-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, M4Wy9bVjG3+3MdpViatT+3UNr71QpU3NCOBHRp4NcaL46i3b8EMepL6GcCjXo+Ma T6kJRcvH7xAFOP7v0f/8Vg== 0000950129-02-002515.txt : 20020514 0000950129-02-002515.hdr.sgml : 20020514 ACCESSION NUMBER: 0000950129-02-002515 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEXICON GENETICS INC/TX CENTRAL INDEX KEY: 0001062822 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 760474169 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-30111 FILM NUMBER: 02647585 BUSINESS ADDRESS: STREET 1: 4000 RESEARCH FOREST DRIVE STREET 2: 281-364-0100 CITY: THE WOODLANDS STATE: TX ZIP: 77381 BUSINESS PHONE: 2813640100 MAIL ADDRESS: STREET 1: 4000 RESEARCH FOREST DR CITY: THE WOODLANDS STATE: TX ZIP: 77381 10-Q 1 h96941e10-q.txt LEXICON GENETICS INC - QTR ENDED MARCH 31, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________ TO _____________ COMMISSION FILE NUMBER: 000-30111 LEXICON GENETICS INCORPORATED (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 76-0474169 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 8800 TECHNOLOGY FOREST PLACE THE WOODLANDS, TEXAS 77381 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE) (281) 863-3000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of May 13, 2002, 52,254,393 shares of the registrant's common stock, par value $0.001 per share, were outstanding. LEXICON GENETICS INCORPORATED TABLE OF CONTENTS PAGE FACTORS AFFECTING FORWARD-LOOKING STATEMENTS............................... 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - March 31, 2002 (unaudited) and December 31, 2001 ............................................. 3 Consolidated Statements of Operations (unaudited) - Three Months Ended March 31, 2002 and 2001........................... 4 Consolidated Statements of Cash Flows (unaudited) - Three Months Ended March 31, 2002 and 2001.................................. 5 Notes to Consolidated Financial Statements (unaudited)............ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................... 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 16 PART II - OTHER INFORMATION Item 5. Other Information................................................. 16 Item 6. Exhibits and Reports on Form 8-K.................................. 16 SIGNATURES................................................................. 17 The Lexicon name and logo, LexVision(R) and OmniBank(R) are registered trademarks and Lexgen.com(TM), Internet Universal(TM) and e-Biology(TM) are trademarks of Lexicon Genetics Incorporated. ------------ FACTORS AFFECTING FORWARD LOOKING STATEMENTS This quarterly report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance. We have attempted to identify forward-looking statements by terminology including "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "potential," "predict," "should" or "will" or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks outlined under "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors," that may cause our or our industry's actual results, levels of activity, performance or achievements to be materially different from any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are not under any duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q to conform these statements to actual results, unless required by law. 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS LEXICON GENETICS INCORPORATED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PAR VALUE)
AS OF MARCH 31, AS OF DECEMBER 31, 2002 2001 --------------- ------------------ ASSETS (UNAUDITED) Current assets: Cash and cash equivalents, including restricted cash of $24,642 and $6,693, respectively ............................................. $ 47,542 $ 23,048 Short-term investments, including restricted investments of $32,520 and $36,645, respectively ............................................ 91,203 133,394 Accounts receivable, net of allowance for doubtful accounts of $175 and $211, respectively .................................................. 4,282 4,544 Prepaid expenses and other current assets .......................................... 6,062 5,456 --------- --------- Total current assets ............................................................ 149,089 166,442 Property and equipment, net of accumulated depreciation of $12,667 and $10,747, respectively ............................................... 33,522 26,707 Long-term investments .................................................................. 10,076 10,398 Goodwill ............................................................................... 25,798 25,798 Intangible assets, net of amortization of $860 and $560, respectively .................. 5,140 5,440 Other assets ........................................................................... 2,898 5,205 --------- --------- Total assets .................................................................... $ 226,523 $ 239,990 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ................................................................... $ 4,046 $ 3,168 Accrued liabilities ................................................................ 4,035 5,016 Current portion of deferred revenue ................................................ 10,093 10,595 --------- --------- Total current liabilities ....................................................... 18,174 18,779 Deferred revenue, net of current portion ............................................... 1,250 2,500 Other long-term liabilities ............................................................ 329 339 --------- --------- Total liabilities ............................................................... 19,753 21,618 Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; 5,000 shares authorized; no shares issued and outstanding ................................................ -- -- Common stock, $.001 par value; 120,000 shares authorized; 52,213 and 52,022 shares issued and outstanding ................................. 52 52 Additional paid-in capital ......................................................... 330,972 331,092 Deferred stock compensation ........................................................ (19,362) (22,260) Accumulated deficit ................................................................ (104,133) (90,075) Accumulated other comprehensive loss ............................................... (759) (437) --------- --------- Total stockholders' equity ...................................................... 206,770 218,372 --------- --------- Total liabilities and stockholders' equity ...................................... $ 226,523 $ 239,990 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 3 LEXICON GENETICS INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, --------------------------------- 2002 2001 -------- -------- Revenues: Subscription and license fees ................................. $ 3,395 $ 1,747 Collaborative research ........................................ 4,256 1,524 Compound libraries ............................................ 5 -- Other ......................................................... -- 40 -------- -------- Total revenues .............................................. 7,656 3,311 Operating expenses: Research and development, including stock-based compensation of $1,307 and $1,396, respectively ............. 16,864 9,863 General and administrative, including stock-based compensation of $1,282 and $1,342, respectively ............. 5,969 4,271 -------- -------- Total operating expenses .................................. 22,833 14,134 -------- -------- Loss from operations ............................................. (15,177) (10,823) Interest and other income ........................................ 1,120 2,896 Interest expense ................................................. (2) (81) -------- -------- Net loss ......................................................... $(14,059) $ (8,008) ======== ======== Net loss per common share, basic and diluted ..................... $ (0.27) $ (0.17) Shares used in computing net loss per common share, basic and diluted ............................................. 52,126 48,343
The accompanying notes are an integral part of these consolidated financial statements. 4 LEXICON GENETICS INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ------------------------------ 2002 2001 --------- --------- Cash flows from operating activities: Net loss .................................................................. $ (14,059) $ (8,008) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation ............................................................ 1,920 954 Amortization of intangible assets, other than goodwill .................. 300 -- Amortization of deferred stock compensation ............................. 2,589 2,738 Changes in operating assets and liabilities (Increase) decrease in accounts receivable ............................ 262 (933) Increase in prepaid expenses and other current assets ................. (684) (1,908) (Increase) decrease in other assets ................................... 2,307 (343) Decrease in accounts payable and other liabilities .................... (113) (647) Increase (decrease) in deferred revenue ............................... (1,752) 172 --------- --------- Net cash used in operating activities ............................... (9,230) (7,975) Cash flows from investing activities: Purchases of property and equipment ....................................... (8,735) (2,496) Purchases of short-term investments ....................................... (14,161) (52,842) Maturities of short-term investments ...................................... 56,352 104,776 --------- --------- Net cash provided by investing activities ........................... 33,456 49,438 Cash flows from financing activities: Proceeds from issuance of common stock .................................... 267 182 Repayment of debt borrowings .............................................. -- (237) --------- --------- Net cash provided by (used in) financing activities ................. 267 (55) --------- --------- Net increase in cash and cash equivalents .................................... 24,493 41,408 Cash and cash equivalents at beginning of period ............................. 23,048 37,811 --------- --------- Cash and cash equivalents at end of period ................................... $ 47,541 $ 79,219 ========= ========= Supplemental disclosure of cash flow information: Cash paid for interest .................................................... $ 2 $ 81 Supplemental disclosure of non-cash investing and financing activities: Unrealized loss on long-term investments .................................. $ (322) $ -- Cancellation of equity securities issued in connection with acquisition ... $ (78) $ -- Reversal of deferred stock compensation ................................... $ 309 $ 561
The accompanying notes are an integral part of these consolidated financial statements. 5 LEXICON GENETICS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Lexicon Genetics Incorporated (Lexicon or the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. For further information, refer to the financial statements and footnotes thereto included in Lexicon's annual report on Form 10-K for the year ended December 31, 2001, as filed with the SEC. In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." These statements, which Lexicon fully adopted on January 1, 2002, generally require that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. Additionally, any resulting goodwill will not be amortized, rather it will be subject to at least an annual impairment test. Acquired intangible assets must be separately recognized and amortized over their useful lives. The adoption of this standard had no impact on the Company, as there were no acquisitions prior to June 30, 2001. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This new standard on asset impairment, which Lexicon adopted effective January 1, 2002, supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The adoption of this standard had no impact on the Company. 2. RESTRICTED CASH AND INVESTMENTS Lexicon is required to maintain restricted cash, cash equivalents or investments to collateralize borrowings made under the synthetic lease agreement under which it leases its office and laboratory facilities in The Woodlands, Texas (see Note 7). As of March 31, 2002 and December 31, 2001, the Company maintained restricted cash and investments of $57.2 million and $43.3 million, respectively, to collateralize borrowings of $55.0 million and $41.7 million. 3. COMPREHENSIVE LOSS Comprehensive loss is comprised of net loss and unrealized gains and losses on long-term investments, which are considered available-for-sale securities. Comprehensive loss for the three month period ended March 31, 2002 included a $0.3 million unrealized loss on long-term investments. 6 4. NET LOSS PER SHARE Net loss per share is computed using the weighted average number of shares of common stock outstanding during the applicable period. Shares associated with stock options and warrants are not included because they are antidilutive. There are no differences between basic and diluted net loss per share for all periods presented. 5. DEFERRED STOCK COMPENSATION Deferred stock compensation represents the difference between the exercise price of stock options and the fair value of Lexicon's common stock at the date of grant. Deferred stock compensation is amortized over the vesting periods of the individual stock options for which it was recorded, generally four years. For the three months ended March 31, 2002 and 2001, Lexicon amortized $2.6 million and $2.7 million, respectively, of deferred stock compensation. If vesting continues in accordance with the outstanding individual stock options, Lexicon expects to record amortization expense for deferred stock compensation as follows: $7.9 million during the last nine months of 2002, $10.5 million during 2003 and $1.0 million during 2004. The amount of stock based compensation expense to be recorded in future periods may decrease if unvested options for which deferred stock compensation expense has been recorded are subsequently canceled or forfeited or may increase if additional options are granted to individuals other than employees or directors. 6. COELACANTH ACQUISITION On July 12, 2001, Lexicon completed the acquisition of Coelacanth Corporation (Coelacanth) in a merger, under an Agreement and Plan of Merger entered into on June 13, 2001. Coelacanth uses proprietary chemistry technologies to create compound libraries for drug discovery screening and innovative compound sets that shorten lead discovery and lead optimization time for drug development. Coelacanth forms the core of Lexicon Pharmaceuticals, the division of the Company responsible for small molecule compound discovery. The results of Lexicon Pharmaceuticals are included in the Company's results of operations subsequent to the acquisition. 7. COMMITMENTS AND CONTINGENCIES In October 2000, Lexicon entered into a synthetic lease agreement under which the lessor purchased the Company's existing laboratory and office buildings and animal facility in The Woodlands, Texas and agreed to fund the construction of an additional laboratory and office building and a second animal facility. The synthetic lease agreement was subsequently expanded to include funding for the construction of a central plant facility. Including the purchase price for the Company's existing facilities, the synthetic lease, as amended, provides for funding of up to $55.0 million in property and improvements. The term of the agreement is six years, which includes the construction period and a lease period. Lease payments for the new facilities began upon completion of construction, which occurred at the end of the first quarter of 2002. Lease payments are subject to fluctuation based on LIBOR rates. Based on a LIBOR rate of 2.0% at March 31, 2002 the Company's total lease payments would be approximately $1.3 million per year. At the end of the lease term, the lease may be extended for one-year terms, up to seven additional terms, or the Company may purchase the properties for a price including the outstanding lease balance. If the Company elects not to renew the lease or purchase the properties, it may arrange for the sale of the properties to a third party or surrender the properties to the lessor. If the Company elects to arrange for the sale of the properties or surrender the properties to the lessor, it has guaranteed approximately 86% of the total original cost as the residual fair value of the properties. The Company is required to maintain restricted cash or investments to collateralize borrowings made under the synthetic lease agreement. In addition, Lexicon has agreed to maintain cash and investments of at 7 least $35.0 million in excess of the Company's restricted cash and investments. If the Company's cash and investments fall below that level, the Company may be required to seek a waiver of that agreement or to purchase the properties or arrange for their sale to a third party. Because the Company's cost to purchase the properties would not materially exceed the amount of restricted cash and investments it is required to maintain under the synthetic lease, the Company believes that any requirement that it do so would not have a material adverse effect on its financial condition. On February 13, 2002, the FASB announced that it intends to propose for adoption before the end of 2002 that companies be required to consolidate special purpose entities, such as the lessor under Lexicon's synthetic lease, on their balance sheets if those entities have outside equity investment representing less than 10 percent of their capitalization. Under present rules, companies need not consolidate such special purpose entities on their balance sheets if an independent third party holds equity representing at least three percent of the entity's capitalization. While the lessor under the Company's synthetic lease qualifies for off-balance sheet treatment under current rules, the Company would be required to consolidate the lessor on the Company's balance sheet if the FASB's intended proposal is adopted. If such consolidation were required, the Company's balance sheet would reflect as assets additional property and equipment approximating the $55.0 million funded under the synthetic lease for property and improvements and the same amount as a liability. In addition, the Company would be required to depreciate such property and improvements over their useful lives. Lexicon believes that the consolidation of the lessor, if required, would not have a material adverse effect on its financial condition or results of operations. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We are a biopharmaceutical company focused on the discovery of breakthrough treatments for human disease. We are using gene knockout technology to systematically discover in living mammals, or in vivo, the functions and pharmaceutical utility of genes. We generate our gene function discoveries using knockout mice - mice whose DNA has been altered to disrupt, or "knock out," the function of the altered gene. Our patented gene trapping and gene targeting technologies enable us to rapidly generate these knockout mice by altering the DNA of genes in a special variety of mouse cells, called embryonic stem (ES) cells, which can be cloned and used to generate mice with the altered gene. We employ an integrated platform of advanced medical technologies to systematically discover and validate, in vivo, the functions and pharmaceutical utility of the genes we have knocked out and the potential targets for therapeutic intervention, or drug targets, they encode. We employ internal resources and drug discovery alliances to discover potential small molecule drugs, therapeutic antibodies and therapeutic proteins for in vivo-validated drug targets that we consider to have high pharmaceutical value. We use our own sophisticated libraries of drug-like chemical compounds and an industrialized medicinal chemistry platform to identify small molecule drug candidates for our in vivo-validated drug targets. We have established alliances with Abgenix, Inc. for the discovery and development of therapeutic antibodies based on our drug target discoveries and with Incyte Genomics, Inc. for the discovery and development of therapeutic proteins. In addition, we have established collaborations and license agreements with many other leading pharmaceutical and biotechnology companies under which we receive fees and, in many cases, are eligible to receive milestone and royalty payments, for access to some of our technologies and discoveries for use in their own drug discovery efforts. We derive substantially all of our revenues from subscriptions to our databases, drug discovery alliances, functional genomics collaborations for the development and, in some cases, analysis of the physiological effects of genes altered in knockout mice, technology licenses and compound library sales. To date, we have generated a substantial portion of our revenues from a limited number of sources. Our operating results and, in particular, our ability to generate additional revenues are dependent on many factors, including our success in establishing new database subscriptions, research collaborations and technology licenses, expirations of our database subscription and research collaborations, the success rate of our discovery efforts leading to opportunities for new research collaborations and licenses, as well as milestone payments and royalties, the timing and willingness of collaborators to commercialize products which may result in royalties, and general and industry-specific economic conditions which may affect research and development expenditures. Our future revenues from database subscriptions, collaborations and alliances are uncertain because our existing agreements have fixed terms or relate to specific projects of limited duration. Our future revenues from technology licenses are uncertain because they depend, in large part, on securing new agreements. Subject to limited exceptions, we do not intend to continue to make our compound libraries available for purchase in the future. Our ability to secure future revenue-generating agreements will depend upon our ability to address the needs of our potential future subscribers, collaborators and licensees, and to negotiate agreements that we believe are in our long-term best interests. We may determine that our interests are better served by retaining rights to our discoveries and advancing our therapeutic programs to a later stage, which could limit our near-term revenues. Because of these and other factors, our quarterly operating results have fluctuated in the past 9 and are likely to do so in the future, and we do not believe that quarter-to- quarter comparisons of our operating results are a good indication of our future performance. Since our inception, we have incurred significant losses and, as of March 31, 2002, we had an accumulated deficit of $104.1 million. Our losses have resulted principally from costs incurred in research and development, general and administrative costs associated with our operations, and non-cash stock-based compensation expenses associated with stock options granted to employees and consultants prior to our April 2000 initial public offering. Research and development expenses consist primarily of salaries and related personnel costs, material costs, legal expenses resulting from intellectual property prosecution and other expenses related to our drug discovery and LexVision programs, the development and analysis of knockout mice and our other functional genomics research efforts, and the development of compound libraries. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, professional fees and other corporate expenses including business development and general legal activities, as well as expenses related to our patent infringement litigation against Deltagen, Inc., which was settled in September 2001. In connection with the expansion of our drug discovery programs and our functional genomics research efforts, we expect to incur increasing research and development and general and administrative costs. As a result, we will need to generate significantly higher revenues to achieve profitability. CRITICAL ACCOUNTING POLICIES Revenue Recognition Fees for access to our databases and other functional genomics resources are recognized ratably over the subscription or access period. Payments received in advance under these arrangements are recorded as deferred revenue until earned. Collaborative research payments are non-refundable, regardless of the success of the research effort, and are recognized as revenue as we perform our obligations related to such research. Milestone-based fees are recognized upon completion of specified milestones according to contract terms. Non-refundable technology license fees are recognized as revenue upon the grant of the license to third parties, when performance is complete and there is no continuing involvement. A change in our revenue recognition policy or changes in the terms of contracts under which we recognize revenues could have an impact on the amount and timing of our recognition of revenues. Research and Development Expenses Research and development expenses consist of costs incurred for company-sponsored as well as collaborative research and development activities. These costs include direct and research-related overhead expenses and are expensed as incurred. Patent costs and technology license fees for technologies that are utilized in research and development and have no alternative future use are expensed when incurred. Stock-Based Compensation Deferred stock-based compensation and related amortization represents the difference between the exercise price of stock options granted and the fair value of our common stock at the applicable date of grant. Stock-based compensation is amortized as research and development expense or general and administrative expense, as appropriate, over the vesting period of the individual stock options for which it was recorded, generally four years. If employees and consultants continue to vest in accordance with their individual stock options, we expect to record amortization expense for deferred stock-based compensation as follows: $7.9 million during the last nine months of 2002, $10.5 million during 2003 and 10 $1.0 million during 2004. The amount of stock-based compensation expense to be recorded in future periods may decrease if unvested options for which deferred stock-based compensation has been recorded are subsequently canceled or forfeited or may increase if additional options are granted to individuals other than employees or directors. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." These statements, which we fully adopted on January 1, 2002, generally require that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. Additionally, any resulting goodwill will not be amortized, but rather will be subject to at least an annual impairment test. Acquired intangible assets will be separately recognized and amortized over their useful lives. The adoption of this standard had no impact on the Company, as there were no acquisitions prior to June 30, 2001. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This new standard on asset impairment, which we adopted effective January 1, 2002, supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The adoption of this standard had no impact on the Company. RESULTS OF OPERATIONS Three Months Ended March 31, 2002 and 2001 Revenues. Total revenues increased 131% to $7.7 million in the three months ended March 31, 2002 from $3.3 million in the corresponding period in 2001. Of the $4.4 million increase, $1.6 million was derived from increased database subscription and technology license fees and $2.7 million was derived from increased revenues from functional genomics collaborations for the development and analysis of knockout mice and from our drug discovery alliance with Incyte Genomics, Inc. Our quarterly operating results have fluctuated in the past and are likely to do so in the future, and we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Research and Development Expenses. Research and development expenses, including stock-based compensation expense, increased 71% to $16.9 million in the three months ended March 31, 2002 from $9.9 million in the corresponding period in 2001. Research and development expenses for the three months ended March 31, 2002 and 2001 included $1.3 million and $1.4 million, respectively, of stock-based compensation primarily relating to option grants made prior to our April 2000 initial public offering. The increase of $7.1 million in research and development expenses exclusive of stock-based compensation was primarily attributable to increased personnel costs to support the expansion of our drug discovery and LexVision programs and our development and analysis of knockout mice and other functional genomics research efforts, as well as increased costs resulting from our acquisition of Coelacanth. General and Administrative Expenses. General and administrative expenses, including stock-based compensation expense, increased 40% to $6.0 million in the three months ended March 31, 2002 from $4.3 million in the corresponding period in 2001. General and administrative expenses for both three-month periods included $1.3 million of stock-based compensation primarily relating to option grants made prior to our April 2000 initial public offering. The increase of $1.8 million in general and 11 administrative expenses exclusive of stock-based compensation was due primarily to additional personnel costs for administration and support services, as well as increased costs resulting from our acquisition of Coelacanth. Interest and Other Income and Interest Expense. Interest and other income decreased to $1.1 million in the three months ended March 31, 2002 from $2.9 million in the corresponding period in 2001. The decrease resulted from lower interest rates and decreased average cash and investment balances during the 2002 period. Interest expense was $2,000 and $81,000 in the three months ended March 31, 2002 and 2001, respectively. Net Loss and Net Loss Per Common Share. Net loss increased to $14.1 million in the three months ended March 31, 2002 from $8.0 million in the corresponding period in 2001. Net loss per common share increased to $0.27 in the three months ended March 31, 2002 from $0.17 in the corresponding period of 2001. A portion of the net loss for the three months ended March 31, 2002 and 2001 was attributable to stock-based compensation expense. Excluding stock-based compensation expense, we would have had a net loss of $11.5 million and net loss per common share of $0.22 in the three months ended March 31, 2002, as compared to a net loss of $5.3 million and net loss per common share of $0.11 in the corresponding period in 2001. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations from inception primarily through sales of common and preferred stock, contract and milestone payments to us under our database subscription, collaboration and license agreements, equipment financing arrangements and leasing arrangements. From our inception through March 31, 2002, we had received net proceeds of $242.4 million from issuances of common and preferred stock, including $203.2 million of net proceeds from the initial public offering of our common stock in April 2000. In addition, from our inception through March 31, 2002, we received $68.0 million in cash payments from database subscription and technology license fees, drug discovery alliances, functional genomics collaborations, sales of compound libraries and reagents and government grants, of which $60.9 million had been recognized as revenues through March 31, 2002. As of March 31, 2002, we had $138.7 million in cash, cash equivalents and short-term investments, as compared to $156.4 million as of December 31, 2001. We also had $10.1 million of long-term investments at March 31, 2002, as compared to $10.4 million at December 31, 2001. We used cash of $9.2 million in operations in the three months ended March 31, 2002. This consisted of the net loss for the period of $14.1 million offset by non-cash charges of $2.6 million related to stock-based compensation expense, $1.9 million related to depreciation expense and $0.3 million related to amortization of intangible assets other than goodwill, and further offset by a net increase in working capital accounts and other liabilities of $20,000. Investing activities provided cash of $33.5 million in the three months ended March 31, 2002, principally as a result of net maturities of short-term investments, offset in part by purchases of property and equipment. We received cash of $0.3 million in financing activities in the three months ended March 31, 2002, principally as a result of stock option exercises. In October 2000, we entered into a synthetic lease agreement under which the lessor purchased our existing laboratory and office buildings and animal facility in The Woodlands, Texas and agreed to fund the construction of an additional laboratory and office building and a second animal facility. The synthetic lease agreement was subsequently expanded to include funding for the construction of a central plant facility for the distribution of utilities and related services among our facilities. Including the purchase price for our existing facilities, the synthetic lease, as amended, provides for funding of up to $55.0 million in property and improvements. The term of the agreement is six years, which includes the construction period and a lease period. Lease payments for the new facilities began upon completion of 12 construction, which occurred at the end of the first quarter of 2002. Lease payments are subject to fluctuation based on LIBOR rates. Based on a LIBOR rate of 2.0% at March 31, 2002, our total lease payments would be approximately $1.3 million per year. At the end of the lease term, the lease may be extended for one-year terms, up to seven additional terms, or we may purchase the properties for a price including the outstanding lease balance. If we elect not to renew the lease or purchase the properties, we may arrange for the sale of the properties to a third party or surrender the properties to the lessor. If we elect to arrange for the sale of the properties or surrender the properties to the lessor, we have guaranteed approximately 86% of the total original cost as the residual fair value of the properties. We are required to maintain restricted cash or investments to collateralize borrowings made under the synthetic lease agreement. In addition, we have agreed to maintain cash and investments of at least $35.0 million in excess of our restricted cash and investments. If our cash and investments fall below that level, we may be required to seek a waiver of that agreement or to purchase the properties or arrange for their sale to a third party. Because our cost to purchase the properties would not materially exceed the amount of restricted cash and investments we are required to maintain under the synthetic lease, we believe that any requirement that we do so would not have a material adverse effect on our financial condition. As of March 31, 2002 and December 31, 2001, we maintained restricted cash and investments of $57.2 million and $43.3 million, respectively, to collateralize borrowings of $55.0 million and $41.7 million. On February 13, 2002, the Financial Accounting Standards Board, or FASB, announced that it intends to propose for adoption before the end of 2002 that companies be required to consolidate special purpose entities, such as the lessor under our synthetic lease, on their balance sheets if those entities have outside equity investment representing less than 10 percent of their capitalization. Under present rules, companies need not consolidate such special purpose entities on their balance sheets if an independent third party holds at-risk equity representing at least three percent of the entity's capitalization and certain other criteria are satisfied. While the lessor under our synthetic lease qualifies for off-balance sheet treatment under current rules, we would be required to consolidate the lessor on our balance sheet if the FASB's intended proposal is adopted. If such consolidation were required, our balance sheet would reflect as assets additional property and equipment approximating the $55.0 million funded under the synthetic lease for property and improvements and the same amount as a liability. In addition, we would be required to depreciate such property and improvements over their useful lives. We believe that the consolidation of the lessor, if required, would not have a material adverse effect on our financial condition or results of operations. We will continue to monitor the FASB's proposals and evaluate their impact on our synthetic lease. Our future capital requirements will be substantial and will depend on many factors, including our ability to obtain database subscription, alliance, collaboration and technology license agreements, the amount and timing of payments under such agreements, the level and timing of our research and development expenditures, market acceptance of our products, the resources we devote to developing and supporting our products and other factors. Our capital requirements will also be affected by any expenditures we make in connection with license agreements and acquisitions of and investments in complementary technologies and businesses. We expect to devote substantial capital resources to continue our research and development efforts, to expand our support and product development activities, and for other general corporate activities. We believe that our current cash and investment balances and revenues we expect to derive from subscriptions to our databases, functional genomics collaborations, technology licenses and drug discovery alliances will be sufficient to fund our operations for at least the next two years. During or after this period, if cash generated by operations is insufficient to satisfy our liquidity requirements, we will need to sell additional equity or debt securities or obtain additional credit arrangements. Additional financing may not be available on terms acceptable to us or at all. The sale of additional equity or convertible debt securities may result in additional dilution to our stockholders. 13 DISCLOSURE ABOUT MARKET RISK We are exposed to limited market and credit risk on our cash equivalents which have maturities of three months or less. We maintain a short-term investment portfolio which consists of U.S. government agency debt obligations and investment grade commercial paper that mature three to twelve months from the time of purchase, which we believe are subject to limited market and credit risk. Additionally, we hold long-term investments consisting of U.S. government agency debt obligations with a maturity of greater than twelve months from the time of purchase. These investments are also subject to market risk and credit risk. A hypothetical one percent increase in market rates would result in a decrease of approximately $0.9 million in the fair value of our long-term investments as of March 31, 2002. We currently do not hedge interest rate exposure or hold any derivative financial instruments in our investment portfolio. We have operated primarily in the United States and substantially all sales to date have been made in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations. RISK FACTORS Our business is subject to certain risks and uncertainties, including those referenced below: Risks Related to Our Business o we have a history of net losses, and we expect to continue to incur net losses and may not achieve or maintain profitability o our quarterly operating results have been and likely will continue to fluctuate, and we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance o we are an early-stage company with an unproven business strategy o we will need additional capital in the future and, if it is not available, we will have to curtail or cease operations o we face substantial competition in the discovery of the DNA sequences of genes and their functions and in our drug discovery and product development efforts o we rely heavily on collaborators to develop and commercialize pharmaceutical products based on genes that we identify as promising candidates for development as drug targets o any cancellation by or conflicts with our collaborators could harm our business o we have no experience in developing and commercializing pharmaceutical products on our own o we may engage in future acquisitions, which may be expensive and time consuming and from which we may not realize anticipated benefits o if we lose our key personnel or are unable to attract and retain additional personnel, we may be unable to pursue collaborations or develop our own products 14 o we may encounter difficulties in managing our growth, which could increase our losses o because our entire OmniBank mouse clone library is located at a single facility, the occurrence of a disaster could significantly disrupt our business Risks Related to Our Industry o our ability to patent our discoveries is uncertain because patent laws and their interpretation are highly uncertain and subject to change o our patent applications may not result in enforceable patent rights o if other companies and institutions obtain patents claiming the functional uses of genes and gene products based upon gene sequence information and predictions of gene function, we may be unable to obtain patents for our discoveries of biological function in knockout mice o we may become involved in patent litigation and other disputes regarding intellectual property rights, and can give no assurance that we will prevail in any such litigation or other dispute o issued patents may not fully protect our discoveries, and our competitors may be able to commercialize products similar to those covered by our issued patents o our rights to the use of technologies licensed by third parties are not within our control o we may be unable to protect our trade secrets o we may become subject to regulation under the Animal Welfare Act, which could subject us to additional costs and permit requirements o we and our collaborators are subject to extensive and uncertain government regulatory requirements, which could increase our operating costs or adversely affect our ability to obtain government approval of products based on genes that we identify in a timely manner or at all o the uncertainty of pharmaceutical pricing and reimbursement may decrease the commercial potential of our products and affect our ability to raise capital o security risks in electronic commerce or unfavorable internet regulation may deter future use of our products and services o we use hazardous chemicals and radioactive and biological materials in our business; any disputes relating to improper handling, storage or disposal of these materials could be time consuming and costly o we may be sued for product liability o public perception of ethical and social issues may limit or discourage the use of our technologies, which could reduce our revenues 15 For additional discussion of the risks and uncertainties that affect our business, see "Item 1. Business - Risk Factors" included in our annual report on Form 10-K for the year ended December 31, 2001, as filed with the Securities and Exchange Commission. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Disclosure about Market Risk" under "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for quantitative and qualitative disclosures about market risk. PART II - OTHER INFORMATION ITEM 5. OTHER INFORMATION As previously disclosed, certain of our corporate officers adopted Rule 10b5-1 plans for the regular, monthly sale of a specified number of shares of common stock underlying stock options, subject to minimum sales prices that vary by individual. These plans were originally adopted effective November 8, 2001. Credit Suisse First Boston Corporation administers each plan. On March 28, 2002, the corporate officers who had adopted such plans amended the terms of the plans to provide for quarterly rather than monthly sales and to increase their minimum sales prices, which continue to vary by individual. The purpose of the plans is to permit such individuals to exercise a portion of their options over time, in advance of the expiration dates of such options, which range from 2005 to 2011. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None. (b) Reports on Form 8-K: On March 29, 2002, we filed a Current Report on Form 8-K dated March 26, 2002 relating to our Board of Directors and Audit Committee's dismissal of Arthur Andersen LLP as our independent public accountants and engagement of Ernst & Young LLP to serve as our independent public accountants for the year ending December 31, 2002. 16 SIGNATURES Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEXICON GENETICS INCORPORATED Date: May 14, 2002 By: /s/ ARTHUR T. SANDS --------------------------------------- Arthur T. Sands, M.D., Ph.D. President and Chief Executive Officer Date: May 14, 2002 By: /s/ JULIA P. GREGORY --------------------------------------- Julia P. Gregory Executive Vice President and Chief Financial Officer 17 -----END PRIVACY-ENHANCED MESSAGE-----