10-Q 1 h29775e10vq.txt LEXICON GENETICS INCORPORATED - DATED 9/30/2005 ================================================================================ 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 SEPTEMBER 30, 2005 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act. Yes [X] No [ ] As of October 27, 2005, 64,537,089 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 - September 30, 2005 (unaudited) and December 31, 2004..... 3 Consolidated Statements of Operations (unaudited) - Three and Nine Months Ended September 30, 2005 and 2004....................................................... 4 Consolidated Statements of Cash Flows (unaudited) - Nine Months Ended September 30, 2005 and 2004....................................................... 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............................. 19 Item 4. Controls and Procedures................................................................ 19 PART II - OTHER INFORMATION Item 5. Other Information...................................................................... 20 Item 6. Exhibits and Reports on Form 8-K....................................................... 20 SIGNATURES...................................................................................... 21
The Lexicon name and logo, LexVision(R) and OmniBank(R) are registered trademarks and Genome5000(TM) and e-Biology(TM) are trademarks of Lexicon Genetics Incorporated. FACTORS AFFECTING FORWARD LOOKING STATEMENTS This quarterly report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance. We have attempted to identify forward-looking statements by terminology including "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "potential," "predict," "should" or "will" or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks outlined under "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors," that may cause our or our industry's actual results, levels of activity, performance or achievements to be materially different from any future results, levels or activity, performance or achievements expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are not under any duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q to conform these statements to actual results, unless required by law. 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS LEXICON GENETICS INCORPORATED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PAR VALUE)
AS OF SEPTEMBER 30, AS OF DECEMBER 31, 2005 2004 ------------------- ------------------ ASSETS (UNAUDITED) Current assets: Cash and cash equivalents............................................ $ 23,120 $ 14,612 Short-term investments, including restricted investments of $430..... 67,121 72,946 Accounts receivable, net of allowance for doubtful accounts of $75... 1,698 5,345 Other receivables.................................................... - 1,052 Prepaid expenses and other current assets............................ 3,433 4,793 ---------------- ----------------- Total current assets.............................................. 95,372 98,748 Property and equipment, net of accumulated depreciation of $45,532 and $41,892, respectively................................. 85,996 84,573 Goodwill................................................................. 25,798 25,798 Intangible assets, net of amortization of $5,060 and $4,160, respectively......................................................... 940 1,840 Other assets............................................................. 861 1,021 ---------------- ----------------- Total assets...................................................... $ 208,967 $ 211,980 ================ ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable..................................................... $ 3,751 $ 7,574 Accrued liabilities.................................................. 8,032 6,945 Current portion of deferred revenue.................................. 31,800 19,500 Current portion of long-term debt.................................... 4,736 4,691 ---------------- ----------------- Total current liabilities......................................... 48,319 38,710 Deferred revenue, net of current portion................................. 47,695 18,092 Long-term debt........................................................... 32,384 32,940 Other long-term liabilities.............................................. 715 644 ---------------- ----------------- Total liabilities................................................. 129,113 90,386 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; 64,537 and 63,491 shares issued and outstanding................... 64 63 Additional paid-in capital........................................... 383,193 382,666 Deferred stock compensation.......................................... (5) (20) Accumulated deficit.................................................. (303,344) (261,115) Accumulated other comprehensive loss................................. (54) -- ---------------- ----------------- Total stockholders' equity........................................ 79,854 121,594 ---------------- ----------------- Total liabilities and stockholders' equity........................ $ 208,967 $ 211,980 ================ =================
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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, ------------------------------ ------------------------------- 2005 2004 2005 2004 -------------- ------------- -------------- ------------- Revenues: Collaborative research....................... $ 13,520 $ 11,492 $ 36,174 $ 27,997 Subscription and license fees................ 443 1,617 5,612 7,732 ------------- ------------- ------------- ------------- Total revenues............................. 13,963 13,109 41,786 35,729 Operating expenses: Research and development..................... 23,344 22,485 69,771 67,466 General and administrative................... 4,674 4,573 13,856 14,259 ------------- ------------- ------------- ------------- Total operating expenses................... 28,018 27,058 83,627 81,725 ------------- ------------- ------------- ------------- Loss from operations............................ (14,055) (13,949) (41,841) (45,996) Interest income................................. 767 405 1,764 1,198 Interest expense................................ (833) (833) (2,465) (1,829) Other income, net............................... - - 313 (4) ------------- ------------- ------------- ------------- Net loss ...................................... $ (14,121) $ (14,377) $ (42,229) $ (46,631) ============= ============= ============= ============= Net loss per common share, basic and diluted.... $ (0.22) $ (0.23) $ (0.66) $ (0.74) Shares used in computing net loss per common share, basic and diluted.............. 64,134 63,422 63,767 63,286
The accompanying notes are an integral part of these consolidated financial statements. 4 LEXICON GENETICS INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------- 2005 2004 ------------- ------------- Cash flows from operating activities: Net loss.............................................................. $ (42,229) $ (46,631) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation........................................................ 7,835 7,976 Amortization of intangible assets, other than goodwill.............. 900 900 Amortization of deferred stock compensation......................... (20) 827 Loss on disposal of property and equipment.......................... 10 - Changes in operating assets and liabilities: Decrease in accounts receivable................................... 4,699 4,558 (Increase) decrease in prepaid expenses and other current assets.. 1,360 (88) (Increase) decrease in other assets............................... 160 (870) Increase (decrease) in accounts payable and other liabilities..... (2,665) 344 Increase (decrease) in deferred revenue........................... 41,903 (4,172) ------------- ------------- Net cash provided by (used in) operating activities............... 11,953 (37,156) Cash flows from investing activities: Purchases of property and equipment................................... (9,391) (6,753) Proceeds from disposal of property and equipment...................... 123 15 Decrease in restricted cash........................................... -- 14,372 Purchases of investments.............................................. (116,120) (147,103) Maturities of investments............................................. 121,891 173,720 ------------- ------------- Net cash provided by (used in) investing activities............... (3,497) 34,251 Cash flows from financing activities: Proceeds from issuance of common stock................................ 563 1,577 Proceeds from debt borrowings......................................... -- 34,000 Repayment of debt borrowings.......................................... (511) (52,574) Repayment of other long-term liabilities.............................. -- (2,466) ------------- ------------- Net cash provided by (used in) financing activities............... 52 (19,436) ------------- ------------- Net increase (decrease) in cash and cash equivalents..................... 8,508 (22,341) Cash and cash equivalents at beginning of period......................... 14,612 35,856 ------------- ------------- Cash and cash equivalents at end of period............................... $ 23,120 $ 13,515 ============= ============= Supplemental disclosure of cash flow information: Cash paid for interest................................................ $ 2,095 $ 1,281 Supplemental disclosure of non-cash investing and financing activities: Unrealized loss on investments........................................ $ (54) $ - Reversal of deferred stock compensation, in connection with stock options.................................................. $ 35 $ 47 Retirement of property and equipment.................................. $ 4,327 $ 298
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 nine-month period ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005. The accompanying consolidated financial statements include the accounts of Lexicon and its subsidiaries. Intercompany transactions and balances are eliminated in consolidation. For further information, refer to the financial statements and footnotes thereto included in Lexicon's annual report on Form 10-K for the year ended December 31, 2004, as filed with the SEC. 2. RECLASSIFICATION As of September 30, 2004 and December 31, 2003, Lexicon reclassified auction rate securities of $53.6 million and $46.1 million, respectively, from cash equivalents to short-term investments and, as of December 31, 2003, Lexicon reclassified $42.6 million from restricted cash to short-term investments. The accompanying consolidated statement of cash flows for the nine months ended September 30, 2004 has been adjusted to reflect these reclassifications. 3. COMPREHENSIVE LOSS Comprehensive loss is comprised of net loss and unrealized gains and losses on short-term investments, which are considered available-for-sale securities. Comprehensive loss for the three months ended September 30, 2005 was $14.2 million, which includes a net loss of $14.1 million and a $33,000 unrealized loss on short-term investments. Comprehensive loss for the nine months ended September 30, 2005 was $42.3 million, which includes a net loss of $42.2 million and a $54,000 unrealized loss on short-term investments. 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. 6 5. STOCK-BASED COMPENSATION Lexicon's stock-based compensation plans are accounted for under the recognition and measurement provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees, and Related Interpretations." Under the intrinsic value method described in APB Opinion No. 25, no compensation expense is recognized if the exercise price of the employee stock option equals the market price of the underlying stock on the date of grant. Lexicon recognized stock-based compensation expense of $0.8 million for the nine months ended September 30, 2004, primarily relating to option grants made prior to Lexicon's April 2000 initial public offering. All deferred stock compensation relating to these options was fully amortized as of January 31, 2004 when these options became fully vested. The following table illustrates the effect on net loss and net loss per share if the fair value recognition provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock Based Compensation," had been applied to all outstanding and unvested awards in each period:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ --------------------------- 2005 2004 2005 2004 -------------- -------------- ------------ ------------ Net loss, as reported:.............................. $ (14,121) $ (14,377) $ (42,229) $ (46,631) Add: Stock-based employee compensation expense included in reported net loss............ - - (20) 827 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards............................ (2,679) (3,842) (8,936) (12,590) ------------- ------------- ----------- ----------- Pro forma net loss.................................. $ (16,800) $ (18,219) $ (51,185) $ (58,394) ============= ============= =========== =========== Net loss per common share, basic and diluted As reported...................................... $ (0.22) $ (0.23) $ (0.66) $ (0.74) ============= ============= =========== =========== Pro forma........................................ $ (0.26) $ (0.29) $ (0.80) $ (0.92) ============= ============= =========== ===========
6. DEBT OBLIGATIONS Genentech Loan: On December 31, 2002, Lexicon borrowed $4.0 million under a note agreement with Genentech, Inc. The proceeds of the loan are to be used to fund research efforts under the alliance agreement with Genentech. The note matures on December 31, 2005, but the Company may prepay it at any time. The Company may repay the note, at its option, in cash, in shares of common stock valued at the then-current market price, or in a combination of cash and shares, subject to certain limitations. The note accrues interest at an annual rate of 8%, compounded quarterly. Mortgage Loan: In April 2004, Lexicon purchased its facilities in The Woodlands, Texas that were previously subject to a synthetic lease. The Company repaid the $54.8 million funded under the synthetic lease with proceeds from a $34.0 million third-party mortgage financing and $20.8 million in cash. The mortgage loan has a ten-year term with a 20-year amortization and bears interest at a fixed rate of 8.23%. As a result of the refinancing, all restrictions on the cash and investments that had secured the obligations under the synthetic lease were eliminated. 7. COMMITMENTS AND CONTINGENCIES In May 2002, Lexicon's subsidiary Lexicon Pharmaceuticals (New Jersey), Inc. leased a 76,000 square-foot laboratory and office space in Hopewell, New Jersey under an agreement which expires in June 2013. The lease provides for an escalating yearly rent payment of $1.3 million in the first year, 7 $2.1 million in years two and three, $2.2 million in years four to six, $2.3 million in years seven to nine and $2.4 million in years ten and eleven. Lexicon is the guarantor of the obligations of its subsidiary under the lease. The Company is required to maintain restricted investments to collateralize the Hopewell lease. As of September 30, 2005, the Company had $430,000 in restricted investments to collateralize a standby letter of credit for this lease. 8. NEW AGREEMENT In July 2005, Lexicon was awarded $35 million from the Texas Enterprise Fund for the creation of a knockout mouse embryonic stem cell library containing 350,000 cell lines using Lexicon's proprietary gene trapping technology. Lexicon will create the library for the Texas Institute for Genomic Medicine (TIGM), a newly formed non-profit institute whose founding members are Texas A&M University, the Texas A&M University System Health Science Center and Lexicon. TIGM researchers may also access specific cells from Lexicon's current gene trap library of 270,000 mouse embryonic stem cell lines and will have certain rights to utilize Lexicon's patented gene targeting technologies. In addition, Lexicon will equip TIGM with the bioinformatics software required for the management and analysis of data relating to the library. The Texas Enterprise Fund has also awarded $15 million to the Texas A&M University System for the creation of facilities and infrastructure to house the library. Under the terms of the award, Lexicon is responsible for the creation of a specified number of jobs, reaching an aggregate of 1,616 new jobs in Texas by December 31, 2015. Lexicon will obtain credits based on funding received by TIGM and certain related parties from sources other than the State of Texas that it may offset against its potential liability for any job creation shortfalls. Lexicon will also obtain credits against future jobs commitment liabilities for any surplus jobs it creates. Subject to these credits, if Lexicon fails to create the specified number of jobs, the state may require Lexicon to repay $2,415 for each job Lexicon falls short. Lexicon's maximum aggregate exposure for such payments, if Lexicon fails to create any new jobs, is approximately $14.4 million, without giving effect to any credits to which Lexicon may be entitled. The Texas A&M University System, together with TIGM, has independent job creation obligations and is obligated for an additional period to maintain an aggregate of 5,000 jobs, inclusive of those Lexicon creates. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We are a biopharmaceutical company focused on discovering and developing breakthrough treatments for human disease. We are using gene knockout technology to systematically discover the physiological functions of genes in living mammals, or in vivo. We generate our gene function discoveries using knockout mice - mice whose DNA has been altered to disrupt, or "knock out," the function of the altered gene. Our patented gene trapping and gene targeting technologies enable us to rapidly generate these knockout mice by altering the DNA of genes in a special variety of mouse cells, called embryonic stem cells, which can be cloned and used to generate mice with the altered gene. We employ an integrated platform of advanced medical technologies to systematically discover and validate which genes, when knocked out, result in a favorable medical profile with pharmaceutical utility. We then pursue those genes and the proteins they encode as potential targets for therapeutic intervention in our drug discovery programs. We employ internal resources and drug discovery alliances to discover potential small molecule, antibody and protein drugs for in vivo-validated drug targets that we consider to have high pharmaceutical value. We use our own sophisticated libraries of drug-like chemical compounds and an industrialized medicinal chemistry platform to identify small molecule drug candidates for our in vivo-validated drug targets. We have established alliances with Bristol-Myers Squibb Company to discover and develop novel small molecule drugs in the neuroscience field; with Genentech, Inc. to discover therapeutic proteins and antibody targets; with N.V. Organon to discover, develop and commercialize novel biotherapeutics; and with Takeda Pharmaceutical Company Limited to discover new drugs for the treatment of high blood pressure. In addition, we have established collaborations and license agreements with many other leading pharmaceutical and biotechnology companies under which we receive fees and, in some cases, are eligible to receive milestone and royalty payments, for access to some of our technologies and discoveries for use in their own drug discovery efforts. We derive substantially all of our revenues from drug discovery alliances, target validation collaborations for the development and, in some cases, analysis of the physiological effects of genes altered in knockout mice and technology licenses. To date, we have generated a substantial portion of our revenues from a limited number of sources. Our operating results and, in particular, our ability to generate additional revenues are dependent on many factors, including our success in establishing research collaborations and technology licenses, expirations of our research collaborations, the success rate of our discovery efforts leading to opportunities for new research collaborations and licenses, as well as milestone payments and royalties, the timing and willingness of collaborators to commercialize products which may result in royalties, and general and industry-specific economic conditions which may affect research and development expenditures. Our future revenues from collaborations 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 offer subscriptions to our databases or make our compound libraries available for purchase in the future. Our ability to secure future revenue-generating agreements will depend upon our ability to address the needs of our potential future collaborators and licensees, and to negotiate agreements that we believe are in our long-term best interests. We may determine that our interests are better served by retaining rights to our discoveries and advancing our therapeutic programs to a later stage, which could limit our near-term revenues. Because of these and other factors, our operating results have fluctuated in the past and are likely to do so in the future, and we 9 do not believe that period-to-period comparisons of our operating results are a good indication of our future performance. Since our inception, we have incurred significant losses and, as of September 30, 2005, we had an accumulated deficit of $303.3 million. Our losses have resulted principally from costs incurred in research and development, general and administrative costs associated with our operations, and non-cash stock-based compensation expenses associated with stock options granted to employees and consultants prior to our April 2000 initial public offering. Research and development expenses consist primarily of salaries and related personnel costs, material costs, facility costs, depreciation on property and equipment, legal expenses resulting from intellectual property prosecution and other expenses related to our drug discovery and Genome5000 programs, the development and analysis of knockout mice and our other target validation research efforts, and the development of compound libraries. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, professional fees and other corporate expenses, including information technology, facilities costs and general legal activities. In connection with the expansion of our drug discovery programs and our target validation research efforts, we expect to incur increasing research and development and general and administrative costs. As a result, we will need to generate significantly higher revenues to achieve profitability. CRITICAL ACCOUNTING POLICIES Revenue Recognition We recognize revenues when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable, and collectibility is reasonably assured. Payments received in advance under these arrangements are recorded as deferred revenue until earned. Upfront fees and annual research funding under our drug discovery alliances are recognized as revenue on a straight-line basis over the estimated period of service, generally the contractual research term, to the extent they are non-refundable. Milestone-based fees are recognized upon completion of specified milestones according to contract terms. Fees for access to our databases and other target validation resources are recognized ratably over the subscription or access period. Payments received under target validation collaborations and government grants are recognized as revenue as we perform our obligations related to such research to the extent such fees are non-refundable. Non-refundable technology license fees are recognized as revenue upon the grant of the license, when performance is complete and there is no continuing involvement. Revenues recognized from multiple element contracts are allocated to each element of the arrangement based on the relative fair value of the elements. The determination of fair value of each element is based on objective evidence. When revenues for an element are specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation associated with the element is completed. When revenues for an element are not specifically tied to a separate earnings process, they are recognized ratably over the term of the agreement. A change in our revenue recognition policy or changes in the terms of contracts under which we recognize revenues could have an impact on the amount and timing of our recognition of revenues. 10 Research and Development Expenses Research and development expenses consist of costs incurred for company-sponsored as well as collaborative research and development activities. These costs include direct and research-related overhead expenses and are expensed as incurred. Patent costs and technology license fees for technologies that are utilized in research and development and have no alternative future use are expensed when incurred. Prior to preclinical development work, we are unable to segregate the costs related to research performed on drug candidates because the drug candidate is often not specifically identified until the later stages of our research. With the commencement of formal preclinical development in 2005, we will account on a program-by-program basis for the costs related to the development of the identified drug products. Goodwill Impairment Goodwill is not amortized, but is tested at least annually for impairment at the reporting unit level. We have determined that the reporting unit is the single operating segment disclosed in our current financial statements. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. The first step in the impairment process is to determine the fair value of the reporting unit and then compare it to the carrying value, including goodwill. We determined that the market capitalization approach is the most appropriate method of measuring fair value of the reporting unit. Under this approach, fair value is calculated as the average closing price of our common stock for the 30 days preceding the date that the annual impairment test is performed, multiplied by the number of outstanding shares on that date. A control premium, which is representative of premiums paid in the marketplace to acquire a controlling interest in a company, is then added to the market capitalization to determine the fair value of the reporting unit. If the fair value exceeds the carrying value, no further action is required and no impairment loss is recognized. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstances that would indicate that, more likely than not, the carrying value of goodwill has been impaired. RESULTS OF OPERATIONS Three Months Ended September 30, 2005 and 2004 Revenues. Total revenues and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
THREE MONTHS ENDED SEPTEMBER 30, -------------------------------- 2005 2004 ------- ------ Total revenues........................... $ 14.0 $ 13.1 Dollar increase.......................... $ 0.9 Percentage increase...................... 7%
- Collaborative research - Revenue from collaborative research increased 18% to $13.5 million primarily due to our recognition of revenues under our biotherapeutics collaboration with Organon, which was entered into in May 2005, and our award from the Texas Enterprise Fund for the creation of a knockout mouse embryonic stem cell library, which was entered into in July 2005. This was offset in part by the recognition in the prior year period of a performance milestone under our therapeutic protein and antibody target discovery alliance with Genentech. 11 - Subscription and license fees - Revenue from subscriptions and license fees decreased 73% to $0.4 million primarily as a result of our termination in December 2004, of the collaboration term under our LexVision(R) database subscription program with Bristol-Myers Squibb. Research and Development Expenses. Research and development expenses and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
THREE MONTHS ENDED SEPTEMBER 30, -------------------------------- 2005 2004 ------- ------- Total research and development expense... $ 23.3 $ 22.5 Dollar increase.......................... $ 0.8 Percentage increase...................... 4%
Research and development expenses consist primarily of salaries and other personnel-related expenses, laboratory supplies, facility and equipment costs, third-party and other services. The change in the three months ended September 30, 2005 as compared to the corresponding period in 2004 resulted primarily from the following costs: - Personnel - Personnel costs increased 5% to $11.5 million primarily due to increased personnel to support the expansion of our drug discovery programs and merit-based pay increases for employees. Salaries, bonuses, employee benefits, payroll taxes, and recruiting and relocation costs are included in personnel costs. - Laboratory supplies - Laboratory supplies expense decreased 18% to $3.2 million due primarily to the bulk purchase of certain supplies in the prior year period. - Facilities and equipment - Facilities and equipment costs increased 7% to $5.2 million due primarily to higher utility costs. - Third-party services - Costs associated with third-party services increased 44% to $2.0 million primarily due to an increase in third-party contract research costs. Costs associated with third-party services include third-party contract research, subscriptions to third-party databases, technology licenses, and legal and patent fees. - Other - Other costs increased by 4% to $1.4 million primarily related to increased information technology costs. General and Administrative Expenses. General and administrative expenses and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
THREE MONTHS ENDED SEPTEMBER 30, -------------------------------- 2005 2004 ------- ------ Total general and administrative expense.. $ 4.7 $ 4.6 Dollar increase........................... $ 0.1 Percentage increase....................... 2%
General and administrative expenses consist primarily of personnel costs to support our research activities, facility and equipment costs and professional fees, such as legal fees. The change in the three months ended September 30, 2005 as compared to the corresponding period in 2004 resulted primarily from the following costs: 12 - Personnel - Personnel costs increased 10% to $2.9 million due to increased personnel and merit-based pay increases for employees. Salaries, bonuses, employee benefits, payroll taxes, recruiting and relocation costs are included in personnel costs. - Facilities and equipment - Facilities and equipment costs increased 7% to $0.8 million due primarily to higher utility costs. - Professional fees - Professional fees decreased 24% to $0.4 million primarily due to lower legal fees. - Other - Other costs decreased 12% to $0.6 million. Interest Income. Interest income increased 89% to $0.8 million in the three months ended September 30, 2005 from $0.4 million in the corresponding period in 2004 due to higher interest rates and higher average cash and investment balances. Interest Expense. Interest expense remained unchanged at $0.8 million in the three months ended September 30, 2005 and 2004. Net Loss and Net Loss Per Common Share. Net loss decreased 2% to $14.1 million in the three months ended September 30, 2005 from $14.4 million in the corresponding period in 2004. Net loss per common share decreased to $0.22 in the three months ended September 30, 2005 from $0.23 in the corresponding period in 2004. 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. Nine Months Ended September 30, 2005 and 2004 Revenues. Total revenues and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2005 2004 ------- ------ Total revenues........................... $ 41.8 $ 35.7 Dollar increase.......................... $ 6.1 Percentage increase...................... 17%
- Collaborative research - Revenue from collaborative research increased 29% to $36.2 million primarily due to our recognition of revenues under our biotherapeutics collaboration with Organon, which was entered into in May 2005, our hypertension drug discovery alliance with Takeda, which was entered into in July 2004, and our award from the Texas Enterprise Fund for the creation of a knockout mouse embryonic stem cell library. This was offset in part by the recognition in the prior year period of a performance milestone under our therapeutic protein and antibody target discovery alliance with Genentech and a decrease in revenues from the termination of our therapeutic protein discovery alliance with Incyte in June 2004. - Subscription and license fees - Revenue from subscriptions and license fees decreased 27% to $5.6 million primarily as a result of the termination in June 2004 and December 2004, respectively, of the collaboration term under our LexVision database subscription programs with Incyte Corporation and Bristol-Myers Squibb. The reduction was offset in 13 part by technology license fees received from Deltagen, Inc. in connection with the settlement of Lexicon's claim in Deltagen's bankruptcy proceedings. Research and Development Expenses. Research and development expenses and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2005 2004 ------- ------- Total research and development expense... $ 69.8 $ 67.5 Dollar increase.......................... $ 2.3 Percentage increase...................... 3%
Research and development expenses consist primarily of salaries and other personnel-related expenses, laboratory supplies, facility and equipment costs, third-party and other services. The change in the nine months ended September 30, 2005 as compared to the corresponding period in 2004 resulted primarily from the following costs: - Personnel - Personnel costs increased 8% to $34.9 million primarily due to increased personnel to support the expansion of our drug discovery programs and merit-based pay increases for employees. - Laboratory supplies - Laboratory supplies expense decreased 11% to $9.6 million due primarily to the bulk purchase of certain supplies in the prior year period. - Facilities and equipment - Facilities and equipment costs increased 4% to $15.6 million primarily due to higher utility costs. - Third-party services - Costs associated with third-party services increased 4% to $5.4 million primarily due to an increase in third-party contract research costs, offset in part by the termination in June 2004 of our LifeSeq(R) Gold database subscription. - Other - Other costs increased by 12% to $4.1 million primarily related to increased information technology costs. General and Administrative Expenses. General and administrative expenses and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2005 2004 ------- ------ Total general and administrative expense.. $ 13.9 $ 14.3 Dollar decrease........................... $ 0.4 Percentage decrease....................... 3%
General and administrative expenses consist primarily of personnel costs to support our research activities, facility and equipment costs and professional fees, such as legal fees. The change in the nine months ended September 30, 2005 as compared to the corresponding period in 2004 resulted primarily from the following costs: - Personnel - Personnel costs increased 2% to $8.3 million. - Facilities and equipment - Facilities and equipment costs remain unchanged at $2.3 million. 14 - Professional fees - Professional fees decreased 5% to $1.4 million primarily due to decreased legal fees. - Other - Other costs decreased 4% to $1.8 million. Interest Income. Interest income increased 47% to $1.8 million in the nine months ended September 30, 2005 from $1.2 million in the corresponding period in 2004 primarily due to higher interest rates and higher average cash and investment balances. Interest Expense. Interest expense increased to $2.5 million in the nine months ended September 30, 2005 from $1.8 million in the corresponding period in 2004. The increase was attributable to interest expense on the $34.0 million mortgage loan on our facilities in The Woodlands, Texas, which was entered into in April 2004. Net Loss and Net Loss Per Common Share. Net loss decreased 9% to $42.2 million in the nine months ended September 30, 2005 from $46.6 million in the corresponding period in 2004. Net loss per common share decreased to $0.66 in the nine months ended September 30, 2005 from $0.74 in the corresponding period in 2004. Net loss includes stock-based compensation expense of $0.8 million in the nine months ended September 30, 2004. 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 drug discovery alliance, target validation, database subscription and license agreements, equipment financing arrangements and leasing arrangements. From our inception through September 30, 2005, we had received net proceeds of $295.4 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 and $50.1 million from our July 2003 common stock offering. In addition, from our inception through September 30, 2005, we received $312.3 million in cash payments from drug discovery alliances, target validation collaborations, database subscription and technology license fees, sales of compound libraries and reagents, and government grants, of which $234.9 million had been recognized as revenues through September 30, 2005. As of September 30, 2005, we had $90.2 million in cash, cash equivalents and short-term investments (including $0.4 million of restricted investments), as compared to $87.6 million (including $0.4 million of restricted investments) as of December 31, 2004. Cash provided by operating activities was $12.0 million in the nine months ended September 30, 2005. This consisted primarily of the net loss for the period of $42.2 million offset by non-cash charges of $7.8 million related to depreciation expense and $0.9 million related to amortization of intangible assets other than goodwill; a $41.9 million increase in deferred revenue; and changes in other operating assets and liabilities of $3.6 million. Cash used in investing activities was $3.5 million in the nine months ended September 30, 2005, primarily due to purchases of property and equipment of $9.4 million offset by net maturities of short-term investments of $5.8 million. In April 2004, we purchased our facilities in The Woodlands, Texas from the lessor under our previous synthetic lease agreement. In connection with such purchase, we repaid the $54.8 million funded under the synthetic lease with proceeds from a $34.0 million third-party mortgage financing and $20.8 million in cash. The mortgage loan has a ten-year term with a 20-year amortization and bears interest at a fixed rate of 8.23%. As a result of the refinancing, all restrictions on the cash and investments that had secured our obligations under the synthetic lease were eliminated. 15 In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc. signed a ten-year lease for a 76,000 square-foot facility in Hopewell, New Jersey. The term of the lease extends until June 30, 2013. The lease provides for an escalating yearly base rent payment of $1.3 million in the first year, $2.1 million in years two and three, $2.2 million in years four to six, $2.3 million in years seven to nine and $2.4 million in years ten and eleven. We are the guarantor of the obligations of our subsidiary under the lease. In December 2002, we borrowed $4.0 million under a note agreement with Genentech. The proceeds of the loan are to be used to fund research efforts under our alliance with Genentech for the discovery of therapeutic proteins and antibody targets. The note matures on or before December 31, 2005, but we may prepay it at any time. We may repay the note, at our option, in cash, in shares of our common stock valued at the then-current market value, or in a combination of cash and shares, subject to certain limitations. The note accrues interest at an annual rate of 8%, compounded quarterly. In July 2005, we were awarded $35 million from the Texas Enterprise Fund for the creation of a knockout mouse embryonic stem cell library containing 350,000 cell lines. We will create the library for the Texas Institute for Genomic Medicine, a newly formed non-profit institute whose founding members are Texas A&M University, the Texas A&M University System Health Science Center and us. Under the terms of the award, we are responsible for the creation of a specified number of jobs, reaching an aggregate of 1,616 new jobs in Texas by December 31, 2015. We will obtain credits based on funding received by the institute and certain related parties from sources other than the State of Texas that we may offset against our potential liability for any job creation shortfalls. We will also obtain credits against future jobs commitment liabilities for any surplus jobs we create. Subject to these credits, if we fail to create the specified number of jobs, the state may require us to repay $2,415 for each job we fall short. Our maximum aggregate exposure for such payments, if we fail to create any new jobs, is approximately $14.4 million, without giving effect to any credits to which we may be entitled. Our future capital requirements will be substantial and will depend on many factors, including our ability to obtain alliance, collaboration and technology license agreements, the amount and timing of payments under such agreements, the level and timing of our research and development expenditures, market acceptance of our products, the resources we devote to developing and supporting our products and other factors. Our capital requirements will also be affected by any expenditures we make in connection with license agreements and acquisitions of and investments in complementary technologies and businesses. We expect to devote substantial capital resources to continue our research and development efforts, to expand our support and product development activities, and for other general corporate activities. We believe that our current unrestricted cash and investment balances and revenues we expect to derive from drug discovery alliances, target validation collaborations and technology licenses will be sufficient to fund our operations through approximately 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. DISCLOSURE ABOUT MARKET RISK We are exposed to limited market and credit risk on our cash equivalents, which have maturities of three months or less at the time of purchase. We maintain a short-term investment portfolio which consists of U.S. government agency debt obligations, investment grade commercial paper, corporate debt securities and certificates of deposit that mature within twelve months and auction rate securities that mature greater than twelve months from the time of purchase, which we believe are subject to limited 16 market and credit risk. We currently do not hedge interest rate exposure or hold any derivative financial instruments in our investment portfolio. We have operated primarily in the United States and substantially all sales to date have been made in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations. RISK FACTORS Our business is subject to certain risks and uncertainties, including those referenced below: Risks Related to Our Company and Business - we have a history of net losses, and we expect to continue to incur net losses and may not achieve or maintain profitability - we will need additional capital in the future and, if it is not available, we will have to curtail or cease operations - any sale of additional equity securities in the future may be dilutive to our stockholders - we are an early-stage company, and we may not successfully develop or commercialize any therapeutics or drug targets that we have identified - we face substantial competition in the discovery of the DNA sequences of genes and their functions and in our drug discovery and product development efforts - we rely heavily on our collaborators to develop and commercialize pharmaceutical products based on genes that we identify as promising candidates for development as drug targets, and our collaborators' efforts may fail to yield pharmaceutical products on a timely basis, if at all - we rely on several key collaborators for a significant portion of our revenues, the loss of any of which would negatively impact our business to the extent such losses are not offset by additional collaborators - cancellations by or conflicts with our collaborators could harm our business - we may be unsuccessful in developing and commercializing pharmaceutical products on our own - we lack the capability to manufacture materials for preclinical studies, clinical trials or commercial sales and will rely on third parties to manufacture our potential products, which may harm or delay our product development and commercialization efforts - we may engage in future acquisitions, which may be expensive and time consuming and from which we may not realize anticipated benefits - 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 - any contamination among our knockout mouse population could negatively affect the reliability of our scientific research or cause us to incur significant remedial costs - because all of our target validation operations are located at a single facility, the occurrence of a disaster could significantly disrupt our business 17 - our operating results have been and likely will continue to fluctuate, and we believe that period-to-period comparisons of our operating results are not a good indication of our future performance Risks Related to Our Industry - our ability to patent our inventions is uncertain because patent laws and their interpretation are highly uncertain and subject to change - our patent applications may not result in enforceable patent rights and, as a result, the protection afforded to our scientific discoveries may be insufficient - if other companies and institutions obtain patents relating to our drug target or product candidate discoveries, we may be unable to obtain patents for our inventions based upon those discoveries and may be blocked from using or developing some of our technologies and products - issued or pending patents may not fully protect our discoveries, and our competitors may be able to commercialize technologies or products similar to those covered by our issued or pending patents - we may be involved in patent litigation and other disputes regarding intellectual property rights and may require licenses from third parties for our discovery and development and planned commercialization activities, and we may not prevail in any such litigation or other dispute or be able to obtain required licenses - we use intellectual property that we license from third parties, and if we do not comply with these licenses, we could lose our rights under them - we have not sought patent protection outside of the United States for some of our inventions, and some of our licensed patents only provide coverage in the United States, and as a result, our international competitors could be granted foreign patent protection with respect to our discoveries - we may be unable to protect our trade secrets - our efforts to discover, evaluate and validate potential targets for drug intervention and our drug discovery programs are subject to evolving data and other risks inherent in the drug discovery process - our industry is subject to extensive and uncertain government regulatory requirements, which could significantly hinder our ability, or the ability of our collaborators, to obtain, in a timely manner or at all, government approval of products based on genes that we identify, or to commercialize such products - if our potential products receive regulatory approval, we or our collaborators will remain subject to extensive and rigorous ongoing regulation - the uncertainty of pharmaceutical pricing and reimbursement may decrease the commercial potential of any products that we or our collaborators may develop and affect our ability to raise capital - we use hazardous chemicals and radioactive and biological materials in our business; any disputes relating to improper handling, storage or disposal of these materials could be time consuming and costly 18 - we may be sued for product liability - public perception of ethical and social issues may limit or discourage the use of our technologies, which could reduce our revenues For additional discussion of the risks and uncertainties that affect our business, see "Item 1. Business - Risk Factors" included in our annual report on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Disclosure about Market Risk" under "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for quantitative and qualitative disclosures about market risk. ITEM 4. CONTROLS AND PROCEDURES Our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) are sufficiently effective to ensure that the information required to be disclosed by us in the reports we file under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness, based on an evaluation of such controls and procedures as of the end of the period covered by this report. Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. 19 PART II OTHER INFORMATION ITEM 5. OTHER INFORMATION On October 26, 2005, the compensation committee of our Board of Directors approved an additional annual retainer of $15,000 for service as non-executive Chairman of our Board of Directors. All non-employee directors currently receive an annual retainer of $15,000 for their service on the Board of Directors. On October 26, 2005, the compensation committee also approved an additional annual option grant to the non-executive Chairman of our Board of Directors under our 2000 Equity Incentive Plan to purchase 10,000 shares of common stock at an exercise price equal to the fair market value of our common stock on the date of grant. All non-employee directors who have served in such capacity for six months currently receive an annual option to purchase 10,000 shares of common stock under our 2000 Non-Employee Directors' Stock Option Plan at an exercise price equal to the fair market value of our common stock on the date of grant. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
EXHIBIT NO. DESCRIPTION ----------- ------------------------------------------------------------------- 10.1 -- Economic Development Agreements dated July 15, 2005, with the State of Texas and the Texas A&M University System +10.2 -- Collaboration and License Agreement, dated July 15, 2005, with the Texas A&M University System and the Texas Institute for Genomic Medicine 10.3 -- Non-Employee Director Compensation 31.1 -- Certification of CEO Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2 -- Certification of CFO Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 32.1 -- Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
+ Confidential treatment has been requested for a portion of this exhibit. The confidential portions of this exhibit have been omitted and filed separately with the Securities and Exchange Commission (b) Reports on Form 8-K: On July 18, 2005, we filed a Current Report on Form 8-K dated July 15, 2005 related to our entry into an Economic Development Agreement, dated July 15, 2005 with the State of Texas and the Texas A&M University System and a Collaboration and License Agreement, dated July 15, 2005, with the Texas A&M University System and the Texas Institute for Genomic Medicine. On July 28, 2005, we filed a Current Report on Form 8-K dated July 28, 2005 related to our issuance of a press release reporting our financial results for the quarter ended June 30, 2005, which press release included our consolidated balance sheet data and consolidated statements of operations data for the period. 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEXICON GENETICS INCORPORATED Date: November 1, 2005 By: /s/ Arthur T. Sands ----------------------------------------------- Arthur T. Sands, M.D., Ph.D. President and Chief Executive Officer Date: November 1, 2005 By: /s/ Julia P. Gregory ----------------------------------------------- Julia P. Gregory Executive Vice President, Corporate Development and Chief Financial Officer 21 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION ----------- ------------------------------------------------------------------- 10.1 -- Economic Development Agreements dated July 15, 2005, with the State of Texas and the Texas A&M University System +10.2 -- Collaboration and License Agreement, dated July 15, 2005, with the Texas A&M University System and the Texas Institute for Genomic Medicine 10.3 -- Non-Employee Director Compensation 31.1 -- Certification of CEO Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 31.2 -- Certification of CFO Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 32.1 -- Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
+ Confidential treatment has been requested for a portion of this exhibit. The confidential portions of this exhibit have been omitted and filed separately with the Securities and Exchange Commission