
- 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 may engage in future acquisitions, which may be expensive and time
consuming and from which we may not realize anticipated benefits
15
- 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
- because all of our target validation operations are located at a single
facility, the occurrence of a disaster could significantly disrupt our
business
- 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
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
- our patent applications may not result in enforceable patent rights
and, as a result, the protection afforded to our scientific discoveries
may be insufficient
- 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
- 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
- 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, and we may not prevail in any such litigation or other
dispute or be able to obtain required licenses
- we use intellectual property that we license from third parties, and if
we do not comply with these licenses, we could lose our rights under
them
- 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, and as a result, our international
competitors could be granted foreign patent protection with respect to
our discoveries
- we may be unable to protect our trade secrets
- 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
- 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
- if our potential products receive regulatory approval, we or our
collaborators will remain subject to extensive and rigorous ongoing
regulation
16
- 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
- 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
- we may be sued for product liability
- public perception of ethical and social issues may limit or discourage
the use of our technologies, which could reduce our revenues
For additional discussion of the risks and uncertainties that affect
our business, see "Item 1. Business - Risk Factors" included in our annual
report on Form 10-K for the year ended December 31, 2003, as filed with the
Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Disclosure about Market Risk" under "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
quantitative and qualitative disclosures about market risk.
ITEM 4. CONTROLS AND PROCEDURES
Lexicon's chief executive officer and chief financial officer have
concluded that the Company's disclosure controls and procedures (as defined in
Securities Exchange Act of 1934 (the "Exchange Act") Rules 13a-15(e) and
15d-15(e)) are sufficiently effective to ensure that the information required to
be disclosed by the Company in the reports it files under the Exchange Act is
gathered, analyzed and disclosed with adequate timeliness, accuracy and
completeness, based on an evaluation of such controls and procedures conducted
within 90 days prior to the date hereof.
Subsequent to the Company's evaluation, there were no significant
changes in internal controls or other factors that could significantly affect
internal controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO. DESCRIPTION
- ---------- -------------------------------------------------------------------------------------
10.1 -- Consulting Agreement with Alan S. Nies, M.D. dated February 19, 2003, as amended
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
17
(b) Reports on Form 8-K:
On February 19, 2004, we filed a Current Report on Form 8-K
dated February 19, 2004 relating to our issuance of a press release reporting
our financial results for the quarter and year ended December 31, 2003, which
press release included our consolidated balance sheet data and consolidated
statements of operations data for the periods.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange 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: April 30, 2004 By: /s/ ARTHUR T. SANDS
-----------------------------------------------
Arthur T. Sands, M.D., Ph.D.
President and Chief Executive Officer
Date: April 30, 2004 By: /s/ JULIA P. GREGORY
-----------------------------------------------
Julia P. Gregory
Executive Vice President, Corporate Development
and Chief Financial Officer
19
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- ------------------------------------------------------------------------------------------
10.1 -- Consulting Agreement with Alan S. Nies, M.D. dated February 19, 2003, as amended
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