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LEXICON PHARMACEUTICALS, INC./DE - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 8, 2014

Overview

We are a biopharmaceutical company focused on the development of breakthrough treatments for human disease. We have advanced multiple drug candidates into clinical development. We are presently devoting most of our resources to the development of our two most advanced drug candidates, LX4211 for diabetes and telotristat etiprate for carcinoid syndrome. Our most advanced drug candidates, as well as compounds from a number of additional drug discovery and development programs that we have advanced into various stages of clinical and preclinical development, originated from our own internal drug discovery efforts. These efforts were driven by a systematic, target biology-driven approach in which we used gene knockout technologies and an integrated platform of advanced medical technologies to systematically study the physiological and behavioral functions of almost 5,000 genes in mice and assessed the utility of the proteins encoded by the corresponding human genes as potential drug targets. We identified and validated in living animals, or in vivo, more than 100 targets with promising profiles for drug discovery. We are working both independently and through strategic collaborations and alliances with third parties to capitalize on our drug target discoveries, and we intend to pursue the same strategy for our drug candidates in clinical development. Consistent with this approach, we seek to retain exclusive rights to the benefits of certain drug discovery and development programs by developing and commercializing drug candidates from those programs internally and to collaborate with other pharmaceutical and biotechnology companies with respect to the development and commercialization of drug candidates from other programs, particularly when the collaboration may provide us with access to expertise and resources that we do not possess internally or are complementary to our own. We also seek to collaborate with other pharmaceutical and biotechnology companies, research institutes and academic institutions to capitalize on our drug target discoveries.



We have derived substantially all of our revenues from drug discovery and development collaborations, research collaborations and technology licenses, and will continue to do so for the foreseeable future. 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 licenses, the success rate of our development efforts leading to opportunities for new collaborations and licenses, the timing and willingness of collaborators to commercialize products that would result in milestone payments and royalties and their success in such efforts, and general and industry-specific economic conditions which may affect research and development expenditures. Future revenues from our existing collaborations are uncertain because they depend, to a large degree, on the achievement of milestones and payment of royalties we earn from any future products developed under the collaboration. As a result, we depend, in part, on securing new collaborations and license 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 certain of our 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, 2014, we had an accumulated deficit of $1.0 billion. 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. We expect to continue to incur significant research and development costs in connection with the continuing development of our drug candidates. 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

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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, 2013.

Recent Accounting Pronouncements

There are no recent accounting pronouncements that have a material impact 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, 2014 2013 Total revenues $ 0.3 $ 0.4 Dollar decrease $ (0.1 ) Percentage decrease (23 )% Collaborative research - Revenue from collaborative research for the three months ended March 31, 2014 decreased from $0.3 million to $0.2 million primarily due to decreased revenues under our alliance with Taconic Farms. Subscription and license fees - Revenue from subscriptions and license fees for the three months ended March 31, 2014 was $0.1 million, consistent with the corresponding period in 2013.



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, 2014 2013



Total research and development expense $ 24.0 $ 20.3 Dollar increase

$ 3.6 Percentage increase 18 %



Research and development expenses consist primarily of salaries and other personnel-related expenses, third-party and other services principally related to preclinical and clinical development activities, facility and equipment costs, stock-based compensation expense, and laboratory supplies costs.

Personnel - Personnel costs for the three months ended March 31, 2014

increased 33% to $9.6 million, as compared to the corresponding period in 2013, primarily due to increased severance costs as a result of reductions in personnel in 2014 (see Note 10, Restructuring Charges, of the Notes to Consolidated Financial Statements, for more information). 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 for the

three months ended March 31, 2014 increased 32% to $9.5 million, as compared to the corresponding period in 2013, primarily due to increases in external clinical research and development costs. Third-party and other services relate principally to our clinical trial and related development activities, such as preclinical and clinical studies and contract manufacturing.



Facilities and equipment - Facilities and equipment costs for the three

months ended March 31, 2014 was

$2.2 million, consistent with the corresponding period in 2013.

Stock-based compensation - Stock-based compensation expense for the three months ended March 31, 2014 increased 10% to $1.5 million, as compared to the corresponding period in 2013. 14



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Laboratory supplies - Laboratory supplies expense for the three months

ended March 31, 2014 decreased 82% to

$0.2 million, as compared to the corresponding period in 2013, primarily due to reductions in research activities.

Other - Other costs for the three months ended March 31, 2014 decreased 25% to $1.1 million, as compared to the corresponding period in 2013.



Increase in Fair Value of Symphony Icon Liability

The increase in fair value of the Symphony Icon purchase liability was $1.1 million and $1.3 million for the three months ended March 31, 2014 and 2013, respectively (see Note 7, Arrangements with Symphony Icon, Inc., of the Notes to Consolidated Financial Statements, for more information).

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, 2014 2013



Total general and administrative expense $ 5.7 $ 4.3 Dollar increase

$ 1.3 Percentage increase 31 %



General and administrative expenses consist primarily of salaries and other personnel-related expenses, professional fees such as legal and consulting fees, stock-based compensation expenses, and facility and equipment costs.

Personnel - Personnel costs for the three months ended March 31, 2014 increased 44% to $3.1 million, as compared to the corresponding period in 2013, primarily due to increased severance costs as a result of reductions in personnel in 2014 (see Note 10, Restructuring Charges, of the Notes to Consolidated Financial Statements, for more information). Salaries, bonuses, employee benefits, payroll taxes, recruiting and relocation costs are included in personnel costs. Professional fees - Professional fees for the three months ended March 31, 2014 increased 58% to $1.1 million, as compared to the corresponding period in 2013, primarily due to increased consulting costs in preparation for commercialization. Stock-based compensation - Stock-based compensation expense for the three months ended March 31, 2014 was



$0.8 million, consistent with the corresponding period in 2013.

Facilities and equipment - Facilities and equipment costs for the three

months ended March 31, 2014 was

$0.4 million, consistent with the corresponding period in 2013.

Other - Other costs for the three months ended March 31, 2014 was $0.3 million, consistent with the corresponding period in 2013.



Interest Income and Interest Expense

Interest Income. Interest income for the three months ended March 31, 2014 and 2013 was $8,000 and $53,000, respectively.

Interest Expense. Interest expense for the three months ended March 31, 2014 was $0.5 million, consistent with the corresponding period in 2013.

Consolidated Net Loss and Consolidated Net Loss per Common Share

Consolidated Net Loss and Consolidated Net Loss per Common Share. Consolidated net loss increased to $30.8 million in the three months ended March 31, 2014 from $26.0 million in the corresponding period in 2013. Consolidated

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net loss per common share increased to $0.06 in the three months ended March 31, 2014 from $0.05 in the corresponding period in 2013.

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, 2014, we had received net proceeds of $987.0 million from issuances of common and preferred stock. In addition, from our inception through March 31, 2014, we received $458.0 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 $445.0 million had been recognized as revenues through March 31, 2014. As of March 31, 2014, we had $98.4 million in cash, cash equivalents and investments. As of December 31, 2013, we had $129.1 million in cash, cash equivalents and investments. We used cash of $30.3 million in operations in the three months ended March 31, 2014. This consisted primarily of the consolidated net loss for the period of $30.8 million and a net increase in other operating assets net of liabilities of $3.5 million, partially offset by non-cash charges of $2.3 million related to stock-based compensation expense, $1.1 million related to the increase in fair value of the Symphony Icon purchase liability and $0.6 million related to depreciation expense. Investing activities provided cash of $40.6 million in the three months ended March 31, 2014, primarily due to net maturities of investments of $39.8 million and proceeds from disposal of property and equipment of $0.8 million. Financing activities used cash of $1.2 million primarily due to repurchase of common stock of $0.9 million and repayment of debt borrowings of $0.4 million. Symphony Drug Development Financing Agreements. In June 2007, we entered into a series of related agreements providing for the financing of the clinical development of certain drug programs, including LX1032 and LX1033, along with any other pharmaceutical compositions modulating the same targets as those drug candidates. Under the financing arrangement, we licensed to Symphony Icon, Inc., a then 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 issued and sold to Holdings shares of our common stock in exchange for $15 million and received an exclusive option to acquire all of the equity of Symphony Icon, thereby allowing us to reacquire the programs. Upon the recommendation of Symphony Icon's development committee, which was comprised of an equal number of representatives from us and Symphony Icon, Symphony Icon's board of directors had the right to 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. Through July 2010, Symphony Icon's board of directors requested us to pay Symphony Icon $9.3 million under the agreement, all of which was paid prior to the exercise of the purchase option in July 2010. In July 2010, we entered into an amended and restated purchase option agreement with Symphony Icon and Holdings and simultaneously exercised our purchase option. Pursuant to the amended terms of the purchase option, we paid Holdings $10 million in July 2010 and issued 13,237,519 shares of common stock to designees of Holdings in July 2012 in satisfaction of an additional $35 million base payment obligation. We also agreed to make up to $45 million in additional contingent payments, which will consist of 50% of any consideration we receive pursuant to any licensing transaction under which we grant a third party rights to commercialize LX1032, LX1033 or other pharmaceutical compositions modulating the same target as those drug candidates, which we refer to as the "LG103 programs," subject to certain exceptions. The contingent payments will be due if and when we receive such consideration from such a licensing transaction. In the event we receive regulatory approval in the United States for the marketing and sale of any product resulting from the LG103 programs prior to entering into such a licensing transaction for the commercialization of such product in the United States, in lieu of any contingent payment from such a licensing transaction, we will pay Holdings the sum of $15 million and the amount of certain expenses we incurred after our exercise of the purchase option which are attributable to the development of such product, reduced by up to 50% of such sum for the amount of any contingent payments paid prior to such United States regulatory approval attributable to any such licensing transaction outside of the United States with respect to such product. In the event we make any such payment upon United States regulatory 16



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approval, we will have no obligation to make subsequent contingent payments attributable to any such licensing transactions for the commercialization of such product outside the United States until the proceeds of such licensing transactions exceed 50% of the payment made as a result of such United States regulatory approval.

The contingent payments may be paid in cash or a combination of cash and common stock, in our discretion, provided that no more than 50% of any contingent payment will be paid in common stock. Texas Institute for Genomic Medicine. In July 2005, we received an award from the Texas Enterprise Fund for the creation of a knockout mouse embryonic stem cell library containing 350,000 cell lines for the Texas Institute for Genomic Medicine, or TIGM, using our proprietary gene trapping technology, which we completed in 2007. We also equipped TIGM with the bioinformatics software required for the management and analysis of data relating to the library. The Texas Enterprise Fund made an additional award to the Texas A&M University System for the creation of facilities and infrastructure to house the library. Under the terms of our award, we are responsible for the creation of a specified number of jobs beginning in 2012, reaching an aggregate of 1,616 new jobs in Texas by December 31, 2016. We will receive credits against those job obligations based on funding received by TIGM and certain related parties from sources other than the State of Texas. We will also receive credits against those jobs obligations for any surplus jobs we create. We may be required to repay the state a portion of the award if we fail to meet those job obligations. Subject to these credits, if we fail to create the specified number of jobs, the State may require us to repay $2,415 for each job we fall short beginning in 2013. Our maximum aggregate exposure for such payments, if we fail to create any new jobs, is approximately $14.2 million, including $1.5 million through 2014, without giving effect to any credits to which we may be entitled. Facilities. In April 2004, we obtained a $34.0 million mortgage on our facilities in The Woodlands, Texas. The mortgage loan originally had a ten-year term with a 20-year amortization and a fixed interest rate of 8.23%. The mortgage was amended in September 2013 to extend the maturity date from April 2014 to April 2017, with the mortgage loan's monthly payment amount and fixed interest rate each remaining unchanged. The mortgage had a principal balance outstanding of $21.5 million as of March 31, 2014. In May 2002, our subsidiary Lexicon Pharmaceuticals (New Jersey), Inc. leased a 76,000 square-foot laboratory and office space in Hopewell, New Jersey. Effective December 31, 2012, this lease was amended to decrease the space to approximately 42,000 square feet. The term of the amended lease extends until June 30, 2018. The amended lease provides for escalating yearly base rent payments starting at $836,000 and increasing to $941,000 in the final year of the lease. 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 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, other collaborations and technology licenses and other sources 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, which we believe are subject to limited market and credit risk. We currently do not hedge interest rate exposure or hold any derivative financial instruments in our investment portfolio.

We had approximately $98.4 million in cash and cash equivalents and short-term investments as of March 31, 2014. We believe that the working capital available to us will be sufficient to meet our cash requirements for at least the next 12 months.

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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.


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