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EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - LEXICON PHARMACEUTICALS, INC.exh31_1.htm
EX-10.1 - COLLABORATION AND LICENSE AGREEMENT - LEXICON PHARMACEUTICALS, INC.exh10_1.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - LEXICON PHARMACEUTICALS, INC.exh31_2.htm
EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE AND FINANCIAL OFFICERS - LEXICON PHARMACEUTICALS, INC.exh32_1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
 
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 31, 2010
 
or
 
 
q
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 Pharmaceuticals, Inc.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
76-0474169
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
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
ü
 
No
 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes
   
No
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer             Accelerated filer     ü    Non-accelerated filer             Smaller reporting company          
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes
   
No
ü
 
As of May 6, 2010, 337,404,194 shares of the registrant’s common stock, par value $0.001 per share, were outstanding.
 


 
 
Lexicon Pharmaceuticals, Inc.
 
 
   
Page
2
3
Item 1.
3
 
Consolidated Balance Sheets – March 31, 2010 (unaudited) and December 31, 2009
3
 
Consolidated Statements of Operations (unaudited) – Three Months Ended March 31, 2010 and 2009
4
 
Consolidated Statements of Stockholders’ Equity (unaudited) – Three Months Ended March 31, 2010 and 2009
5
 
Consolidated Statements of Cash Flows (unaudited) – Three Months Ended March 31, 2010 and 2009
6
 
7
Item 2.
16
Item 3.
23
Item 4.
23
24
Item 1.
24
Item 1A.
24
Item 2.
26
Item 6.
27
 
28
     

The Lexicon name and logo, OmniBank® and LexVision® are registered trademarks and Genome5000 is a trademark of Lexicon Pharmaceuticals, Inc.
 
——————

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 “Part II, Item 1A. – 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.
 
Part I – Financial Information
 
Item 1.                 Financial Statements
 
Lexicon Pharmaceuticals, Inc.
 
Consolidated Balance Sheets
(In thousands, except par value)
 
   
As of March 31,
   
As of December 31,
 
   
2010
   
2009
 
Assets
 
(unaudited)
       
Current assets:
           
Cash and cash equivalents
 
$
260,126
   
$
100,554
 
Short-term investments, including restricted investments of $430
   
54,055
     
56,542
 
Short-term investments held by Symphony Icon, Inc. (Note 4)
   
     
5,417
 
Accounts receivable, net of allowances of $35
   
1,969
     
815
 
Prepaid expenses and other current assets
   
5,757
     
6,356
 
Total current assets
   
321,907
     
169,684
 
Property and equipment, net of accumulated depreciation and amortization of $76,015 and $75,795, respectively
   
57,850
     
58,754
 
Goodwill
   
25,798
     
25,798
 
Other assets
   
3,656
     
3,325
 
Total assets
 
$
409,211
   
$
257,761
 
                 
Liabilities and Equity
               
                 
Current liabilities:
               
Accounts payable
 
$
4,773
   
$
5,919
 
Accrued liabilities
   
5,368
     
5,611
 
Current portion of deferred revenue
   
576
     
942
 
Current portion of long-term debt
   
36,599
     
38,482
 
Total current liabilities
   
47,316
     
50,954
 
Deferred revenue, net of current portion
   
14,212
     
14,212
 
Long-term debt
   
28,199
     
28,482
 
Other long-term liabilities
   
579
     
616
 
Total liabilities
   
90,306
     
94,264
 
                 
Commitments and contingencies
               
                 
Equity:
               
Lexicon Pharmaceuticals, Inc. stockholders’ equity:
               
Preferred stock, $.01 par value; 5,000 shares authorized; no shares issued and outstanding
   
     
 
Common stock, $.001 par value; 900,000 shares authorized; 337,562 and 175,785 shares issued, respectively
   
338
     
176
 
Additional paid-in capital
   
916,505
     
733,874
 
Accumulated deficit
   
(597,701
)
   
(570,175
)
Treasury stock, at cost, 158 and 80 shares, respectively
   
(237
)
   
(88
)
Total Lexicon Pharmaceuticals, Inc. stockholders’ equity
   
318,905
     
163,787
 
Noncontrolling interest in Symphony Icon, Inc. (Note 4)
   
     
(290
)
Total equity
   
318,905
     
163,497
 
Total liabilities and equity
 
$
409,211
   
$
257,761
 

The accompanying notes are an integral part of these consolidated financial statements.
 
Lexicon Pharmaceuticals, Inc.
 
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 

   
Three Months Ended March 31,
 
   
2010
   
2009
 
Revenues:
           
Collaborative research
 
$
1,641
   
$
3,605
 
Subscription and license fees 
   
     
563
 
Total revenues 
   
1,641
     
4,168
 
Operating expenses:
               
Research and development, including stock-based compensation of $806 and $829, respectively
   
21,088
     
22,864
 
General and administrative, including stock-based compensation of $499 and $613, respectively
   
5,519
     
4,874
 
Total operating expenses
   
26,607
     
27,738
 
Loss from operations 
   
(24,966
)
   
(23,570
)
Gain on investments, net
   
88
     
517
 
Interest income 
   
217
     
327
 
Interest expense 
   
(727
)
   
(666
)
Other expense, net
   
(682
)
   
(945
)
Consolidated net loss
   
(26,070
)
   
(24,337
)
Less: Net loss attributable to noncontrolling interest in Symphony Icon, Inc. (Note 4)
   
     
2,777
 
Net loss attributable to Lexicon Pharmaceuticals, Inc.
 
$
(26,070
)
 
$
(21,560
)
                 
Net loss attributable to Lexicon Pharmaceuticals, Inc. per common share, basic and diluted
 
$
(0.13
)
 
$
(0.16
)
Shares used in computing net loss attributable to Lexicon Pharmaceuticals, Inc. per common share, basic and diluted  
   
197,239
     
137,075
 


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

 
Lexicon Pharmaceuticals, Inc.
 
Consolidated Statements of Stockholders’ Equity
(In thousands)
(Unaudited)


   
Lexicon Pharmaceuticals, Inc. Stockholders
             
               
Additional Paid-In
Capital
   
Accumulated Deficit
   
Accumulated Other Comprehensive Loss
   
Treasury Stock
   
Total
   
Noncontrolling Interest
(Note 4)
   
Total Equity
 
   
Common Stock
 
   
Shares
   
Par Value
 
Balance at December 31, 2008
   
136,797
   
$
137
   
$
672,838
   
$
(487,395
)
 
$
   
$
   
$
185,580
   
$
10,247
   
$
195,827
 
Stock-based compensation
   
     
     
1,807
     
     
     
     
1,807
     
     
1,807
 
Grant of restricted stock
   
534
     
     
     
     
     
     
     
     
 
Net loss
   
     
     
     
(21,560
)
   
     
     
(21,560
)
   
(2,777
)
   
(24,337
)
Unrealized loss on investments
   
     
     
     
     
(5
)
   
     
(5
)
   
     
(5
)
Comprehensive loss
                                                   
(21,565
)
           
(24,342
)
Balance at March 31, 2009
   
137,331
   
$
137
   
$
674,645
   
$
(508,955
)
 
$
(5
)
 
$
   
$
165,822
   
$
7,470
   
$
173,292
 
                                                                         
Balance at December 31, 2009
   
175,785
   
$
176
   
$
733,874
   
$
(570,175
)
 
$
   
$
(88
)
 
$
163,787
   
$
(290
)
 
$
163,497
 
Deconsolidation of Symphony Icon
   
     
     
     
     
     
     
     
290
     
290
 
Cumulative-effect adjustment for adoption of new accounting principle
   
     
     
     
(1,456
   
     
     
(1,456
   
     
(1,456
)
Stock-based compensation
   
     
     
1,305
     
     
     
     
1,305
     
     
1,305
 
Issuance of common stock, net of fees
   
161,770
     
162
     
181,309
     
     
     
     
181,471
     
     
181,471
 
Exercise of common stock options
   
7
     
     
17
     
     
     
     
17
     
     
17
 
Repurchase of common stock
   
     
     
     
     
     
(149
   
(149
)
   
     
(149
)
Net loss
   
     
     
     
(26,070
)
   
     
     
(26,070
)
   
     
(26,070
)
Balance at  March 31, 2010
   
337,562
   
$
338
   
$
916,505
   
$
(597,701
)
 
$
   
$
(237
 
$
318,905
   
$
   
$
318,905
 


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


 
Lexicon Pharmaceuticals, Inc.
 
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Consolidated net loss
 
$
(26,070
)
 
$
(24,337
)
Adjustments to reconcile consolidated net loss to net cash used in operating activities:
               
Depreciation
   
1,380
     
1,772
 
Impairment of fixed assets
   
     
406
 
Amortization of Symphony Icon, Inc. purchase option
   
678
     
535
 
Stock-based compensation
   
1,305
     
1,442
 
(Gain) loss on auction rate securities (“ARS”)
   
(2,238
)
   
41
 
Loss (gain) on ARS Rights
   
2,150
     
(558
)
Loss on disposal of property and equipment
   
     
2
 
Changes in operating assets and liabilities:
               
Increase in accounts receivable
   
(737
)
   
(680
)
Decrease in prepaid expenses and other current assets
   
3,285
     
1,784
 
Decrease in other assets
   
24
     
26
 
Decrease in accounts payable and other liabilities
   
(1,111
)
   
(6,024
)
Decrease in deferred revenue
   
(366
)
   
(2,563
)
Net cash used in operating activities
   
(21,700
)
   
(28,154
)
Cash flows from investing activities:
               
Purchases of property and equipment
   
(485
)
   
(156
)
Proceeds from disposal of property and equipment
   
9
     
36
 
Maturities of investments held by Symphony Icon, Inc. (Note 4)
   
     
4,778
 
Purchases of investments
   
     
(59,955
)
Maturities of investments
   
2,575
     
100
 
Net cash provided by (used in) investing activities
   
2,099
     
(55,197
)
Cash flows from financing activities:
               
Proceeds from issuance of common stock
   
181,488
     
 
Repurchase of common stock
   
(149
)
   
 
Proceeds from debt borrowings
   
750
     
14,800
 
Repayment of debt borrowings
   
(2,916
)
   
(369
)
Net cash provided by financing activities
   
179,173
     
14,431
 
Net increase (decrease) in cash and cash equivalents
   
159,572
     
(68,920
)
Cash and cash equivalents at beginning of period
   
100,554
     
85,873
 
Cash and cash equivalents at end of period
 
$
260,126
   
$
16,953
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
 
$
606
   
$
626
 
                 
Supplemental disclosure of non-cash investing and financing activities:
               
Unrealized loss on investments
 
$
   
$
(5
)
 

The accompanying notes are an integral part of these consolidated financial statements.
 
Lexicon Pharmaceuticals, Inc.
 
Notes to Consolidated Financial Statements
(Unaudited)
 
1.      Basis of Presentation
 
The accompanying unaudited consolidated financial statements of Lexicon Pharmaceuticals, Inc. (“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, 2010 are not necessarily indicative of the results that may be expected for the year ended December 31, 2010.
 
The accompanying consolidated financial statements include the accounts of Lexicon and its wholly-owned subsidiaries. Intercompany transactions and balances are eliminated in consolidation. In 2009, the consolidated financial statements also include the accounts of one variable interest entity, Symphony Icon, Inc. (“Symphony Icon”), for which the Company was the primary beneficiary and therefore had consolidated the financial condition and results of operations of Symphony Icon.  Upon the adoption of a new accounting pronouncement regarding variable interest entities (formerly Statement of Financial Accounting Standards (“SFAS”) No. 167, “Amendments to FASB Interpretation No. 46(R)”) on January 1, 2010, Lexicon determined that it is no longer the primary beneficiary of Symphony Icon, and is therefore no longer consolidating the financial condition and results of operations of Symphony Icon.
 
Certain amounts in the prior year’s financial statements have been reclassified to conform to the current year presentation.  These include the reclassification of $112,000 of patent-related legal costs from research and development expense to general and administrative expense on the consolidated statement of operations for the three months ended March 31, 2009.
 
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, 2009, as filed with the SEC.
 
2.      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.
 
3.      Stock-Based Compensation
 
The Company recorded $1.3 million and $1.4 million of stock-based compensation expense for the three months ended March 31, 2010 and 2009, respectively.  The Company utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation granted, with the following weighted-average assumptions for options granted in the three months ended March 31, 2010 and 2009:
 
   
Expected Volatility
   
Risk-free Interest Rate
   
Expected Term
   
Estimated Forfeitures
   
Dividend
Rate
 
March 31, 2010:
                             
Employees
   
86
%
   
2.4
%
   
5
     
22
%
   
0
%
Officers and non-employee directors
   
80
%
   
3.3
%
   
8
     
7
%
   
0
%
March 31, 2009:
                                       
Employees
   
78
%
   
1.9
%
   
5
     
23
%
   
0
%
Officers and non-employee directors
   
76
%
   
2.6
%
   
8
     
6
%
   
0
%

The following is a summary of option activity under Lexicon’s stock option plans for the three months ended March 31, 2010:
 
   
Options
   
Weighted Average Exercise Price
   
(in thousands)
     
Outstanding at December 31, 2009
   
17,346
   
$
4.16
Granted
   
4,517
     
1.90
Exercised
   
(7
   
2.50
Expired
   
(1,439
   
4.13
Forfeited
   
(263
)
   
1.55
Outstanding at March 31, 2010
   
20,154
     
3.69
Exercisable at March 31, 2010
   
10,554
   
$
5.34

During 2009, Lexicon granted its officers restricted stock bonus awards in lieu of cash bonus awards.  The shares subject to the awards vested in two installments over the one-year period following the date of grant.  The following is a summary of restricted stock activity under Lexicon’s stock option plans for the three months ended March 31, 2010:
 
   
Shares
   
Weighted Average Grant Date
Fair Value
   
(in thousands)
     
Outstanding at December 31, 2009
   
255
   
$
1.45
Vested
   
(255
)
   
1.45
Nonvested at March 31, 2010
   
   
  $

During the three months ended March 31, 2010, Lexicon granted certain employees restricted stock units with a performance condition.  The shares subject to the restricted stock units vest upon the dosing of the first patient in a pivotal human clinical trial in any country, the results of which could be used to establish safety and efficacy of a pharmaceutical product discovered or developed by Lexicon as a basis for a New Drug Application.  Stock-based compensation expense for awards with performance conditions is recognized over the period from the date the performance condition is determined to be probable of occurring through the time the applicable condition is met.  The following is a summary of restricted stock units activity under Lexicon’s stock option plans for the three months ended March 31, 2010:
 
   
Shares
   
Weighted Average Grant Date
Fair Value
   
(in thousands)
     
Outstanding at December 31, 2009
   
   
$
Granted
   
387
     
1.90
Nonvested at March 31, 2010
   
387
   
  $
1.90

4.      Recent Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued a new accounting pronouncement regarding variable interest entities (formerly SFAS No. 167) which changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated.  The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities that most significantly impacts the entity’s economic performance.  The impact of the adoption of this pronouncement may be applied retrospectively with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated, or through a cumulative-effect adjustment on the date of adoption.  This pronouncement, found under FASB ASC Topic 810, is effective for fiscal years, and interim periods within those fiscal years, beginning on or after November 15, 2009.  The Company has determined that upon adoption of this pronouncement on January 1, 2010, Lexicon is no longer the primary beneficiary of Symphony Icon, and therefore has not included the financial condition and results of operations of Symphony Icon in its consolidated financial statements as of and for the three months ended March 31, 2010.  As of December 31, 2009, Symphony Icon had $6.2 million in current assets, $5.4 million of which was short-term investments, and $4.2 million in current liabilities.  On January 1, 2010, Lexicon recorded a cumulative-effect adjustment to retained earnings (accumulated deficit) as a result of adopting this pronouncement, which increased the accumulated deficit balance by $1.5 million.
 
In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, “Multiple-Deliverable Revenue Arrangements”, which amends FASB ASC Topic 605.  ASU No. 2009-13 addresses how to determine whether an arrangement involving multiple deliverables contain more than one unit of accounting and how to allocate consideration to each unit of accounting in the arrangement.  This pronouncement replaces all references to fair value as the measurement criteria with the term selling price and establishes a hierarchy for determining the selling price of a deliverable.  The pronouncement also eliminates the use of the residual value method for determining the allocation of arrangement consideration, and requires additional disclosures.  This pronouncement should be applied prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted.  This pronouncement’s impact on accounting for revenue arrangements is dependent upon arrangements entered into on or after that time.
 
5.      Cash and Cash Equivalents and Investments
 
The fair value of cash and cash equivalents and investments held at March 31, 2010 and December 31, 2009 are as follows:
 
   
As of March 31, 2010
 
   
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Fair Value
 
   
(in thousands)
 
Cash and cash equivalents
 
$
260,126
   
$
   
$
   
$
260,126
 
                                 
Securities maturing within one year:
                               
Certificates of deposit
   
508
     
     
     
508
 
ARS Rights
   
     
7,575
     
     
7,575
 
Securities maturing after ten years:
                               
Auction rate securities
   
53,600
     
     
(7,628
)
   
45,972
 
Total short-term investments
 
$
54,108
   
$
7,575
   
$
(7,628
)
 
$
54,055
 
                                 
Total cash and cash equivalents and investments
 
$
314,234
   
$
7,575
   
$
(7,628
)
 
$
314,181
 



   
As of December 31, 2009
 
   
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Fair Value
 
           
(in thousands)
         
Cash and cash equivalents
 
$
100,554
   
$
   
$
   
$
100,554
 
                                 
Securities maturing within one year:
                               
Certificates of deposit
   
508
     
     
     
508
 
ARS rights
   
     
9,725
     
     
9,725
 
Securities maturing after ten years:
                               
Auction rate securities
   
56,175
     
     
(9,866
)
   
46,309
 
Total short-term investments
 
$
56,683
   
$
9,725
   
$
(9,866
)
 
$
56,542
 
Short-term investments held by Symphony Icon, Inc.:
                               
Cash and cash equivalents
   
5,417
     
     
     
5,417
 
Total short-term investments held by Symphony Icon, Inc.
 
$
5,417
   
$
   
$
   
$
5,417
 
                                 
Total cash and cash equivalents and investments
 
$
162,654
   
$
9,725
   
$
(9,866
)
 
$
162,513
 

There were no realized gains or losses for the three months ended March 31, 2010 and 2009, respectively. The cost of securities sold is based on the specific identification method.
 
At March 31, 2010, Lexicon held $53.6 million (par value), with an estimated fair value of $46.0 million, of investments with an auction interest rate reset feature, known as auction rate securities.  At December 31, 2009, Lexicon held $56.2 million (par value), with an estimated fair value of $46.3 million, of auction rate securities.  These notes are issued by various state agencies for the purpose of financing student loans.  The securities have historically traded at par and are redeemable at par plus accrued interest at the option of the issuer. Interest is typically paid at the end of each auction period or semiannually.  Until February 2008, the market for Lexicon’s auction rate securities was highly liquid. However, starting in February 2008, a substantial number of auctions “failed,” meaning that there was not enough demand to sell all of the securities that holders desired to sell at auction. The immediate effect of a failed auction is that such holders cannot sell the securities at auction and the interest rate on the security generally resets to a maximum interest rate.  In the case of funds invested by Lexicon in auction rate securities which are the subject of a failed auction, Lexicon may not be able to access the funds without a loss of principal unless a future auction on these investments is successful or the issuer redeems the security.  Lexicon has modified its current investment strategy to reallocate its investments more into U.S. treasury securities and U.S. treasury-backed money market investments.
 
At March 31, 2010 and December 31, 2009, observable auction rate securities market information was not available to determine the fair value of Lexicon’s investments. Lexicon has estimated the fair value of these securities at $46.0 million and $46.3 million as of March 31, 2010 and December 31, 2009, respectively, using models of the expected future cash flows related to the securities and taking into account assumptions about the cash flows of the underlying student loans, as well as secondary market trading data.  The assumptions used in preparing the discounted cash flow model include estimates of interest rates, timing and amount of cash flows, liquidity premiums and expected holding periods of the auction rate securities, based on data available as of March 31, 2010 and December 31, 2009.  The underlying assumptions are volatile and are subject to change as market conditions change.
 
In November 2008, Lexicon accepted an offer from UBS AG, the investment bank that sold Lexicon the auction rate securities, providing Lexicon with rights related to its auction rate securities (“ARS Rights”).  The ARS Rights permit Lexicon to require UBS to purchase its $53.6 million (par value) of auction rate securities at par value during the period from June 30, 2010 through July 2, 2012.  Conversely, UBS has the right, in its discretion, to purchase or sell the securities at any time by paying Lexicon the par value of such securities.  Management expects to exercise the ARS Rights and sell Lexicon’s auction rate securities back to UBS on June 30, 2010, the earliest date allowable under the ARS Rights.  Lexicon is also eligible to borrow from UBS Bank USA, an affiliate of UBS, at no net cost up to 75% of the market value of the securities, as determined by UBS Bank USA, which loans would become payable upon the purchase or sale of the securities by UBS (see note 7).
 
The enforceability of the ARS Rights results in a separate asset that is measured at its fair value.  Lexicon elected to measure the ARS Rights under a fair value option, which permits entities to choose, at certain election dates, to measure eligible items at fair value.  As a result of accepting the ARS Rights, Lexicon has elected to classify the ARS Rights and reclassify its investments in auction rate securities as trading securities from available-for-sale securities.  As a result, Lexicon is required to assess the fair value of these two individual assets and record changes each period until the ARS Rights are exercised and the auction rate securities are redeemed.  Lexicon expects that subsequent changes in the value of the ARS Rights will largely offset the subsequent fair value movements of the auction rate securities, subject to the continued expected performance by the investment bank of its obligations under the agreement.
 
6.      Fair Value Measurements
 
The Company uses various inputs in determining the fair value of its investments and measures these assets on a recurring basis.  Financial assets recorded at fair value in the consolidated balance sheets are categorized by the level of objectivity associated with the inputs used to measure their fair value.  The following levels are directly related to the amount of subjectivity associated with the inputs to fair valuation of these financial assets:
 
 
·
Level 1 – quoted prices in active markets for identical investments
 
 
·
Level 2 – other significant observable inputs (including quoted prices for similar investments, market corroborated inputs, etc.)
 
 
·
Level 3 – significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments)
 
The inputs or methodology used for valuing securities are not necessarily an indication of the credit risk associated with investing in those securities.  The following table provides the fair value measurements of applicable Company financial assets that are measured at fair value on a recurring basis according to the fair value levels described above as of March 31, 2010 and December 31, 2009.
 
 
Financial Assets at Fair Value as of March 31, 2010
 
 
Level 1
 
Level 2
 
Level 3
   
Total
 
 
(in thousands)
 
Cash and cash equivalents
 
$
260,126
   
$
   
$
   
$
260,126
 
Short-term investments
   
508
     
     
53,547
     
54,055
 
Total cash and cash equivalents and investments
 
$
260,634
   
$
   
$
53,547
   
$
314,181
 

 
Financial Assets at Fair Value as of December 31, 2009
 
 
Level 1
 
Level 2
 
Level 3
   
Total
 
 
(in thousands)
 
Cash and cash equivalents
 
$
100,554
   
$
   
$
   
$
100,554
 
Short-term investments
   
508
     
     
56,034
     
56,542
 
Short-term investments held by  Symphony Icon, Inc.
   
5,417
     
     
     
5,417
 
Total cash and cash equivalents and investments
 
$
106,479
   
$
   
$
56,034
   
$
162,513
 

The table presented below summarizes the change in consolidated balance sheet carrying value associated with Level 3 financial assets for the three months ended March 31, 2010 and 2009.
 
   
Short-term Investments
   
Long-term Investments
   
Total
 
   
(in thousands)
 
Balance at December 31, 2009
 
$
56,034
   
$
  —
   
$
56,034
 
Unrealized gains included in earnings as gain on investments, net
   
  88
     
  —
     
88 
 
Net sales and settlements
   
(2,575
)
   
  —
     
(2,575
)
Balance at March 31, 2010
 
$
53,547
   
$
   
$
53,547
 
                         
Balance at December 31, 2008
 
$
   
$
  55,686
   
$
 55,686
 
Unrealized gains included in earnings as gain on investments, net
   
     
  517
     
  517
 
Balance at March 31, 2009
 
$
   
$
 56,203
     
  56,203
 

The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis.  These assets include goodwill associated with the acquisition of Coelacanth Corporation in 2001.  For these assets, measurement at fair value in periods subsequent to their initial recognition is applicable if one or more is determined to be impaired.
 
7.      Debt Obligations
 
Mortgage Loan.  In April 2004, Lexicon obtained a $34.0 million mortgage on its facilities in The Woodlands, Texas.  The mortgage loan has a ten-year term with a 20-year amortization and bears interest at a fixed rate of 8.23%.  The mortgage had a principal balance outstanding of $29.3 million as of March 31, 2010.  The fair value of Lexicon’s mortgage loan approximates its carrying value.  The fair value of Lexicon’s mortgage loan is estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rate.
 
UBS Credit Line.  In January 2009, Lexicon entered into a credit line agreement with UBS Bank USA that provides, as of March 31, 2010, up to an aggregate amount of $35.7 million in the form of an uncommitted, demand, revolving line of credit.  Lexicon entered into the credit line in connection with its acceptance of an offer from UBS AG, the investment bank that sold Lexicon its auction rate securities, providing Lexicon with rights to require UBS to purchase its $53.6 million (par value) of auction rate securities at par value during the period from June 30, 2010 through July 2, 2012.  The credit line is secured only by these auction rate securities and advances under the credit line are made on a “no net cost” basis, meaning that the interest paid by Lexicon on advances will not exceed the interest or dividends paid to Lexicon by the issuer of the auction rate securities.  The interest rate paid on the line of credit is less than the Company’s estimated current incremental borrowing rate.  As of March 31, 2010, Lexicon had $35.5 million outstanding under this credit line.
 
8.      Arrangements with Symphony Icon, Inc.
 
On June 15, 2007, Lexicon entered into a series of related agreements providing for the financing of the clinical development of certain of our drug candidates, including LX1031 and LX1032, along with any other pharmaceutical compositions modulating the same targets as those drug candidates (the “Programs”).  The agreements include a Novated and Restated Technology License Agreement pursuant to which the Company licensed to Symphony Icon, a wholly-owned subsidiary of Symphony Icon Holdings LLC (“Holdings”), the Company’s intellectual property rights related to the Programs.  Holdings contributed $45 million to Symphony Icon in order to fund the clinical development of the Programs.
 
Under a Share Purchase Agreement, dated June 15, 2007, between the Company and Holdings, the Company issued and sold to Holdings 7,650,622 shares of its common stock on June 15, 2007 in exchange for $15 million and the Purchase Option (as defined below).
 
Under a Purchase Option Agreement, dated June 15, 2007, among the Company, Symphony Icon and Holdings, the Company received from Holdings an exclusive purchase option (the “Purchase Option”) that gives the Company the right to acquire all of the equity of Symphony Icon, thereby allowing the Company to reacquire all of the Programs.  The Purchase Option is exercisable by the Company at any time, in its sole discretion, until June 15, 2011 at an exercise price of (i) $81 million, if the Purchase Option is exercised before June 15, 2010 and (ii) $90 million, if the Purchase Option is exercised on or after June 15, 2010 and before June 15, 2011.  The Purchase Option exercise price may be paid in cash or a combination of cash and common stock, at the Company’s sole discretion, provided that the common stock portion may not exceed 40% of the Purchase Option exercise price.  Lexicon originally calculated the value of the Purchase Option as the difference between the fair value of the common stock issued to Holdings of $23.6 million (calculated at the time of issuance) and the $15.0 million in cash received from Holdings for the issuance of the common stock.  Lexicon has recorded the value of the Purchase Option as an asset, and is amortizing this asset over the four-year option period.  Upon the adoption of a new accounting pronouncement regarding variable interest entities (formerly SFAS No. 167) on January 1, 2010, $2.3 million of structuring and legal fees originally allocated to noncontrolling interest was allocated to the value of the Purchase Option.  This resulted in a cumulative-effect adjustment to retained earnings of $1.5 million, representing the additional amortization expense that would have been recorded through December 31, 2009.  The unamortized balance of $3.3 million and $3.1 million is recorded in other assets in the accompanying consolidated balance sheets as of March 31, 2010 and December 31, 2009, respectively, and the amortization expense of $678,000 and $535,000 is recorded in other expense, net in the accompanying consolidated statements of operations for the three months ended March 31, 2010 and 2009, respectively.
 
Under an Amended and Restated Research and Development Agreement, dated June 15, 2007, among the Company, Symphony Icon and Holdings (the “R&D Agreement”), Symphony Icon and the Company are developing the Programs in accordance with a specified development plan and related development budget.  The R&D Agreement provides that the Company will continue to be primarily responsible for the development of the Programs.  The Company’s development activities are supervised by Symphony Icon’s development committee, which is comprised of an equal number of representatives from the Company and Symphony Icon.  The development committee reports to Symphony Icon’s board of directors, which is currently comprised of five members, including one member designated by the Company and two independent directors.
 
Under a Research Cost Sharing, Payment and Extension Agreement, dated June 15, 2007, among the Company, Symphony Icon and Holdings, upon the recommendation of the development committee, Symphony Icon’s board of directors may require the Company to pay Symphony Icon up to $15 million for Symphony Icon’s use in the development of the Programs in accordance with the specified development plan and related development budget.  The development committee’s right to recommend that Symphony Icon’s board of directors submit such funding requirement to the Company will terminate on the one-year anniversary of the expiration of the Purchase Option, subject to limited exceptions.  Through March 2010, Symphony Icon’s board of directors has requested the Company to pay Symphony Icon $5.3 million under this agreement, all of which has been paid through March 31, 2010, and management expects that additional funding will be needed in the future.
 
Prior to January 1, 2010, Lexicon had determined that Symphony Icon was a variable interest entity for which it is the primary beneficiary.  This determination was based on Holdings’ lack of controlling rights with respect to Symphony Icon’s activities and the limitation on the amount of expected residual returns Holdings may expect from Symphony Icon if Lexicon exercises its Purchase Option.  Lexicon had determined it was a variable interest holder of Symphony Icon due to its contribution of the intellectual property relating to the Programs and its issuance of shares of its common stock in exchange for the Purchase Option, which Lexicon intends to exercise if the development of the Programs is successful.  Lexicon had determined that it was a primary beneficiary as a result of certain factors, including its primary responsibility for the development of the Programs and its contribution of the intellectual property relating to the Programs.  As a result, Lexicon has included the financial condition and results of operations of Symphony Icon in its consolidated financial statements through December 31, 2009.  Symphony Icon’s cash and cash equivalents have been recorded on Lexicon’s consolidated financial statements as short-term investments held by Symphony Icon as of December 31, 2009.  The noncontrolling interest in Symphony Icon on Lexicon’s consolidated balance sheet initially reflected the $45 million proceeds contributed into Symphony Icon less $2.3 million of structuring and legal fees.  As the collaboration progressed, this line item was reduced by Symphony Icon’s losses, which were $2.8 million in the three months ended March 31, 2009. The reductions to the noncontrolling interest in Symphony Icon were reflected in Lexicon’s consolidated statements of operations using a similar caption and reduced the amount of Lexicon’s reported net loss.
 
Upon the adoption of a new accounting pronouncement regarding variable interest entities (formerly SFAS No. 167) on January 1, 2010, Lexicon determined that it is no longer the primary beneficiary of Symphony Icon.  Under the new accounting guidance, neither Lexicon nor Holdings has the power to direct the activities that most significantly impact the economic performance of Symphony Icon; therefore, there is no primary beneficiary.  As a result, Lexicon has deconsolidated Symphony Icon as of January 1, 2010, and has not included the financial condition and results of operations of Symphony Icon in its consolidated financial statements as of and for the three months ended March 31, 2010.  Symphony Icon had $5.1 million of total assets and $3.1 million of total liabilities as of March 31, 2010 based on information provided by Symphony Icon.  Lexicon’s maximum exposure to loss as a result of its involvement with Symphony Icon is limited to additional funding of $9.7 million under the Research Cost Sharing, Payment and Extension Agreement as discussed above.  Through March 31, 2010, Lexicon has not charged any license fees and has not recorded any revenue from Symphony Icon, and does not expect to do so based on the current agreements with Symphony Icon and Holdings.
 
9.      Commitments and Contingencies
 
Operating Lease Obligations:  A Lexicon subsidiary leases laboratory and office space in Hopewell, New Jersey under an agreement which expires in June 2013.  The lease provides for two five-year renewal options at 95% of the fair market rent and includes escalating lease payments.  Rent expense is recognized on a straight-line basis over the original lease term.  Lexicon is the guarantor of the obligations of its subsidiary under this lease.  The maximum potential amount of future payments the Company could be required to make under this agreement is $8.3 million.  The Company is required to maintain restricted investments to collateralize a standby letter of credit for this lease.  The Company had $0.4 million in restricted investments as collateral as of March 31, 2010 and December 31, 2009.  Additionally, Lexicon leases certain equipment under operating leases.
 
Legal Proceedings.  Lexicon is from time to time party to claims and legal proceedings that arise in the normal course of its business and that it believes will not have, individually or in the aggregate, a material adverse effect on its results of operations, financial condition or liquidity.
 
10.      Other Capital Stock Agreements
 
Common Stock: In March 2010, Lexicon completed the public offering and sale and concurrent private placement of an aggregate of 161,770,206 shares of its common stock at a price of $1.15 per share, resulting in net proceeds of $181.5 million, after deducting underwriting discounts and commissions of $4.3 million and offering expenses of $0.3 million.  Invus purchased 94,270,206 of these shares.  All of the net proceeds of this offering are reflected as issuance of common stock in the accompanying financial statements.
 
11.      Collaboration and License Agreements
 
Lexicon has derived substantially all of its revenues from drug discovery and development collaborations, target validation collaborations for the development and, in some cases, analysis of the physiological effects of genes altered in knockout mice, government grants and contracts, technology licenses, subscriptions to its databases and compound library sales.  Revenues generated from third parties under collaborative arrangements are recorded on a gross basis on the consolidated statements of operations as Lexicon is the principal participant for these transactions for the purpose of accounting for these arrangements.
 
Lexicon established an alliance with Bristol-Myers Squibb in December 2003 to discover, develop and commercialize small molecule drugs in the neuroscience field.  Revenue recognized under this agreement was none and $0.8 million for the three months ended March 31, 2010 and 2009, respectively.
 
Lexicon established an alliance with Organon in May 2005 to jointly discover, develop and commercialize novel biotherapeutic drugs.  Revenue recognized under this agreement was $0.2 million and $1.5 million for the three months ended March 31, 2010 and 2009, respectively.
 
Lexicon established an alliance with Taconic Farms in November 2005 for the marketing, distribution and licensing of certain lines of knockout mice and entered into an expanded collaboration with Taconic in July 2009.  Revenue recognized under these agreements was $0.7 million and $0.4 million for the three months ended March 31, 2010 and 2009, respectively.
 
Item 2.                 Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
 We are a biopharmaceutical company focused on the discovery and development of breakthrough treatments for human disease.  We have used our proprietary gene knockout technologies and an integrated platform of advanced medical technologies to identify and validate, in vivo, more than 100 targets with promising profiles for drug discovery.  For targets that we believe have high pharmaceutical value, we engage in programs for the discovery and development of potential new drugs, focusing in the core therapeutic areas of immunology, metabolism, cardiology and ophthalmology.  Human clinical trials are currently underway for four of our drug candidates, with one additional drug candidate in preclinical development and compounds from a number of additional programs in various stages of preclinical research.
 
We are working both independently and through strategic collaborations and alliances to capitalize on our technology, drug target discoveries and drug discovery and development programs.  Consistent with this approach, we seek to retain exclusive rights to the benefits of certain of our small molecule drug programs by developing drug candidates from such programs internally and to collaborate with third parties with respect to the discovery, development and commercialization of small molecule and biotherapeutic drug candidates for other targets, particularly when the collaboration provides us with access to expertise and resources that we do not possess internally or are complementary to our own.  We have established drug discovery and development collaborations with a number of leading pharmaceutical and biotechnology companies which have enabled us to generate near-term cash while offering us the potential to retain economic participation in products our collaborators develop through the collaboration.  In addition, we have established collaborations and license agreements with other leading pharmaceutical and biotechnology companies, research institutes and academic institutions under which we received fees and, in some cases, are eligible to receive milestone and royalty payments, in return for granting access to some of our technologies and discoveries.
 
We derive substantially all of our revenues from drug discovery and development collaborations and other collaborations 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 new collaborations and technology licenses, expirations of our existing collaborations and alliances, the success rate of our discovery and development efforts leading to opportunities for new collaborations and licenses, as well as milestone payments and royalties, the timing and willingness of collaborators to commercialize products that would result in milestone payments and royalties, and general and industry-specific economic conditions which may affect research and development expenditures.  Our future revenues from collaborations and technology licenses are uncertain because our existing agreements have fixed terms or relate to specific projects of limited duration and we depend, in part, on securing new agreements.  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, as we have with our four clinical drug candidates, 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 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 March 31, 2010, we had an accumulated deficit of $597.7 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 and restricted stock granted to employees and consultants.  Research and development expenses consist primarily of salaries and related personnel costs, external research costs related to our preclinical and clinical efforts, material costs, facility costs, depreciation on property and equipment and other expenses related to our drug discovery and development programs. General and administrative expenses consist primarily of salaries and related expenses for executive and administrative personnel, professional fees and other corporate expenses including information technology, facilities costs and general legal activities.  In connection with the continued expansion of our drug discovery and development programs, we expect to continue to incur significant research and development costs. As a result, we will need to generate significantly higher revenues to achieve profitability.
 
Critical Accounting Policies
 
The preparation of financial statements in conformity with generally accepted accounting principles requires us to make judgments, estimates and assumptions in the preparation of our consolidated financial statements and accompanying notes.  Actual results could differ from those estimates.  We believe there have been no significant changes in our critical accounting policies as discussed in our Annual Report on Form 10-K for the year ended December 31, 2009.
 
Recent Accounting Pronouncements
 
See Note 4, Recent Accounting Pronouncements, of the Notes to Consolidated Financial Statements, for a discussion of the impact of the new accounting standards on our consolidated financial statements.
 
Results of Operations
 
Revenues
 
Total revenues and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Total revenues
 
$
1.6
   
$
4.2
 
Dollar decrease
 
$
(2.5
       
Percentage decrease
   
(61
)%
       

 
·
Collaborative research – Revenue from collaborative research decreased 54% to $1.6 million, primarily due to reduced revenues in the three months ended March 31, 2010 under our alliances with N.V. Organon and Bristol-Myers Squibb due to the completion in 2009 of the target discovery portion of these alliances.
 
 
·
Subscription and license fees – Revenue from subscriptions and license fees decreased 100% primarily due to a decrease in technology license fees.
 
Research and Development Expenses
 
Research and development expenses and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Total research and development expense
 
$
21.1
   
$
22.9
 
Dollar decrease
 
$
(1.8
)
       
Percentage decrease 
   
(8
)%
       

Research and development expenses consist primarily of salaries and other personnel-related expenses, third-party and other services, facility and equipment costs, laboratory supplies, and stock-based compensation expenses.
 
 
·
Personnel – Personnel costs decreased 23% to $8.2 million, primarily due to a reduction in our personnel in January 2009 and associated severance costs.  Salaries, bonuses, employee benefits, payroll taxes, recruiting and relocation costs are included in personnel costs.
 
 
·
Third-party and other services – Third-party and other services increased 24% to $6.0 million, primarily due to an increase in external clinical research and development costs.
 
 
·
Facilities and equipment – Facilities and equipment costs decreased 12% to $3.6 million, primarily due to a decrease in depreciation expense.
 
 
·
Laboratory supplies – Laboratory supplies expense decreased 11% to $1.5 million, primarily due to reductions in compound acquisitions and genetic research activities.
 
 
·
Stock-based compensation – Stock-based compensation expense was $0.8 million, consistent with the prior year.
 
 
·
Other – Other costs increased 20% to $1.0 million.
 
General and Administrative Expenses  
 
General and administrative expenses and dollar and percentage changes as compared to the corresponding period in the prior year are as follows (dollar amounts are presented in millions):
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Total general and administrative expense
 
$
5.5
   
$
4.9
 
Dollar increase
 
$
0.6
         
Percentage increase
   
13
%
       

General and administrative expenses consist primarily of salaries and other personnel-related expenses, professional fees such as legal fees, facility and equipment costs, and stock-based compensation expenses.
 
 
·
Personnel – Personnel costs increased 9% to $2.7 million.  Salaries, bonuses, employee benefits, payroll taxes, recruiting and relocation costs are included in personnel costs.
 
 
·
Professional fees – Professional fees increased 69% to $1.3 million, primarily due to increased patent-related legal costs.
 
 
·
Facilities and equipment – Facilities and equipment costs decreased 9% to $0.6 million.
 
 
·
Stock-based compensation – Stock-based compensation expense decreased 19% to $0.5 million.
 
 
·
Other – Other costs increased 29% to $0.4 million.
 
Gain on Investments, Net, Interest Income, Interest Expense and Other Expense, Net
 
Gain on Investments, Net.  Gain on investments was $2.2 million for the three months ended March 31, 2010, representing the increase in fair value of our student loan auction rate securities.  This gain was offset by a loss on investments of $2.2 million for the three months ended March 31, 2010, representing the decline in fair value of the rights obtained from UBS AG, the investment bank that sold us our auction rate securities.
 
Interest Income.  Interest income decreased 34% to $0.2 million in the three months ended March 31, 2010 from $0.3 million in the corresponding period in 2009, due to lower yields on our investments.
 
Interest Expense.  Interest expense was $0.7 million in the three months ended March 31, 2010, consistent with the prior year.
 
Other Expense, Net.  Other expense, net decreased 28% to $0.7 million in the three months ended March 31, 2010 from $0.9 million in the corresponding period in 2009, primarily due to an impairment in 2009 of surplus equipment as a result of our restructuring.
 
Noncontrolling Interest in Symphony Icon, Inc.
 
For the three months ended March 31, 2009, the losses attributable to the noncontrolling interest holders of Symphony Icon were $2.8 million.  As discussed in Note 4, Recent Accounting Pronouncements of the Notes to Consolidated Financial Statements, we have determined that upon the adoption of a new accounting pronouncement regarding variable interest entities on January 1, 2010, we are not the primary beneficiary of Symphony Icon, and therefore, we are no longer including the financial condition and results of operations of Symphony Icon in our consolidated financial statements.
 
Net Loss Attributable to Lexicon Pharmaceuticals, Inc. and Net Loss Attributable to Lexicon Pharmaceuticals, Inc. per Common Share
 
Net Loss Attributable to Lexicon Pharmaceuticals, Inc. and Net Loss Attributable to Lexicon Pharmaceuticals, Inc. per Common Share.  Net loss attributable to Lexicon Pharmaceuticals, Inc. increased to $26.1 million in the three months ended March 31, 2010 from $21.6 million in the corresponding period in 2009.  Net loss attributable to Lexicon Pharmaceuticals, Inc. per common share decreased to $0.13 in the three months ended March 31, 2010 from $0.16 in the corresponding period in 2009.
 
Our quarterly operating results have fluctuated in the past and are likely to do so in the future, and we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.
 
Liquidity and Capital Resources
 
We have financed our operations from inception primarily through sales of common and preferred stock, contract and milestone payments to us under our drug discovery and development collaborations, target validation, database subscription and technology license agreements, government grants and contracts, and financing obtained under debt and lease arrangements.  We have also financed certain of our research and development activities under our agreements with Symphony Icon, Inc.  From our inception through March 31, 2010, we had received net proceeds of $786.9 million from issuances of common and preferred stock.  In addition, from our inception through March 31, 2010, we received $448.8 million in cash payments from drug discovery and development collaborations, target validation, database subscription and technology license agreements, sales of compound libraries and reagents, and government grants and contracts, of which $436.3 million had been recognized as revenues through March 31, 2010.
 
As of March 31, 2010, we had $314.2 million in cash, cash equivalents and investments, including $53.5 million in auction rate securities and related rights as discussed below under “Disclosure about Market Risk.”  As of December 31, 2009, we had $157.1 million in cash, cash equivalents and investments, including $56.0 million of auction rate securities and related rights, and $5.4 million in investments held by Symphony Icon.  We used cash of $21.7 million in operations in the three months ended March 31, 2010. This consisted primarily of the consolidated net loss for the period of $26.1 million and a net gain on investments and auction rate security rights of $0.1 million, partially offset by non-cash charges of $1.4 million related to depreciation expense, $1.3 million related to stock-based compensation expense, a net decrease in other operating assets net of liabilities of $1.1 million and $0.7 million related to the amortization of the Symphony Icon purchase option.  Investing activities provided cash of $2.1 million in the three months ended March 31, 2010, primarily due to maturities of investments of $2.6 million, partially offset by purchases of property and equipment of $0.5 million.  Financing activities provided cash of $179.2 million due to net proceeds from issuance of common stock of $181.5 million, partially offset by net repayment of debt borrowings of $2.2 million.
 
UBS Credit Line.  In January 2009, we entered into a credit line agreement with UBS Bank USA that provides, as of March 31, 2010, up to an aggregate amount of $35.7 million in the form of an uncommitted, demand, revolving line of credit.  We entered into the credit line in connection with our acceptance of an offer from UBS AG, the investment bank that sold us our auction rate securities, providing us with rights to require UBS to purchase our $53.6 million (par value) of auction rate securities at par value during the period from June 30, 2010 through July 2, 2012.  The credit line is secured only by these auction rate securities and advances under the credit line will be made on a “no net cost” basis, meaning that the interest paid by us on advances will not exceed the interest or dividends paid to us by the issuer of the auction rate securities.  As of March 31, 2010, we had $35.5 million outstanding under this credit line.
 
Invus Securities Purchase Agreement.  In June 2007, we entered into a securities purchase agreement with Invus, L.P, pursuant to which Invus purchased 50,824,986 shares of our common stock for approximately $205.4 million in August 2007.  Pursuant to the securities purchase agreement, as amended and supplemented, and after accounting for the $181.5 million net proceeds of our public offering and concurrent private placement of common stock in March 2010, Invus has the right to require us to initiate one pro rata rights offering to our stockholders, which would provide all stockholders with non-transferable rights to acquire shares of our common stock, in an aggregate amount of up to approximately $163.0 million, less the proceeds of any “qualified offerings” that we may complete in the interim involving the sale of our common stock at prices above $4.50 per share.  We have not completed any such qualified offering.  Invus may exercise its right to require us to conduct such a rights offering by giving us notice within a period of one year beginning on February 28, 2011, which will be extended by the number of days during such period that Invus is not permitted under the securities purchase agreement to initiate the rights offering as a result of any “blackout period” in connection with certain public offerings of our common stock.  If Invus elects to exercise its right to require us to initiate a rights offering, Invus would be required to purchase its pro rata portion of the offering.
 
In connection with the securities purchase agreement, we entered into a stockholders’ agreement with Invus under which Invus (a) has specified rights with respect to designation of directors and participation in future equity issuances by us, (b) is subject to certain standstill restrictions, as well as restrictions on transfer and the voting of the shares of common stock held by it and its affiliates, and (c), as long as Invus holds at least 15% of the total number of outstanding shares of our common stock, is entitled to certain minority protections.
 
Symphony Drug Development Financing Agreement.  In June 2007, we entered into a series of related agreements providing for the financing of the clinical development of certain of our drug candidates, including LX1031 and LX1032, along with any other pharmaceutical compositions modulating the same targets as those drug candidates.  Under the financing arrangement, we licensed to Symphony Icon, a wholly-owned subsidiary of Symphony Icon Holdings LLC, our intellectual property rights related to the programs and Holdings contributed $45 million to Symphony Icon in order to fund the clinical development of the programs.  We also entered into a share purchase agreement with Holdings under which we issued and sold to Holdings 7,650,622 shares of our common stock in exchange for $15 million and an exclusive option to acquire all of the equity of Symphony Icon, thereby allowing us to reacquire the programs.  The purchase option is exercisable by us at any time, in our sole discretion, until June 15, 2011 at an exercise price of (a) $81 million, if the purchase option is exercised before June 15, 2010 and (b) $90 million, if the purchase option is exercised on or after June 15, 2010 and before June 15, 2011.  The purchase option exercise price may be paid in cash or a combination of cash and common stock, at our sole discretion, provided that the common stock portion may not exceed 40% of the purchase option exercise price.
 
Upon the recommendation of Symphony Icon’s development committee, which is comprised of an equal number of representatives from us and Symphony Icon, Symphony Icon’s board of directors may require us to pay Symphony Icon up to $15 million for Symphony Icon’s use in the development of the programs in accordance with the specified development plan and related development budget.  The development committee’s right to recommend that Symphony Icon’s board of directors submit such funding requirement to us will terminate on the one-year anniversary of the expiration of the purchase option, subject to limited exceptions.  Through March 2010, Symphony Icon’s board of directors has requested us to pay Symphony Icon $5.3 million under this agreement, all which has been paid through March 31, 2010, and we expect that additional funding will be needed in the future.
 
Facilities.  In April 2004, we obtained a $34.0 million mortgage on our facilities in The Woodlands, Texas.  The mortgage loan has a ten-year term with a 20 year amortization and bears interest at a fixed rate of 8.23%.  The mortgage had a principal balance outstanding of $29.3 million as of March 31, 2010.  In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc. leased a 76,000 square-foot laboratory and office space 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.
 
Our future capital requirements will be substantial and will depend on many factors, including our ability to obtain drug discovery and development collaborations and other collaborations 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 cash and revenues we expect to derive from drug discovery and development collaborations and other collaborations and technology licenses will be sufficient to fund our operations for at least the next 12 months. 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. Treasury bills, money market accounts and certificates of deposit that mature three to 12 months from the time of purchase and auction rate securities that mature greater than 12 months from the time of purchase, which we believe are subject to limited market and credit risk, other than as discussed below.  We currently do not hedge interest rate exposure or hold any derivative financial instruments in our investment portfolio.
 
At March 31, 2010, we held $53.6 million (par value), with an estimated fair value of $46.0 million, of investments with an auction interest rate reset feature, known as auction rate securities.  These notes are issued by various state agencies for the purpose of financing student loans.  The securities have historically traded at par and are redeemable at par plus accrued interest at the option of the issuer.  Interest is typically paid at the end of each auction period or semiannually.  Until February 2008, the market for our auction rate securities was highly liquid.  Starting in February 2008, a substantial number of auctions “failed,” meaning that there was not enough demand to sell all of the securities that holders desired to sell at auction.  The immediate effect of a failed auction is that such holders cannot sell the securities at auction and the interest rate on the security generally resets to a maximum interest rate.  In the case of funds invested by us in auction rate securities which are the subject of a failed auction, we may not be able to access the funds without a loss of principal, unless a future auction on these investments is successful or the issuer redeems the security.  We have modified our current investment strategy to reallocate our investments more into U.S. treasury securities and U.S. treasury-backed money market investments.
 
At March 31, 2010, observable auction rate securities market information was not available to determine the fair value of our investments. We have estimated the fair value of these securities at $46.0 million as of March 31, 2010 using models of the expected future cash flows related to the securities and taking into account assumptions about the cash flows of the underlying student loans, as well as secondary market data.  The assumptions used in preparing the discounted cash flow model include estimates of interest rates, timing and amount of cash flows, liquidity premiums and expected holding periods of the auction rate securities, based on data available as of March 31, 2010.  The underlying sources of these assumptions are volatile and the assumptions are subject to change as those sources and market conditions change.
 
In November 2008, we accepted an offer from UBS AG, the investment bank that sold us our auction rate securities, providing us with rights related to our auction rate securities.  The rights permit us to require UBS to purchase our $53.6 million (par value) of auction rate securities at par value during the period from June 30, 2010 through July 2, 2012.  Conversely, UBS has the right, in its discretion, to purchase or sell the securities at any time by paying us the par value of such securities.  We expect to exercise the rights and sell our auction rate securities back to UBS on June 30, 2010, the earliest date allowable under the rights.
 
The enforceability of the rights results in a separate asset that will be measured at its fair value.  We elected to measure the rights under a fair value option, which permits entities to choose, at certain election dates, to measure eligible items at fair value.  As a result of accepting the rights, we have elected to classify the rights and reclassify our investments in auction rate securities as trading securities from available-for-sale securities.  As a result, we will assess the fair value of these two individual assets and record changes each period until the rights are exercised and the auction rate securities are redeemed.  We expect that subsequent changes in the value of the rights will largely offset the subsequent fair value movements of the auction rate securities, subject to the continued expected performance by the investment bank of its obligations under the agreement.
 
Excluding auction rate securities and the ARS Rights, at March 31, 2010, we had approximately $260.6 million in cash and cash equivalents and short-term investments.  We believe that the working capital available to us excluding the funds held in auction rate securities will be sufficient to meet our cash requirements for at least the next 12 months.
 
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.
 
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 principal executive officer and principal 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) are effective to ensure that the information required to be disclosed by us in the reports we file under the Securities 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.
 
Other Information
 
Item 1.                                Legal Proceedings
 
We are from time to time party to claims and legal proceedings that arise in the normal course of our business and that we believe will not have, individually or in the aggregate, a material adverse effect on our results of operations, financial condition or liquidity.
 
Item 1A.                      Risk Factors
 
The following risks and uncertainties are important factors that could cause actual results or events to differ materially from those indicated by forward-looking statements.  The factors described below are not the only ones we face and additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations.
 
Risks Related to Our Need for Additional Financing and Our Financial Results
 
 
·
We will need additional capital in the future and, if it is unavailable, we will be forced to significantly curtail or cease our operations.  If it is not available on reasonable terms, we will be forced to obtain funds by entering into financing agreements on unattractive terms.
 
 
·
We have a history of net losses, and we expect to continue to incur net losses and may not achieve or maintain profitability.
 
 
·
We have licensed the intellectual property, including commercialization rights, to our drug candidates LX1031 and LX1032 to Symphony Icon and will not receive any future royalties or revenues with respect to these drug candidates unless we exercise our option to purchase Symphony Icon.
 
 
·
At March 31, 2010, we held $53.6 million (par value), with an estimated fair value of $46.0 million, of auction rate securities for which auctions have failed and, as a result, we may not be able to access at least a portion of these funds without a loss of principal.
 
 
·
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 Discovery and Development of Our Drug Candidates
 
 
·
We are an early-stage company, and have not proven our ability to successfully develop and commercialize drug candidates based on our drug target discoveries.
 
 
·
Clinical testing of our drug candidates in humans is an inherently risky and time-consuming process that may fail to demonstrate safety and efficacy, which could result in the delay, limitation or prevention of regulatory approval.
 
Risks Related to Regulatory Approval of Our Drug Candidates
 
 
·
Our drug candidates are subject to a lengthy and uncertain regulatory process that may not result in the necessary regulatory approvals, which could adversely affect our ability to commercialize products.
 
 
·
If our potential products receive regulatory approval, we or our collaborators will remain subject to extensive and rigorous ongoing regulation.
 
Risks Related to Commercialization of Products
 
 
·
The commercial success of any products that we may develop will depend upon the degree of market acceptance of our products among physicians, patients, health care payors, private health insurers and the medical community.
 
 
·
If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to market and sell our drug candidates, we may be unable to generate product revenues.
 
 
·
If we are unable to obtain adequate coverage and reimbursement from third-party payors for any products that we may develop, our revenues and prospects for profitability will suffer.
 
 
·
Our competitors may develop products that make our products obsolete.
 
 
·
We may not be able to manufacture our drug candidates in commercial quantities, which would prevent us from commercializing our drug candidates.
 
Risks Related to Our Relationships with Third Parties
 
 
·
Disagreements with Symphony Icon regarding the development of our drug candidates LX1031 or LX1032 could negatively affect or delay their development.
 
 
·
We are dependent in many ways upon our collaborations with major pharmaceutical companies.  The revenues we receive under our existing collaborations have been decreasing in recent periods and are likely to continue to decrease in the future.  If we are unable to achieve milestones under our collaborations or if our collaborators’ efforts fail to yield pharmaceutical products on a timely basis, our opportunities to generate revenues and earn royalties will be reduced.
 
 
·
Conflicts with our collaborators could jeopardize the success of our collaborative agreements and harm our product development efforts.
 
 
·
We rely on third parties to carry out drug development activities.
 
 
·
We lack the capability to manufacture materials for preclinical studies, clinical trials or commercial sales and rely on third parties to manufacture our drug candidates, which may harm or delay our product development and commercialization efforts.
 
Risks Related to Our Intellectual Property
 
 
·
If we are unable to adequately protect our intellectual property, third parties may be able to use our technology, which could adversely affect our ability to compete in the market.
 
 
·
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.  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.  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.  As a result, our international competitors could be granted foreign patent protection with respect to our discoveries.
 
 
 
·
We may be subject to damages resulting from claims that we, our employees or independent contractors have wrongfully used or disclosed alleged trade secrets of their former employers.
 
Risks Related to Employees, Growth and Facilities Operations
 
 
·
The loss of key personnel or the inability to attract and retain additional personnel could impair our ability to expand our operations.
 
 
·
Our collaborations with outside scientists may be subject to restriction and change.
 
 
·
Security breaches may disrupt our operations and harm our operating results.
 
 
·
Because most of our operations are located at a single facility, the occurrence of a disaster could significantly disrupt our business.
 
Risks Related to Environmental and Product Liability
 
 
·
We use hazardous chemicals and radioactive and biological materials in our business.  Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.
 
 
·
We may be sued for product liability.
 
Risks Related to Our Common Stock
 
 
·
Our stock price may be extremely volatile.
 
 
·
Invus’ ownership of our common stock and its other rights under our stockholders’ agreement we entered into in connection with Invus’ $205.4 million initial investment in our common stock provide Invus with substantial influence over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, as well as other corporate matters.
 
 
·
We may engage in future acquisitions, which may be expensive and time consuming and from which we may not realize anticipated benefits.
 
 
·
Future sales of our common stock may depress our stock price.
 
 
·
If we are unable to meet Nasdaq continued listing requirements, Nasdaq may take action to delist our common stock.
 
For additional discussion of the risks and uncertainties that affect our business, see “Item 1A. Risk Factors” included in our annual report on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission.
 
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds
 
The following table provides information about our purchases of shares of our common stock during the three months ended March 31, 2010:

Period
 
Total Number of Shares Purchased
   
Average Price Paid Per Share
   
Total Number of Shares Purchased as Part of a Publicly Announced Program
   
Maximum Number of Shares that May Yet be Purchased Under the Program (1)
 
January 1 – 31, 2010
        $           $  
February 1 – 28, 2010
    77,892 (2)   $ 1.91 (3)         $  
March 1 – 31, 2010
        $           $  
 
 

 
(1)
In connection with the vesting of restricted stock bonus awards granted under our Equity Incentive Plan, which was adopted in February 2009 as an amendment and restatement of our 2000 Equity Incentive Plan and expires in February 2019, certain recipients of such restricted stock bonus awards elected to satisfy their withholding tax obligations with respect to such vesting event by having us retain a portion of the vested shares.  In the future, we may grant additional restricted equity securities under our Equity Incentive Plan for which the recipient’s tax withholding obligations may be satisfied by our retention of a portion of such securities.  Further, the number of such restricted equity securities which may vest will be dependent on the continued employment of such recipients or other performance-based conditions.  As a result, we cannot predict with any certainty either the total amount of restricted equity securities or the approximate dollar value of such securities that we may purchase in future years as those securities vest.
 
 
(2)
Represents shares retained by us at the election of certain recipients of restricted stock bonus awards granted under our Equity Incentive Plan in satisfaction of their withholding tax obligations with respect to the vesting of those awards.
 
 
(3)
Represents the market price of our common stock on the date of vesting, calculated in accordance with the process for determination of fair market value under our Equity Incentive Plan.

Item 6.        Exhibits
 
Exhibit No.
 
Description
10.1
 
 
Collaboration and License Agreement, dated February 16, 2010, with N.V. Organon and its affiliates Intervet Inc. and Schering Corporation, acting through its Schering-Plough Research Institute division
31.1
 
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 
Certification of Principal Executive and Principal Financial Officers 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.
 
 
 

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 Pharmaceuticals, Inc.
     
Date:  May 7, 2010
By:
/s/ Arthur T. Sands
   
Arthur T. Sands, M.D., Ph.D.
   
President and Chief Executive Officer

Date:  May 7, 2010
By:
/s/ James F. Tessmer
   
James F. Tessmer
   
Vice President, Finance and Accounting


Index to Exhibits
 
 
 
Exhibit No.
 
Description
10.1
 
 
Collaboration and License Agreement, dated February 16, 2010, with N.V. Organon and its affiliates Intervet Inc. and Schering Corporation, acting through its Schering-Plough Research Institute division
31.1
 
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 
Certification of Principal Executive and Principal Financial Officers 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.