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)
<Table>
<Caption>
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
========= =========
</Table>
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)
<Table>
<Caption>
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
</Table>
The accompanying notes are an integral part of
these consolidated financial statements.
4
LEXICON GENETICS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
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
</Table>
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
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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.
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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
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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
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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.
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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
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