UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

 

 

For the transition period from             to           

 

Commission File Number: 0-30235

 

 

Exelixis, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

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 ý No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

 

On April 29, 2004, there were 71,896,139 shares of common stock, par value $.001 per share, of Exelixis, Inc. outstanding.

 

 

EXELIXIS, INC.

 

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

 

INDEX

Part I.  Financial Information
Item 1.	Unaudited Financial Statements
	Condensed Consolidated Balance Sheets March 31, 2004 and December 31, 2003
	Condensed Consolidated Statements of Operations Three Months Ended March 31, 2004 and 2003
	Condensed Consolidated Statements of Cash Flows Three Months Ended March 31, 2004 and 2003
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 4.	Controls and Procedures
Part II.  Other Information
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

2

 

ITEM 1. FINANCIAL STATEMENTS

 

EXELIXIS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

		March 31, 2004			December 31, 2003 (1)
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	80,323		$	111,828
Short-term investments		121,551			125,264
Other receivables		3,556			3,846
Other current assets		3,780			3,156
Total current assets		209,210			244,094
Restricted cash and investments		5,137			4,838
Property and equipment, net		32,077			33,500
Goodwill		67,364			67,364
Other intangibles, net		3,969			4,136
Other assets		3,900			3,862
Total assets		$	321,657		$	357,794
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	2,938		$	6,151
Other accrued expenses		11,867			10,400
Accrued compensation and benefits		4,914			6,139
Current portion of capital lease obligations		3,408			4,490
Current portion of notes payable and bank obligations		4,658			5,367
Deferred revenue		20,029			21,579
Total current liabilities		47,814			54,126
Capital lease obligations		1,136			1,790
Notes payable and bank obligations		13,273			14,437
Convertible promissory note and loan		85,000			85,000
Other long-term liabilities		1,734			1,184
Deferred revenue		38,053			39,775
Total liabilities		187,010			196,312
Commitments
Stockholders’ equity:
Preferred stock		—			—
Common stock		72			71
Additional paid-in-capital		543,922			541,917
Notes receivable from stockholders		—			(53		)
Deferred stock compensation, net		—			(33		)
Accumulated other comprehensive income		1,624			1,708
Accumulated deficit		(410,971		)	(382,128		)
Total stockholders’ equity		134,647			161,482
Total liabilities and stockholders’ equity		$	321,657		$	357,794

 

(1) The condensed consolidated balance sheet at December 31, 2003 has been derived from the audited financial statement at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

EXELIXIS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

		Three Months Ended March 31,
		2004			2003
		(unaudited)
Revenues:
Contract and government grants		$	8,764		$	9,202
License		3,128			3,128
Total revenues		11,892			12,330
Operating expenses:
Research and development		34,224			30,303
General and administrative		5,576			5,168
Restructuring charge		537			—
Amortization of intangibles		166			166
Total operating expenses		40,503			35,637
Loss from operations		(28,611		)	(23,307		)
Other income (expense):
Interest income		916			1,226
Interest expense		(1,233		)	(918		)
Other income (expense), net		85			36
Total other income (expense)		(232		)	344
Loss before income taxes		(28,843		)	(22,963		)
Provision for income taxes		—			95
Net loss		$	(28,843	)	$	(23,058	)
Net loss per share, basic and diluted		$	(0.40	)	$	(0.39	)
Shares used in computing basic and diluted net loss per share		71,512			59,261

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

 

EXELIXIS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Three Months Ended March 31,
		2004			2003
		(unaudited)
Cash flows from operating activities:
Net loss		$	(28,843	)	$	(23,058	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		4,478			3,964
Stock compensation expense		33			444
Non-cash portion of restructuring charge		(150		)	—
Amortization of intangibles		166			166
Other		562			95
Changes in assets and liabilities:
Other receivables		792			(389		)
Other current assets		(446		)	(501		)
Other assets		(315		)	222
Accounts payable and other accrued expenses		(2,613		)	809
Other long-term liabilities		550			250
Deferred revenue		(3,228		)	2,569
Net cash used in operating activities		(29,014		)	(15,429		)
Cash flows from investing activities:
Purchases of property and equipment		(3,062		)	(2,661		)
Changes in restricted cash and investments		(299		)	(1,849		)
Proceeds from maturities of short-term investments		29,307			59,440
Purchases of short-term investments		(25,874		)	(51,247		)
Net cash provided by investing activities		72			3,683
Cash flows from financing activities:
Proceeds from exercise of stock options, net of repurchases		721			99
Repayment of notes from stockholders		53			365
Payments on capital lease obligations		(1,736		)	(1,681		)
Proceeds from bank obligations		—			2,034
Principal payments on notes payable and bank obligations		(1,553		)	(539		)
Net cash provided by (used in) financing activities		(2,515		)	278
Effect of foreign exchange rates on cash and cash equivalents		(48		)	92
Net decrease in cash and cash equivalents		(31,505		)	(11,376		)
Cash and cash equivalents, at beginning of period		111,828			84,522
Cash and cash equivalents, at end of period		$	80,323		$	73,146

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

 

EXELIXIS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2004

(unaudited)

 

NOTE 1  Organization and Summary of Significant Accounting Policies

 

Organization

 

Exelixis, Inc. (“Exelixis” or the “Company”) is a biotechnology company whose primary mission is to leverage its biological expertise and integrated drug discovery capabilities to develop high quality, differentiated pharmaceutical products in the treatment of cancer and other serious diseases. The Company uses comparative genomics and model system genetics to find new drug targets and compounds that it believes would be difficult or impossible to uncover using other experimental approaches.  The Company’s research is designed to identify novel genes and proteins expressed by those genes that, when changed, either decrease or increase the activity in a specific disease pathway in a therapeutically relevant manner.  These genes and proteins represent either potential product targets or drugs that may treat disease or prevent disease initiation or progression. The Company’s most advanced pharmaceutical programs focus on drug discovery and development of small molecules in cancer.  The company also believes that its proprietary technologies are valuable to other industries whose products can be enhanced by an understanding of DNA or proteins, including the agrochemical, agricultural and diagnostic industries.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the instructions for Form 10-Q and Article 10 of Regulation S-X 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 the Company’s management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for the periods presented 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 ending December 31, 2004, or for any future period.  These financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2003 included in the Company’s Annual Report on Form 10-K filed with the SEC on February 20, 2004.

 

Net Loss Per Share

 

Basic and diluted net loss per share are computed by dividing the net loss for the period by the weighted-average number of shares of common stock outstanding during the period, less shares that are subject to repurchase.  The calculation of diluted net loss per share excludes potential common stock because their effect is antidilutive. Potential common stock consists of common stock subject to repurchase, incremental common shares issuable upon the exercise of stock options and warrants and shares issuable upon conversion of convertible debt.

 

Stock-Based Compensation

 

The Company recognizes employee stock-based compensation under the intrinsic value method of accounting as prescribed by Accounting Principles Board Opinion 25, “Accounting for Stock Issued to Employees” and related interpretations.  Accordingly, no compensation expense is recognized in the Company’s financial statements for the stock options granted to employees that had an exercise price equal to the fair value of the underlying common stock on the date of grant.  The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123” (in thousands, except per share amounts):

 

6

 

			Three Months Ended March 31,
			2004			2003
Net loss:
As reported			$	(28,843	)	$	(23,058	)
Add:	Stock-based employee compensation expense included in reported net loss		32			444
Deduct:	Total stock-based employee compensation expense determined under fair value method for all awards		(5,581		)	(5,723		)
Pro forma net loss			$	(34,392	)	$	(28,337	)
Net loss per share (basic and diluted):
As reported			$	(0.40	)	$	(0.39	)
Pro forma			$	(0.48	)	$	(0.48	)

 

Since options vest over several years and additional option grants are expected to be made in future years, the pro forma impact on the results of operations for the three-month periods ended March 31, 2004 and 2003 is not necessarily representative of the pro forma effects on the results of operations for future periods.

 

New Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 requires an investor with a majority of the variable interests in a variable interest entity (“VIE”) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the equity investors do not have a controlling interest, or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from the other parties. The Company adopted the remaining provisions of FIN 46 on January 1, 2004, related to variable interests held prior to January 31, 2003, and the adoption did not have a material impact on its financial condition or results of operations.

 

NOTE 2  Comprehensive Income (Loss)

 

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss).  Other comprehensive income (loss) includes unrealized gains and losses on available-for-sale securities, unrealized gains and losses on cash flow hedges and cumulative translation adjustments.  Comprehensive income (loss) for the three-month periods ended March 31, 2004 and 2003 are as follows (in thousands):

 

		Three Months Ended March 31,
		2004			2003
Net loss		$	(28,843	)	$	(23,058	)
Increase (decrease) in unrealized gains on  available-for-sale securities		175			(29		)
Increase in unrealized gains on cash flow hedges		—			132
Increase (decrease) in cumulative translation adjustment		(31		)	105
Reclass of cumulative translation adjustment to income		(228		)	—
Comprehensive loss		$	(28,927	)	$	(22,850	)

 

NOTE 3  Restructuring

 

During the third quarter of 2003, the Company implemented a worldwide restructuring of its research and development organization designed to reallocate resources and enhance the efficiency of its operations. The restructuring included a reduction in force of 61 research personnel located in South San Francisco, California and Tübingen, Germany, closure of the Company’s Tübingen location and relocation of certain research activities and employees from Tübingen to South San Francisco.  The restructuring plan is substantially complete as of the first quarter of 2004.

 

7

 

In connection with the restructuring plan, the Company has recorded a cumulative charge of approximately $1.5 million to date in accordance with Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”), of which approximately $537,000 was recorded during the three months ended March 31, 2004. This charge primarily consists of severance, retention bonuses, relocation, lease buyout costs and legal and outplacement services fees. The restructuring charge also includes non-cash activity including an impairment of assets of approximately $78,000 and a gain on closure of the Company’s Tübingen facility of approximately $228,000 related to the removal from equity of the cumulative currency translation adjustment attributable to the Tübingen location.  The current balance of the remaining restructuring liability is included under the caption, “Other Accrued Expenses,” on the balance sheet and is summarized in the following table (in thousands):

 

		Restructuring Liability at December 31, 2003			Restructuring Expenses Incurred During the Period (1)			Cash Payments			Exchange Rate Impact on Liability			Restructuring Liability at March 31, 2004
Severance and benefits		$	389		$	81		$	(354	)	$	—		$	116
Legal and other fees		18			128			(62		)	(3		)	81
Lease buyout costs		—			307			(51		)	(3		)	253
Relocation		6			171			(76		)	—			101
		$	413		$	687		$	(543	)	$	(6	)	$	551

 

(1) Excludes a net gain of $150,000 relating to non-cash items.

 

The Company does not expect to record any additional expenses related to this restructuring plan.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis contains forward-looking statements.  These statements are based on our current expectations, assumptions, estimates and projections about our business and our industry, and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied in, or contemplated by, the forward-looking statements. Words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “should,” “estimate,” “predict,” “potential,” “continue” or the negative of such terms or other similar expressions, identify forward-looking statements.  Our actual results and the timing of events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include those discussed under the caption “Risk Factors” below, as well as those discussed elsewhere in this quarterly report on Form 10-Q.

 

This discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in this report and the 2003 audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission on February 20, 2004. Operating results are not necessarily indicative of results that may occur in future periods.  We undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

 

Overview

 

Our primary mission is to develop proprietary human therapeutics by leveraging our integrated discovery platform to increase the speed, efficiency and quality of pharmaceutical product discovery and development.  We have generated a substantial development pipeline of small molecule cancer compounds that we believe are therapeutically differentiated and commercially valuable. The pipeline is led by XL119, our Phase 3 cancer compound, and includes XL784, XL647, XL999, XL844, XL820, XL880 and additional novel cancer-related compounds arising from our gene-to-drug platform.

 

We have incurred net losses since inception and expect to incur substantial losses for at least the next several years as we continue our research and development activities, including manufacturing and development expenses for compounds in preclinical and clinical studies.  As of March 31, 2004, we had approximately $207.0 million in cash, cash equivalents, short-term investments and restricted cash and investments.  We anticipate that our current cash, cash equivalents, short-term investments and funding to be received from current collaborators will enable us to maintain our currently planned operations for at least the next two years.  Changes to our current operating plan may require us to consume available capital resources significantly sooner than we expect.

 

We have collaborations with major pharmaceutical, biotechnology and agrochemical companies based on the strength of our technologies and biological expertise in order to support additional development of our proprietary product candidates.  Through these collaborations, we obtain license fees and research funding, together with the opportunity to receive milestone payments and royalties

 

8

 

from research results and subsequent product development.  In addition, many of our collaborations have been structured strategically to provide us access to technology to more rapidly advance our internal programs, while at the same time retaining rights to use the same information in different industries or for different development opportunities.  We have ongoing commercial collaborations with several leading pharmaceutical, biotechnology and agrochemical companies, including: Bayer CropScience LP (formerly Aventis USA LP), Bayer Corporation, Bristol-Myers Squibb Company (two collaborations), Cytokinetics, Inc., Dow AgroSciences LLC, Elan Pharmaceuticals, Inc., Merck & Co., Inc. (two collaborations), Renessen LLC, Scios Inc., Schering-Plough Research Institute, Inc. and SmithKlineBeecham Corporation.

 

As our company has matured and our development efforts have intensified, we have restructured the organization as needed to reallocate resources and enhance the efficiency of our operations. We believe that these efforts have strengthened us by enabling us to achieve an appropriate functional balance within the organization. We expect to continue to use corporate partnering as a strategic tool to cultivate our assets, fund our operations, and to expand the therapeutic and commercial potential of our pipeline.

 

Recent Developments

 

Clinical update

 

Our clinical pipeline continues to advance.  The following summarizes the status of our clinical and preclinical development pipeline and serves as an update to the disclosures we made in the business section of our Annual Report on Form 10-K for the year ended December 31, 2003. Several compounds in our pipeline, such as XL647 and XL999 and others, are Spectrum Selective Kinase Inhibitors™ that target proteins involved in both tumor proliferation and angiogenesis. Each compound has a different inhibition spectrum of receptor tyrosine kinases (“RTKs”), and each has the potential to maximize efficacy through simultaneous inhibition of multiple RTKs.

 

•                  XL119 – We anticipate that the Phase 3 clinical trial will begin in the second quarter of 2004. The National Cancer Institute (“NCI”) may also expand its Phase 2 program to include additional tumor types or combination studies.  Drug substance to be used in company-sponsored clinical trials has been manufactured in bulk supply by third-party suppliers.  We expect that the available supply of the compound will be sufficient to support our clinical needs as well as any trials that may be initiated by the NCI. In March 2004, the FDA granted orphan drug designation to XL119.

 

•                  XL784 – Data from a Phase 1 clinical trial of orally administered XL784 in 70 healthy volunteers showed single doses of the compound to be free of side effects and to have an attractive pharmacokinetic profile. In 2004, we plan to pursue a development path in renal disease. We plan to develop a new formulation suitable for chronic administration in patients with renal failure with the intention of moving the compound through development.

 

•                  XL647 – The IND for XL647 was filed in February 2004 and is currently active. We plan to initiate the Phase 1 clinical trial in the second quarter of 2004.

 

•                  XL999 – We anticipate filing an IND application for XL999 in the second quarter of 2004.

 

•                  XL844 – We anticipate filing an IND application for XL844 in early 2005.

 

•                  XL820 – We advanced XL820 into preclinical development during the first quarter of 2004, with the goal of filing an IND application for the compound in the first half of 2005.  XL820 is a selective inhibitor of RTKs, demonstrating potent inhibitory activity in biochemical and cellular assays against KIT, FLT3, PDGFR and KDR. It has also demonstrated potent inhibitory activity in cellular autophosphorylation assays against mutationally activated forms of human KIT and FLT3 that have been implicated in some human cancers.  XL820 has displayed favorable pharmaceutical properties and oral bioavailability in preclinical models and shows sustained inhibition of target RTKs in vivo following a single oral dose.  At doses consistent with those required for target modulation in vivo, XL820 exhibits dose-dependent growth inhibition in tumor models for breast carcinomas, gliomas and leukemia and has been shown to cause tumor regression.  Consistent with its spectrum of activity, analysis of tumors from XL820-treated animals shows significant increase in tumor cell death and decreases in both tumor vascularity and tumor cell proliferation.

 

•                  XL880 – We advanced XL880 into preclinical development during the first quarter of 2004, with the goal of filing an IND application for the compound in the first half of 2005.  XL880 is an inhibitor of MET and VEGFR. The compound has demonstrated favorable pharmaceutical properties and oral bioavailability in preclinical models and showed sustained inhibition of target RTKs in vivo following a single oral dose. The compound has demonstrated dose-dependent growth inhibition of tumor models for breast, colon and small cell lung cancer and glioblastoma and has been shown in tumor models to cause tumor regression. Consistent with its spectrum of activity, analysis of tumors from XL880-treated animals shows significant increase in tumor cell hypoxia and death and decreases in both tumor vascularity and tumor cell proliferation.

 

9

 

Results of Operations

 

Revenues

 

Total revenues and dollar and percentage changes as compared to the prior year period are as follows (dollar amounts are presented in millions):

 

 

The decrease in revenues from 2003 to 2004 was primarily a result of the successful conclusion of our collaboration with Protein Design Labs in May 2003, partially offset by an increase in revenues from compound deliveries under our combinatorial chemistry collaborations.

 

Research and Development Expenses

 

Total research and development expenses and dollar and percentage changes as compared to the prior year period are as follows (dollar amounts are presented in millions):

 

 

Research and development expenses consist primarily of salaries and other personnel-related expenses, laboratory supplies, consulting and facilities costs.  The increase in 2004 over 2003 resulted primarily from the following costs:

 

•                  Personnel – Staffing costs increased 8% to $12.3 million primarily due to merit pay increases for employees and increasing employee benefit costs.  Salaries, bonuses, related fringe benefits, recruiting and relocation costs are included in personnel costs.

 

•                  Lab Supplies – Lab supplies expense increased 19% to $6.5 million due primarily to an increase in drug discovery activities such as lead optimization, high throughput screening and compound synthesis.

 

•                  Facilities – As a result of our expanding drug discovery and development operations, facilities expense increased 42% to $4.4 million primarily due to our March 2003 expansion into an additional building in South San Francisco, California.

 

The table below summarizes the status of our current drug candidates:

 

 

We currently estimate that typical Phase 1 clinical trials last approximately one year, Phase 2 clinical trials last approximately one to two years and Phase 3 clinical trials last approximately two to four years.  However, the length of time generally varies substantially according to factors relating to the trial, such as the type and intended use of the product candidate, the trial design and ability to enroll suitable patients.

 

10

 

We expect that research and development expenses will continue to increase in the future as we advance our compounds through development.  We currently do not have estimates of total costs to reach the market by a particular drug candidate or in total.  Our potential therapeutic products are subject to a lengthy and uncertain regulatory process that may not result in the necessary regulatory approvals, which could adversely affect our ability to commercialize products.  In addition, clinical trials of our potential products may fail to demonstrate safety and efficacy, which could prevent or significantly delay regulatory approval.

 

General and Administrative Expenses

 

Total general and administrative expenses and dollar and percentage changes as compared to the prior year period are as follows (dollar amounts are presented in millions):

 

 

General and administrative expenses consist primarily of staffing costs to support our research activities, facilities costs and depreciation expense. The increase in 2004 from 2003 was primarily due to merit pay increases for employees as well as an increase in facilities costs due to our March 2003 expansion into an additional building in South San Francisco, California.

 

Amortization of Intangibles

 

Intangibles result from our acquisitions of Genomica, Artemis and Agritope (renamed Exelixis Plant Sciences).  Total amortization expense related to these intangibles is expected to be $666,000 for the year ending December 31, 2004.

 

Restructuring Charge

 

In the third quarter of 2003, we implemented a restructuring of our research and development organization designed to reallocate resources and enhance the efficiency of our operations. The restructuring included a reduction in force of 61 research personnel located in South San Francisco, California and Tübingen, Germany, closure of our Tübingen facility and relocation of certain research activities and employees from Tübingen to South San Francisco. The restructuring plan is substantially complete as of March 31, 2004.

 

In connection with the restructuring plan, we recorded a cumulative charge of approximately $1.5 million to date in accordance with Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”), of which approximately $537,000 was recorded during the three months ended March 31, 2004.  This charge consists primarily of severance, retention bonuses, relocation, lease buyout costs and legal and outplacement services fees. The restructuring charge also includes non-cash activity including an impairment of assets of approximately $78,000 and a gain on closure of our Tübingen facility of approximately $228,000 related to the removal from equity of the cumulative currency translation adjustment attributable to the Tübingen location.  We do not expect to record any additional expenses associated with this restructuring, as the restructuring plan is substantially complete.

 

Other Income (Expense), Net

 

Total other income (expense), net and dollar and percentage changes as compared to the prior year period are as follows (dollar amounts are presented in millions):

 

 

Other income, net consists primarily of interest income earned on cash, cash equivalents and short-term investments, offset by interest expense incurred on notes payable, bank obligations and capital lease obligations.  The decrease in 2004 from 2003 was the result of a decrease in interest income due to an overall decline in interest rates coupled with an increase in interest expense related to an increase in our long-term debt.

 

11

 

Income Taxes

 

We have incurred net losses since inception and, consequently, have not recorded any U.S. federal or state income taxes.  We recorded a tax provision of approximately $95,000 during the three months ended March 31, 2003 related to income earned in our foreign operations.  Due to the tax implications associated with our 2003 restructuring plan, we reversed the tax provision in the fourth quarter of 2003.

 

Liquidity and Capital Resources

 

Cash Requirements

 

To date, we have financed our operations primarily through the sale of equity, payments and loans from collaborators, equipment financing facilities and interest income.  In addition, we acquired Genomica in December 2001, including $109.6 million in cash and investments.  As of March 31, 2004, we had approximately $207.0 million in cash, cash equivalents, short-term investments and restricted cash and investments.

 

We have incurred net losses since inception, including a net loss of approximately $28.8 million for the three months ended March 31, 2004, and expect to incur substantial losses for at least the next several years as we continue our research and development activities, including manufacturing and development expenses for compounds in preclinical and clinical studies.  We anticipate that our current cash, cash equivalents, short-term investments and funding to be received from current collaborators will enable us to maintain our currently planned operations for at least the next two years.  It is possible that we will seek additional financing within this timeframe through public or private financing, collaborative relationships or other arrangements.  Changes to our current operating plan may require us to consume available capital resources significantly sooner than we expect.

 

Our future capital requirements will be substantial and will depend on many factors, including:

 

•                  payments received under collaborative and agreements;

•                  the progress and scope of our collaborative and independent research and development projects; and

•                  the expansion of our product and clinical development efforts as well as development of manufacturing and marketing capabilities to commercialize products;

 

If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds. We may be unable to raise sufficient additional capital when we need it, on favorable terms or at all. The sale of equity or convertible debt securities in the future may be dilutive to our stockholders, and debt-financing arrangements may require us to pledge certain assets and enter into covenants that would restrict certain business activities or our ability to incur further indebtedness and may contain other terms that are not favorable to our stockholders or us. If we are unable to obtain adequate funds on reasonable terms, we may be required to curtail operations significantly or to obtain funds by entering into financing, supply or collaboration agreements on unattractive terms.

 

Sources and Uses of Cash

 

Our operating activities used cash of approximately $29.0 million and $15.4 million for the three-months ended March 31, 2004 and 2003, respectively. Cash used in operating activities relates primarily to funding net losses, changes in deferred revenue from collaborators and changes in accounts payable and other accrued expenses, partially offset by non-cash charges related to depreciation and amortization.  We expect to use cash for operating activities for at least the next several years as we continue to incur net losses associated with our research and development activities, including manufacturing and development expenses for compounds in preclinical and clinical studies.

 

Our investing activities provided cash of approximately $72,000 and $3.7 million for the three-months ended March 31, 2004 and 2003, respectively. Changes in cash from investing activities are primarily due to purchases and maturities of short-term investments and purchases of property and equipment.  We expect to continue to make significant investments in research and development and our administrative infrastructure, including the purchase of property and equipment to support our expanding drug discovery and development operations.

 

Our financing activities used cash of approximately $2.5 million and provided cash of approximately $278,000 for the three-months ended March 31, 2004 and 2003, respectively.  Changes in cash from financing activities are primarily due to payments and proceeds associated with equipment financing facilities and bank obligations.  We finance property and equipment purchases through equipment financing facilities, such as capital leases, notes and bank obligations.  Over the next several years, we are required to make certain payments on capital leases, notes, bank obligations and loans from collaborators.  Under our collaboration agreement with GSK, we have the option to sell additional shares of common stock to GSK and draw up to another $30 million under a loan facility

 

12

 

for use in our efforts under the collaboration. GSK may elect to expand the collaboration, upon which the loan facility, as well as development funding and milestone payments, would be significantly expanded.

 

RISK FACTORS

 

Risks Related to Our Financial Results and Need for Additional Financing

 

We have a history of net losses. We expect to continue to incur net losses, and we may not achieve or maintain profitability.

 

We have incurred net losses each year since our inception, including a net loss of approximately $28.8 million for the three months ended March 31, 2004. As of that date, we had an accumulated deficit of approximately $411.0 million. We expect these losses to continue and anticipate negative operating cash flow for the foreseeable future. The size of these net losses will depend, in part, on the rate of growth, if any, in our license and contract revenues and on the level of our expenses. These losses have had and will continue to have an adverse effect on our stockholders’ equity and working capital.  Our research and development expenditures and general and administrative costs have exceeded our revenues to date, and we expect to spend significant additional amounts to fund research and development in order to enhance our core technologies and undertake product development. In 2001, we acquired XL119, a rebeccamycin analogue that was in Phase 2 clinical development.  We are currently undertaking activities leading to the initiation of the Phase 3 clinical trial of XL119 as a potential treatment for bile duct tumors, with the goal of beginning the study in the second quarter of 2004.  We have conducted Phase 1 clinical trials for XL784, a potent inhibitor of the ADAM-10 metalloprotease enzyme, and plan to pursue a development path in renal and cardiovascular disease.  In addition, during the first quarter of 2004, we filed an IND application for XL647, a potent inhibitor of RTKs that are implicated in driving tumor proliferation and vascularization, and plan on initiating a Phase 1 clinical trial during the second quarter of 2004.  In the last year, we have added multiple potential anticancer compounds to our development pipeline, and we anticipate filing IND applications for additional product candidates during the next twelve months.  As a result, we expect that our operating expenses will increase significantly in the near term, and, consequently, we will need to generate significant additional revenues to achieve profitability. Because of the numerous risks and uncertainties associated with developing small molecule drugs, we are unable to predict the extent of any future losses or when we will become profitable, if at all.  Even if we do increase our revenues and achieve profitability, we may not be able to maintain or increase profitability.

 

We will need additional capital in the future, which may not be available to us, which would force us to delay, reduce or eliminate our product development programs or commercialization efforts.

 

We will need to raise additional capital to:

 

•                  fund our operations and clinical trials;

•                  continue our research and development efforts; and

•                  commercialize our identified product candidates, if any such compounds receive regulatory approval for commercial sale.

 

We anticipate that our current cash and cash equivalents, short-term investments and funding to be received from current collaborators will enable us to maintain our currently planned operations for at least the next two years. Our future capital requirements will be substantial and will depend on many factors, including:

 

•                  payments received under collaborative agreements, licensing agreements and other arrangements;

•                  the progress and scope of our collaborative and independent clinical trials and other research and development projects;

•                  future clinical trial results;

•                  our need to expand our product and clinical development efforts;

•                  the cost and timing of regulatory approvals;

•                  the cost of establishing clinical and research supplies of our product candidates;

•                  the effect of competing technological and market developments;

•                  the filing, prosecution and enforcement of patent claims and other intellectual property rights;

•                  the cost of any acquisitions of or investments in businesses, products and technologies, although we currently have no commitments or agreements relating to any such transactions;

•                  the cost and timing of establishing or contracting for sales, marketing and distribution capabilities; and

•                  increased costs for clinical activities.

 

In addition, changes to our current operating plan may require us to consume available capital resources significantly sooner than we expect. If our capital resources are insufficient to meet future capital requirements, we will have to raise additional funds. We may be unable to raise sufficient additional capital when we need it, on favorable terms or at all. The sale of equity or convertible debt securities in the future may be dilutive to our stockholders, and debt-financing arrangements may require us to pledge certain assets and enter into covenants that would restrict certain business activities or our ability to incur further indebtedness and may contain

 

13

 

other terms that are not favorable to our stockholders or us. If we are unable to obtain adequate funds on reasonable terms, we may be required to curtail operations significantly or to obtain funds by entering into financing, supply or collaboration agreements on unattractive terms. If we raise additional funds through collaboration arrangements with third parties, it will be necessary to relinquish some rights to our technologies or our product candidates, or we may be required to grant licenses on terms that are not favorable to us.

 

Risks Related to Development of Product Candidates

 

Clinical testing of our product candidates may fail to demonstrate safety and efficacy, which could prevent or significantly delay regulatory approval.

 

Clinical trials are inherently risky and may reveal that our product candidates are ineffective or have unacceptable toxicity or other side effects that may significantly decrease the likelihood of regulatory approval of the product candidate. The results of preliminary studies do not necessarily predict clinical or commercial success, and larger later-stage clinical trials may fail to confirm the results observed in the preliminary studies. With respect to our own proprietary compounds in development, we have established timelines for manufacturing and clinical development based on existing knowledge of the compound and industry metrics. However, we cannot provide assurance that any specified timelines with respect to the initiation or completion of clinical studies may be achieved.

 

We may experience numerous unforeseen events during, or as a result of, clinical testing that could delay or prevent commercialization of our product candidates, including:

 

•                  regulators or institutional review boards may not authorize us to commence a clinical trial or conduct a clinical trial at a prospective trial site;

•                  our clinical testing may produce negative or inconclusive results, which may require us to conduct further testing or to abandon projects that we expect to be promising;

•                  patient registration or enrollment in our clinical testing may be lower than we anticipate, resulting in the delay or cancellation of clinical testing;

•                  regulators or institutional review boards may delay, suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements or their determination that participating patients are being exposed to unacceptable health risks; and

•                  the effects of our product candidates may not be the desired effects or may include undesirable side effects.

 

If any of these events were to occur and, as a result, we were to have significant delays in or termination of our clinical testing, our expenses could increase and our ability to generate revenue could be impaired, which would adversely impact our financial results.

 

In July 2001, we acquired our XL119 cancer compound, a rebeccamycin analogue, for which we plan to initiate a Phase 3 clinical trial in the second quarter of 2004. We have completed Phase 1 clinical trials for XL784, a potent inhibitor of the ADAM-10 metalloprotease enzyme.  We will have to conduct additional clinical testing in order to meet FDA requirements for regulatory approval of these and other product candidates. We have limited experience in conducting clinical trials and may not be able to rapidly or effectively continue the further development of these compounds or meet current or future requirements identified based on our discussions with the FDA. We do not know whether our planned clinical trials will begin on time, will be completed on schedule, or at all, will be sufficient for registration of these compounds or will result in approvable products.

 

Completion of clinical trials may take several years or more, but the length of time generally varies substantially according to the type, complexity, novelty and intended use of a product candidate.  The duration and the cost of clinical trials may vary significantly over the life of a project as a result of factors relating to the trial, including, among others, the following:

 

•                  the number of patients that ultimately participate in the trial;

•                  the duration of patient follow-up that seems appropriate in view of the results;

•                  the number of clinical sites included in the trials; and

•                  the length of time required to enroll suitable patient subjects.

 

In addition, our research and clinical testing regarding our product candidates may be delayed or abandoned as a result of other compounds subsequently discovered by us, or our competitors, that we believe show significantly improved safety or efficacy in comparison to our product candidates, which could cause us additional expense and could materially and adversely effect the market price of our common stock.

 

14

 

Risks Related to Our Dependence on Third Parties

 

We are dependent on our collaborations with major companies. If we are unable to achieve milestones, develop products or renew or enter into new collaborations, our revenues may decrease and our activities may fail to lead to commercialized products.

 

Substantially all of our revenues to date have been derived from collaborative research and development agreements. Revenues from research and development collaborations depend upon continuation of the collaborations, the achievement of milestones and royalties derived from future products developed from our research. If we are unable to successfully achieve milestones or our collaborators fail to develop successful products, we will not earn the revenues contemplated under such collaborative agreements. In addition, some of our collaborations are exclusive and preclude us from entering into additional collaborative arrangements with other parties in the area or field of exclusivity.  Future collaborations may require us to relinquish some important rights, such as marketing and distribution rights.

 

We currently have collaborative research agreements with Bayer Corporation, Bristol-Myers Squibb (two agreements), SmithKlineBeecham, Dow AgroSciences, Renessen and Bayer CropScience. Our current collaborative agreement with Bayer Corporation is scheduled to expire in 2008, after which it will automatically be extended for one-year terms unless terminated by either party upon 12-months written notice. Our agreement permits Bayer to terminate our collaborative activities prior to 2008 upon the occurrence of specified conditions, such as the failure to agree on key strategic issues after a period of years or the acquisition of us by certain specified third parties. Our agreement with Bayer is subject to termination at an earlier date if two or more of our Chief Executive Officer, Chief Scientific Officer, Agricultural Biotechnology Program Leader and Chief Informatics Officer cease to have a relationship with us within nine months of each other.  Our former Chief Scientific Officer, Geoffrey Duyk, M.D., Ph.D., left the Company at the end of 2003.

 

Our mechanism of action collaborative agreement with Bristol-Myers Squibb expires in September 2004. Collaborative research under our cancer collaborative agreement with Bristol-Myers Squibb expires in January 2007, though Bristol-Myers Squibb has the option to extend this collaborative research until July 2009. Our alliance with SmithKlineBeecham is scheduled to expire in October 2008, but is subject to earlier termination at the discretion of SmithKlineBeecham starting in 2005 if we fail to meet certain diligence obligations. Research funding under our agreement with Protein Design Labs expired in May 2003. Funding under our arrangement with Dow AgroSciences is scheduled to expire in July 2004, after which Dow AgroSciences has the option to renew on an annual basis.  Our collaborative research arrangement with Bayer CropScience is scheduled to expire in September 2004. The Bayer CropScience arrangement is conducted through a limited liability company, Agrinomics, which is owned equally by Bayer CropScience and Exelixis.  Agrinomics is party to a recent collaborative agreement with Renessen, which expires in December 2005. We also have additional agreements providing lower amounts of committed funding with the following chemistry collaborators: Cytokinetics, Inc., Scios Inc., Schering-Plough Research Corporation, Merck & Co., Inc. and Elan Pharmaceuticals.

 

If these existing agreements are not renewed or if we are unable to enter into new collaborative agreements on commercially acceptable terms, our revenues and product development efforts may be adversely affected. For example, our agreement with Pharmacia Corporation terminated by mutual agreement in February 2002, which eliminated the opportunity for us to earn approximately $9.0 million in research revenue in 2002 and 2003. Although we have entered into other collaborations that offset this loss of revenue, we may not be able to enter into a new collaborative agreement on similar or superior financial terms than those under our existing arrangements, and the timing of new collaborative agreements may have a material adverse effect on our ability to continue to successfully meet our corporate goals and milestones.

 

Conflicts with our collaborators could jeopardize the outcome of our collaborative agreements and our ability to commercialize products.

 

We are conducting proprietary research programs in specific disease, therapeutic modality and agricultural product areas that are not covered by our collaborative agreements. Our pursuit of opportunities in agricultural and pharmaceutical markets could, however, result in conflicts with our collaborators in the event that any of our collaborators take the position that our internal activities overlap with those areas that are exclusive to our collaborative agreements, and we should be precluded from such internal activities. Moreover, disagreements with our collaborators could develop over rights to our intellectual property. In addition, our collaborative agreements may have provisions that give rise to disputes regarding the rights and obligations of the parties, including the rights of collaborators with respect to our internal programs and disease area research. Any conflict with or among our collaborators could lead to the termination of our collaborative agreements, delay collaborative activities, reduce our ability to renew agreements or obtain future collaboration agreements or result in litigation or arbitration and would negatively impact our relationship with existing collaborators.  Further, if our collaborators fail to develop or commercialize any of our compounds or product candidates, we may not receive any future royalties or milestone payments for such compounds or product candidates.

 

We have limited or no control over the resources that our collaborators may choose to devote to our joint efforts. Our collaborators may breach or terminate their agreements with us or fail to perform their obligations thereunder. Further, our collaborators may elect not to develop products arising out of our collaborative arrangements, may experience financial difficulties, may undertake business

 

15

 

combinations or significant changes in business strategy that adversely affect their willingness or ability to complete their obligations under any arrangement or may fail to devote sufficient resources to the development, manufacture, marketing or sale of such products. Certain of our collaborators could also become our competitors in the future. If our collaborators develop competing products, preclude us from entering into collaborations with their competitors, fail to obtain necessary regulatory approvals, terminate their agreements with us prematurely or fail to devote sufficient resources to the development and commercialization of our products, our product development efforts could be delayed and may fail to lead to commercialized products.

 

We lack the capability to manufacture compounds for clinical trials and rely on third parties to manufacture our product candidates, and we may be unable to obtain required material in a timely manner, at an acceptable cost or at a quality level required to receive regulatory approval.

 

We currently do not have manufacturing capabilities or experience necessary to produce materials for clinical trials, including XL119, XL784 and XL647. We intend to rely on collaborators and third-party contractors to produce materials necessary for preclinical and clinical testing.  We will rely on selected manufacturers to deliver materials on a timely basis and to comply with applicable regulatory requirements, including the FDA’s current Good Manufacturing Practices, or GMP.  These outsourcing efforts with respect to manufacturing clinical supplies will result in a dependence on our suppliers to timely manufacture and deliver sufficient quantities of materials produced under GMP conditions to enable us to conduct planned clinical trials and, if possible, to bring products to market in a timely manner.

 

Our current and anticipated future dependence upon these third-party manufacturers may adversely affect our future profit margins and our ability to develop and commercialize product candidates on a timely and competitive basis.  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.  We may not be able to maintain or renew our existing third-party manufacturing arrangements, or enter into new arrangements, on acceptable terms, or at all. Our third-party manufacturers could terminate or decline to renew our manufacturing arrangements based on their own business priorities, at a time that is costly or inconvenient for us.  If we are unable to contract for the production of materials in sufficient quantity and of sufficient quality on acceptable terms, our planned clinical trials may be delayed. Delays in preclinical or clinical testing could delay the filing of our IND applications and the initiation of clinical trials that we have currently planned.

 

Our third-party manufacturers may not be able to comply with the GMP regulations, other applicable FDA regulatory requirements or similar regulations applicable outside of the United States. Additionally, if we are required to enter into new supply arrangements, we may not be able to obtain approval from the FDA of any alternate supplier in a timely manner, or at all, which could delay or prevent the clinical development and commercialization of any related product candidates.  Failure of our third-party manufacturers or us to obtain approval from the FDA or to comply with applicable regulations could result in sanctions being imposed on us, including fines, civil penalties, delays in or failure to grant marketing approval of our product candidates, injunctions, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of products and compounds, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our business.

 

If third parties on whom we rely do not perform as contractually required or expected, we may not be able to obtain regulatory approval for or commercialize our product candidates.

 

We do not have the ability to independently conduct clinical trials for our product candidates, and we must rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories to conduct our clinical trials. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if the third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our preclinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates.

 

Risks Related to Regulatory Approval of Our Product Candidates

 

Our product candidates are subject to a lengthy and uncertain regulatory process that may not result in the necessary regulatory approvals, which could adversely affect our ability to commercialize products.

 

Our product candidates, as well as the activities associated with their research, development and commercialization, are subject to extensive regulation by the FDA and other regulatory agencies in the United States and by comparable authorities in other countries. Failure to obtain regulatory approval for a product candidate would prevent us from commercializing that product candidate. We have not received regulatory approval to market any of our product candidates in any jurisdiction and have only limited experience in preparing and filing the applications necessary to gain regulatory approvals. The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon the type, complexity and novelty of the product candidates involved.  Before a new drug application can be filed with the FDA, the product candidate must

 

16

 

undergo extensive clinical trials, which can take many years and may require substantial expenditures. Any clinical trial may fail to produce results satisfactory to the FDA. The FDA could determine that the design of a clinical trial is inadequate to produce reliable results. The regulatory process also requires preclinical testing, and data obtained from preclinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. In addition, delays or rejections may be encountered based upon changes in regulatory policy for product approval during the period of product development and regulatory agency review.

 

Changes in regulatory approval policy, regulations or statutes or the process for regulatory review during the development or approval periods of our product candidates may cause delays in the approval or rejection of an application. Even if the FDA or a comparable authority in another country approves a product candidate, the approval may impose significant restrictions on the indicated uses, conditions for use, labeling, advertising, promotion, marketing and/or production of such product and may impose ongoing requirements for post-approval studies, including additional research and development and clinical trials. These agencies also may impose various civil or criminal sanctions for failure to comply with regulatory requirements, including withdrawal of product approval.

 

Risks Related to Commercialization of Products

 

The commercial success of any products that we may develop will depend upon the degree of market acceptance of our products among physicians, patients, health care payors, private health insurers and the medical community.

 

Our ability to commercialize any products that we may develop will be highly dependent upon the extent to which these products gain market acceptance among physicians, patients, health care payors, such as Medicare and Medicaid, private health insurers, including managed care organizations and group purchasing organizations, and the medical community.  If these products do not achieve an adequate level of acceptance, we may not generate material product revenues, and we may not become profitable.  The degree of market acceptance of our product candidates, if approved for commercial sale, will depend on a number of factors, including:

 

•                  the existence of any significant side effects, as well as their severity in comparison to any competing products;

•                  potential advantages over alternative treatments;

•                  the ability to offer our product candidates for sale at competitive prices;

•                  relative convenience and ease of administration;

•                  the strength of marketing and distribution support; and

•                  sufficient third-party coverage or reimbursement.

 

If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to market and sell our product candidates, we may be unable to generate product revenues.

 

We have no experience as a company in the sales, marketing and distribution of pharmaceutical products and do not currently have a sales organization.  Developing a sales force would be expensive and time-consuming and could delay any product launch, and we could not be certain that we could develop this capacity. However, to the extent that we enter into arrangements with third parties to perform sales, marketing and distribution services, our product revenues are likely to be lower than if we market and sell any products that we develop ourselves. If we are unable to establish adequate sales, marketing and distribution capabilities, independently or with others, we may not be able to generate product revenues and may not become profitable.

 

If we are unable to obtain adequate coverage and reimbursement from third-party payors for any products that we may develop, our revenues and prospects for profitability will suffer.

 

Our ability to commercialize any products that we may develop will be highly dependent on the extent to which coverage and reimbursement for our products will be available from third-party payors, including governmental payors, such as Medicare and Medicaid, and private health insurers, including managed care organizations and group purchasing organizations. Many patients will not be capable of paying for some or all of the products that we may develop themselves and will rely on third-party payors to pay for their medical needs. If third-party payors do not provide coverage or reimbursement for any products that we may develop, our revenues and prospects for profitability will suffer. In addition, even if third-party payors provide some coverage or reimbursement for our products, the availability of such coverage or reimbursement for prescription drugs under private health insurance and managed care plans often varies based on the type of contract or plan purchased.

 

A primary trend in the United States health care industry is toward cost containment.  In December 2003, the President signed into law legislation creating a prescription drug benefit program for Medicare recipients. The prescription drug program established by the legislation may have the effect of reducing the prices that we are able to charge for products we develop and sell through these plans. This prescription drug legislation may also cause third-party payors other than the federal government, including the States under the Medicaid program, to discontinue coverage for products we develop or to lower the amount that they will pay.

 

Another development that may affect the pricing of drugs is the proposed Congressional action regarding drug reimportation into the United States. The Medicare Prescription Drug Plan legislation gives additional discretion to the Secretary of Health and Human

 

17

 

Services to allow drug reimportation from foreign countries into the United States under some circumstances, including countries where the drugs are sold at a lower price than in the United States. Proponents of drug reimportation may attempt to pass legislation, which would directly allow reimportation under certain circumstances. If legislation or regulations were passed allowing the reimportation of drugs, they could decrease the price we receive for any products that we may develop, negatively affecting our revenues and prospects for profitability.

 

In addition, in some foreign countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take six to 12 months or longer after the receipt of regulatory marketing approval for a product.  To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost effectiveness of our product candidates or products to other available therapies. The conduct of such a clinical trial could be expensive and result in delays in our commercialization. Third-party payors are challenging the prices charged for medical products and services, and many third-party payors limit reimbursement for newly approved health care products. In particular, third-party payors may limit the indications for which they will reimburse patients who use any products that we may develop. Cost-control initiatives could decrease the price we might establish for products that we may develop, which would result in lower product revenues to us.

 

Our competitors may develop products and technologies that make our products and technologies obsolete.

 

The biotechnology industry is highly fragmented and is characterized by rapid technological change. In particular, the area of gene research is a rapidly evolving field. We face, and will continue to face, intense competition from large biotechnology and pharmaceutical companies, as well as academic research institutions, clinical reference laboratories and government agencies that are pursuing research activities similar to ours. Some of our competitors have entered into collaborations with leading companies within our target markets, including some of our existing collaborators. In addition, significant delays in the development of our product candidates could allow our competitors to bring products to market before us, which would impair our ability to commercialize our product candidates. Our future success will depend on our ability to maintain a competitive position with respect to technological advances.

 

Any products that are developed through our technologies will compete in highly competitive markets. Further, our competitors may be more effective at using their technologies to develop commercial products. Many of the organizations competing with us have greater capital resources, larger research and development staffs and facilities, more experience in obtaining regulatory approvals and more extensive product manufacturing and marketing capabilities. As a result, our competitors may be able to more easily develop technologies and products that would render our technologies and products, and those of our collaborators, obsolete and noncompetitive.  In addition, there may be product candidates of which we are not aware at an earlier stage of development that may compete with our product candidates.

 

Risks Related to Our Intellectual Property

 

If we are unable to adequately protect our intellectual property, third parties may be able to use our technology, which could adversely affect our ability to compete in the market.

 

Our success will depend in part on our ability to obtain patents and maintain adequate protection of the intellectual property related to our technologies and products. The patent positions of biotechnology companies, including our patent position, are generally uncertain and involve complex legal and factual questions. We will be able to protect our intellectual property rights from unauthorized use by third parties only to the extent that our technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the U.S., and many companies have encountered significant problems in protecting and defending such rights in foreign jurisdictions. We will continue to apply for patents covering our technologies and products as and when we deem appropriate. However, these applications may be challenged or may fail to result in issued patents.  In addition, because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that cover the production, manufacture, commercialization or use of our product candidates. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. Furthermore, others may independently develop similar or alternative technologies or design around our patents. In addition, our patents may be challenged or invalidated or may fail to provide us with any competitive advantages, if, for example, others were the first to invent or to file patent applications for these inventions.

 

We rely on trade secret protection for our confidential and proprietary information. We have taken security measures to protect our proprietary information and trade secrets, but these measures may not provide adequate protection. While we seek to protect our proprietary information by entering into confidentiality agreements with employees, collaborators and consultants, we cannot assure you that our proprietary information will not be disclosed, or that we can meaningfully protect our trade secrets. In addition, our competitors may independently develop substantially equivalent proprietary information or may otherwise gain access to our trade secrets.

 

18

 

Litigation or third-party claims of intellectual property infringement could require us to spend substantial time and money and adversely affect our ability to develop and commercialize products.

 

Our commercial success depends in part on our ability to avoid infringing patents and proprietary rights of third parties and not breaching any licenses that we have entered into with regard to our technologies. Other parties have filed, and in the future are likely to file, patent applications covering genes and gene fragments, techniques and methodologies relating to model systems and products and technologies that we have developed or intend to develop. If patents covering technologies required by our operations are issued to others, we may have to rely on licenses from third parties, which may not be available on commercially reasonable terms, or at all, and may require us to pay substantial royalties, grant a cross-license to some of our patents to another patent holder or redesign the formulation of a product candidate so that it does not infringe these patents, which may not be possible or could require substantial time and expense.

 

Third parties may accuse us of employing their proprietary technology without authorization. In addition, third parties may obtain patents that relate to our technologies and claim that use of such technologies infringes these patents. Regardless of their merit, such claims could require us to incur substantial costs, including the diversion of management and technical personnel, in defending ourselves against any such claims or enforcing our patents. In the event that a successful claim of infringement is brought against us, we may be required to pay damages and obtain one or more licenses from third parties. We may not be able to obtain these licenses at a reasonable cost, or at all. Defense of any lawsuit or failure to obtain any of these licenses could adversely affect our ability to develop and commercialize products.

 

Risks Related to Employees, Growth and Location

 

The loss of key personnel or the inability to attract and retain additional personnel could impair our ability to expand our operations.

 

We are highly dependent on the principal members of our management and scientific staff, the loss of whose services might adversely impact the achievement of our objectives and the continuation of existing collaborations. However, we do not currently have sufficient executive management and technical personnel to fully execute our business plan. In addition, our former Chief Scientific Officer left the Company at the end of 2003.  Recruiting and retaining qualified scientific and clinical personnel will be critical to support activities related to advancing our clinical and preclinical development programs, and supporting our collaborative arrangements and our internal proprietary research and development efforts. Although we believe we will be successful in attracting and retaining qualified management, competition is intense for experienced technical personnel, and we may be unable to retain or recruit scientists with the expertise or experience necessary to allow us to pursue collaborations, develop our products and core technologies or expand our operations to the extent otherwise possible.

 

Our collaborations with outside scientists may be subject to restriction and change.

 

We work with scientific and clinical advisors and collaborators at academic and other institutions that assist us in our research and development efforts. These scientists and advisors are not our employees and may have other commitments that would limit their availability to us. Although our advisors and collaborators generally agree not to do competing work, if a conflict of interest between their work for us and their work for another entity arises, we may lose their services. In addition, although our advisors and collaborators sign agreements not to disclose our confidential information, it is possible that valuable proprietary knowledge may become publicly known through them.

 

Difficulties we may encounter managing our growth may divert resources and limit our ability to successfully expand our operations.

 

We have experienced a period of rapid and substantial growth that has placed, and our anticipated growth in the future will continue to place, a strain on our research, administrative and operational infrastructure. As our operations expand domestically and internationally, we will need to continue to manage multiple locations and additional relationships with various collaborative partners, suppliers and other third parties. Our ability to manage our operations and growth effectively requires us to continue to improve our reporting systems and procedures as well as our operational, financial and management controls. In addition, recent SEC rules and regulations have increased the internal control and regulatory requirements under which we operate. We may not be able to successfully implement improvements to our management information and control systems in an efficient or timely manner and may discover deficiencies in existing systems and controls.

 

Our headquarters facilities are located near known earthquake fault zones, and the occurrence of an earthquake or other catastrophic disaster could cause damage to our facilities and equipment, which could require us to cease or curtail operations.

 

Given our headquarters location in South San Francisco, California, our facilities are vulnerable to damage from earthquakes. We are also vulnerable worldwide to damage from other types of disasters, including fire, floods, power loss, communications failures,

 

19

 

terrorism and similar events. If any disaster were to occur, our ability to operate our business at our facilities would be seriously, or potentially completely, impaired. In addition, the unique nature of our research activities could cause significant delays in our programs and make it difficult for us to recover from a disaster. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions. Accordingly, an earthquake or other disaster could materially and adversely harm our ability to conduct business.

 

Risks Related to Research and Genetic Engineering of Products

 

Social issues may limit the public acceptance of genetically engineered products, which could reduce demand for our products.

 

Although our technology is not dependent on genetic engineering, genetic engineering plays a prominent role in our approach to product development. For example, research efforts focusing on plant traits may involve either selective breeding or modification of existing genes in the plant under study. Public attitudes may be influenced by claims that genetically engineered products are unsafe for consumption or pose a danger to the environment. Such claims may prevent our genetically engineered products from gaining public acceptance. The commercial success of our future products will depend, in part, on public acceptance of the use of genetically engineered products, including drugs and plant and animal products.

 

The subject of genetically modified organisms has received negative publicity, which has aroused public debate. For example, certain countries in Europe are considering regulations that ban products or require express labeling of products that contain genetic modifications or are “genetically modified.” Adverse publicity has resulted in greater regulation internationally and trade restrictions on imports of genetically altered products. If similar action is taken in the U.S., genetic research and genetically engineered products could be subject to greater domestic regulation, including stricter labeling requirements. To date, our business has not been hampered by these activities. However, such publicity in the future may prevent any products resulting from our research from gaining market acceptance and reduce demand for our products.

 

Laws and regulations may reduce our ability to sell genetically engineered products that we or our collaborators develop in the future.

 

We or our collaborators may develop genetically engineered agricultural and animal products. The field-testing, production and marketing of genetically engineered products are subject to regulation by federal, state, local and foreign governments. Regulatory agencies administering existing or future regulations or legislation may prevent us from producing and marketing genetically engineered products in a timely manner or under technically or commercially feasible conditions. In addition, regulatory action or private litigation could result in expenses, delays or other impediments to our product development programs and the commercialization of products. The FDA has released a policy statement stating that it will apply the same regulatory standards to foods developed through genetic engineering as it applies to foods developed through traditional plant breeding. Genetically engineered food products will be subject to premarket review, however, if these products raise safety questions or are deemed to be food additives. Our products may be subject to lengthy FDA reviews and unfavorable FDA determinations if they raise questions regarding safety or our products are deemed to be food additives.

 

To date, the FDA has not required genetically engineered agricultural products to be labeled as such, provided that these products are as safe and have the same nutritional characteristics as conventionally developed products. The FDA may reconsider or change its policies, and local or state authorities may enact labeling requirements, either of which could have a material adverse effect on our ability or the ability of our collaborators to develop and market products resulting from our efforts.

 

We use hazardous chemicals and radioactive and biological materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

 

Our research and development processes involve the controlled use of hazardous materials, including chemicals and radioactive and biological materials. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of hazardous materials. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our insurance coverage and our total assets. Compliance with environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development and production efforts.

 

In addition, our collaborators may use hazardous materials in connection with our collaborative efforts. To our knowledge, their work is performed in accordance with applicable biosafety regulations. In the event of a lawsuit or investigation, however, we could be held responsible for any injury caused to persons or property by exposure to, or release of, these hazardous materials used by these parties. Further, we may be required to indemnify our collaborators against all damages and other liabilities arising out of our development activities or products produced in connection with these collaborations.

 

20

 

If product liability lawsuits are successfully brought against us, we could face substantial liabilities that exceed our resources.

 

We may be held liable if any product our collaborators or we develop causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing or sale. Regardless of merit or eventual outcome, product liability claims could result in decreased demand for our product candidates, injury to our reputation, withdrawal of patients from our clinical trials, substantial monetary awards to trial participants and the inability to commercialize any products that we may develop.  Although we intend to obtain general liability and product liability insurance, this insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or to otherwise protect ourselves against potential product liability claims could prevent or inhibit the commercialization of products developed by our collaborators or us.

 

Risks Related to Our Common Stock

 

We expect that our quarterly results of operations will fluctuate, and this fluctuation could cause our stock price to decline, causing investor losses.

 

Our quarterly operating results have fluctuated in the past and are likely to fluctuate in the future. A number of factors, many of which we cannot control, could subject our operating results and stock price to volatility, including:

 

•                  recognition of upfront licensing or other fees;

•                  payments of non-refundable upfront or licensing fees to third parties;

•                  acceptance of our technologies and platforms;

•                  the success rate of our discovery efforts leading to milestone payments and royalties;

•                  the introduction of new technologies or products by our competitors;

•                  the timing and willingness of collaborators to commercialize our products;

•                  our ability to enter into new collaborative relationships;

•                  the termination or non-renewal of existing collaborations;

•                  the timing and amount of expenses incurred for clinical development and manufacturing of our products;

•                  the impairment of acquired goodwill and other assets; and

•                  general and industry-specific economic conditions that may affect our collaborators’ research and development expenditures.

 

A large portion of our expenses, including expenses for facilities, equipment and personnel, are relatively fixed in the short term. In addition, we expect operating expenses to increase significantly during the next year. Accordingly, if our revenues decline or do not grow as anticipated due to the expiration of existing contracts or our failure to obtain new contracts, our inability to meet milestones or other factors, we may not be able to correspondingly reduce our operating expenses. Failure to achieve anticipated levels of revenues could therefore significantly harm our operating results for a particular fiscal period.

 

Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. As a result, in some future quarters, our operating results may not meet the expectations of stock market analysts and investors, which could result in a decline in the price of our stock.

 

Our stock price may be extremely volatile.

 

We believe the trading price of our common stock will remain highly volatile and may fluctuate substantially due to factors such as the following:

 

•                  adverse results or delays in clinical trials;

•                  announcement of FDA approval or non-approval, or delays in the FDA review process, of our or our collaborators’ product candidates or those of our competitors or actions taken by regulatory agencies with respect to our, our collaborators’ or our competitors’ clinical trials;

•                  the announcement of new products by us or our competitors;

•                  quarterly variations in our or our competitors’ results of operations;

•                  any intellectual property infringement lawsuit involving us;

•                  failure to achieve operating results projected by securities analysts;

•                  changes in earnings estimates or recommendations by securities analysts;

•                  developments in the biotechnology industry;

•                  sales of large blocks of our common stock or sales of our common stock by our executive officers, directors and significant stockholders;

•                  departures of key personnel;

•                  acquisitions of other companies or technologies; and

 

21

 

•                  general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.

 

These factors and fluctuations, as well as general economic, political and market conditions, may materially adversely affect the market price of our common stock.

 

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in substantial costs and divert management’s attention and resources, which could have a material and adverse effect on our business.

 

We are exposed to risks associated with acquisitions.

 

We have made, and may in the future make, acquisitions of, or significant investments in, businesses with complementary products, services and/or technologies. Acquisitions involve numerous risks, including, but not limited to:

 

•                  difficulties and increased costs in connection with integration of the personnel, operations, technologies and products of acquired companies;

•                  diversion of management’s attention from other operational matters;

•                  the potential loss of key employees of acquired companies;

•                  the potential loss of key collaborators of the acquired companies;

•                  lack of synergy, or the inability to realize expected synergies, resulting from the acquisition; and

•                  acquired intangible assets becoming impaired as a result of technological advancements or worse-than-expected performance of the acquired company.

 

Mergers and acquisitions are inherently risky, and the inability to effectively manage these risks could materially and adversely affect our business, financial condition and results of operations.

 

Future sales of our common stock may depress our stock price.

 

If our stockholders sell substantial amounts of our common stock (including shares issued upon the exercise of outstanding options and warrants) in the public market, the market price of our common stock could fall. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deemed appropriate. For example, following an acquisition, a significant number of shares of our common stock held by new stockholders may become freely tradable or holders of registration rights could cause us to register their shares for resale. Sales of these shares of common stock held by existing stockholders could cause the market price of our common stock to decline.

 

Some of our existing stockholders can exert control over us, and their interests could conflict with the best interests of our other stockholders.

 

Due to their combined stock holdings, our officers, directors and principal stockholders (stockholders holding more than 5% of our common stock), acting together, may be able to exert significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of our company, even when a change may be in the best interests of our stockholders. In addition, the interests of these stockholders may not always coincide with our interests as a company or the interests of other stockholders. Accordingly, these stockholders could cause us to enter into transactions or agreements that you would not approve of.

 

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

 

Provisions in our corporate charter and bylaws may discourage, delay or prevent an acquisition of us, a change in control, or attempts by our stockholders to replace or remove members of our current Board of Directors. Because our Board of Directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt by our stockholders to replace current members of our management team. These provisions include:

 

•                  a classified Board of Directors;

•                  a prohibition on actions by our stockholders by written consent;

•                  the ability of our Board of Directors to issue preferred stock without stockholder approval, which could be used to institute a “poison pill” that would work to dilute the stock ownership of a potential hostile acquirer, effectively preventing acquisitions that have not been approved by our Board of Directors; and

•                  limitations on the removal of directors.

 

22

 

Moreover, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved in a prescribed manner. Finally, these provisions establish advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted upon at stockholder meetings. These provisions would apply even if the offer may be considered beneficial by some stockholders.

 

Available Information

 

We maintain a site on the World Wide Web at www.exelixis.com; however, information found on our website is not incorporated by reference into this quarterly report on Form 10-Q.  We make available free of charge on or through our website our SEC filings, including 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 Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of disclosure controls and procedures.  Based on their evaluation as of the end of the period covered by this Quarterly Report, our principal executive officer and principal financial officer have concluded that Exelixis’ disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were sufficiently effective to ensure that the information required to be disclosed by Exelixis in the reports that we file under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness.

 

Changes in internal controls.  There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above, nor were there any significant deficiencies or material weaknesses in Exelixis’ internal controls.  Accordingly, no corrective actions were required or undertaken.

 

Limitations on the effectiveness of controls.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our chief executive officer and chief financial officer have concluded, based on their evaluation, that our disclosure controls and procedures were sufficiently effective as of March 31, 2004 to provide reasonable assurance that the objectives of our disclosure control system were met.

 

PART II. OTHER INFORMATION

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a)          Exhibits

 

The exhibits listed on the accompanying index to exhibits are filed or incorporated by reference (as stated therein) as part of this Quarterly Report on Form 10-Q.

 

(b)         Reports on Form 8-K

 

On February 17, 2004, we furnished a current report on Form 8-K under Item 12, describing and furnishing the press release announcing certain financial results and information for the quarter and year ended December 31, 2003.

 

23

 

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.

 

 

		EXELIXIS, INC.
Date:  May 4, 2004		/s/ Frank Karbe
		Frank Karbe
		Senior Vice President, Chief Financial Officer
		(Principal Financial and Accounting Officer)

 

24

 

EXHIBIT INDEX

 

Number			Exhibit Description
3.1	*		Amended and Restated Certificate of Incorporation of Exelixis, Inc.
3.2	*		Amended and Restated Bylaws of Exelixis, Inc.
4.1	*		Specimen Common Stock Certificate.
31.1			Certification required by Rule 13a-14(a) or Rule 15d-14(a).
31.2			Certification required by Rule 13a-14(a) or Rule 15d-14(a).
32.1	**		Certification by the Chief Executive Officer and the Chief Financial Officer of Exelixis, Inc., as required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).

 

* Filed as an Exhibit to Exelixis, Inc.’s Registration Statement on Form S-1 (File No. 333-30978), as filed with the Securities and Exchange Commission on February 7, 2000, as amended, and incorporated herein by reference.

 

** This certification accompanies this Quarterly Report on Form 10-Q, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of this Quarterly Report on Form 10-Q), irrespective of any general incorporation language contained in such filing.

 

25