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, 2009
  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
                ü
                
                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
April 27, 2009, 137,330,254 shares of the registrant’s common stock, par value
$0.001 per share, were outstanding.
  
 
 Lexicon
Pharmaceuticals, Inc.
 Tableof Contents
  PageFactors Affecting Forward-Looking
      Statements
                    2Part I – Financial InformationItem
      1.
                    Financial StatementsConsolidated Balance Sheets– March 31, 2009
      (unaudited) and December 31, 2008
                    3Consolidated Statements of Operations(unaudited) – Three Months Ended March 31, 2009 and
      2008
                    4Consolidated Statements of Stockholders’
      Equity (unaudited) – Three Months Ended March 31, 2009 and
      2008
                    5Consolidated Statements of Cash Flows (unaudited) –
      Three Months Ended March 31, 2009 and 2008
                    6Notes to Consolidated Financial Statements
      (unaudited)
                    7Item
      2.
                    Management’s Discussion and Analysis of Financial Condition
      and Resultsof
      Operations
                    17Item
      3.
                    Quantitative and Qualitative Disclosures about Market
      Risk
                    25Item
      4.
                    Controls and Procedures
                    25Part II – Other InformationItem
      1A.
                    Risk Factors
                    26Item
      6.
                    Exhibits
                    28Signatures
                    29
 
 The
Lexicon name and logo, LexVision® and
OmniBank® are
registered trademarks and Genome5000TM,
e-BiologyTM and
10TO10TM are
trademarks of Lexicon Pharmaceuticals, Inc.
  ——————
 
 FactorsAffecting 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.
  2
 Table
of Contents
 PartI – Financial Information
  Item
1.          FinancialStatements
  Lexicon Pharmaceuticals, Inc.
  Consolidated
BalanceSheets
 (In
thousands, except par value)
  As
      of March 31,
                        
                        
                        As
      of December 31,2009
                        
                        
                        2008Assets
                        
                        (unaudited)Current
      assets:Cash and cash
      equivalents
                        
                        $
                        16,953
                        
                        
                        $
                        85,873Short-term investments,
      including restricted investments of $430
                        
                        
                        60,479
                        
                        
                        
                        629Short-term investments held by
      Symphony Icon, Inc.
                        
                        
                        11,832
                        
                        
                        
                        16,610Accounts receivable, net of
      allowances of $35
                        
                        
                        1,248
                        
                        
                        
                        568Prepaid expenses and other
      current assets
                        
                        
                        3,703
                        
                        
                        
                        5,487Total current
      assets
                        
                        
                        94,215
                        
                        
                        
                        109,167Long-term
      investments
                        
                        
                        56,203
                        
                        
                        
                        55,686Property
      and equipment, net of accumulated depreciation and amortization of $72,887
      and $71,102, respectively
                        
                        
                        63,027
                        
                        
                        
                        65,087Goodwill
                        
                        
                        25,798
                        
                        
                        
                        25,798Other
      assets
                        
                        
                        5,209
                        
                        
                        
                        5,770Total assets
                        
                        $
                        244,452
                        
                        
                        $
                        261,508Liabilities
      and EquityCurrent
      liabilities:Accounts
    payable
                        
                        $
                        3,083
                        
                        
                        $
                        7,926Accrued
      liabilities
                        
                        
                        5,106
                        
                        
                        
                        6,615Current portion of deferred
      revenue
                        
                        
                        3,109
                        
                        
                        
                        5,672Current portion of long-term
      debt
                        
                        
                        984
                        
                        
                        
                        963Total current
      liabilities
                        
                        
                        12,282
                        
                        
                        
                        21,176Deferred
      revenue, net of current portion
                        
                        
                        14,212
                        
                        
                        
                        14,212Long-term
      debt
                        
                        
                        43,939
                        
                        
                        
                        29,529Other
      long-term liabilities
                        
                        
                        727
                        
                        
                        
                        764Total
    liabilities
                        
                        
                        71,160
                        
                        
                        
                        65,681Commitments
      and contingenciesEquity:Lexicon Pharmaceuticals, Inc.
      stockholders’ equity:Preferred stock, $.01 par
      value; 5,000 shares authorized; no shares issued and
      outstanding
                        
                        
                        —
                        
                        
                        
                        —Common stock, $.001 par value;
      300,000 shares authorized; 137,331 and 136,797 shares issued and
      outstanding, respectively
                        
                        
                        137
                        
                        
                        
                        137Additional paid-in
      capital
                        
                        
                        674,645
                        
                        
                        
                        672,838Accumulated
      deficit
                        
                        
                        (508,955
                        )
                        
                        
                        (487,395
                        )Accumulated other
      comprehensive loss
                        
                        
                        (5
                        )
                        
                        
                        —Total Lexicon Pharmaceuticals,
      Inc. stockholders’ equity
                        
                        
                        165,822
                        
                        
                        
                        185,580Noncontrolling interest in
      Symphony Icon, Inc.
                        
                        
                        7,470
                        
                        
                        
                        10,247Total equity
                        
                        
                        173,292
                        
                        
                        
                        195,827Total liabilities and
      equity
                        
                        $
                        244,452
                        
                        
                        $
                        261,508
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  3
 Table
of Contents
  Lexicon
Pharmaceuticals, Inc.
  Consolidated
Statements of Operations
 (In
thousands, except per share amounts)
 (Unaudited)
  
 Three
      Months Ended March 31,2009
                            
                            
                            2008Revenues:Collaborative
      research
                            
                            
                            $
                            3,605
                            
                            
                            $
                            7,634Subscription and license
      fees
                            
                            
                            
                            563
                            
                            
                            
                            1,259Total revenues
                            
                            
                            
                            4,168
                            
                            
                            
                            8,893Operating
      expenses:Research and development,
      including stock-based compensation of $829 and $1,127,
      respectively
                            
                            
                            
                            22,976
                            
                            
                            
                            27,802General and administrative,
      including stock-based compensation of $613 and $652,
      respectively
                            
                            
                            
                            4,762
                            
                            
                            
                            5,529Total
      operating expenses
                            
                            
                            
                            27,738
                            
                            
                            
                            33,331Loss
      from operations
                            
                            
                            
                            (23,570
                            )
                            
                            
                            (24,438
                            )Gain
      on long-term investments, net
                            
                            
                            
                            517
                            
                            
                            
                            —Interest
      income
                            
                            
                            
                            327
                            
                            
                            
                            2,781Interest
      expense
                            
                            
                            
                            (666
                            )
                            
                            
                            (670
                            )Other
      expense, net
                            
                            
                            
                            (945
                            )
                            
                            
                            (547
                            )Consolidated
      net loss
                            
                            
                            
                            (24,337
                            )
                            
                            
                            (22,874
                            )Less:
      Net loss attributable to noncontrolling interest in Symphony Icon,
      Inc.
                            
                            
                            
                            2,777
                            
                            
                            
                            4,924Net
      loss attributable to Lexicon Pharmaceuticals, Inc.
                            
                            
                            $
                            (21,560
                            )
                            
                            $
                            (17,950
                            )Net
      loss attributable to Lexicon Pharmaceuticals, Inc. per common share, basic
      and diluted
                            
                            
                            $
                            (0.16
                            )
                            
                            $
                            (0.13
                            )Shares
      used in computing net loss attributable to Lexicon Pharmaceuticals, Inc.
      per common share, basic and diluted
                            
                            
                            
                            137,075
                            
                            
                            
                            136,795
 
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
 
 4
 Table
of Contents
 
 Lexicon
Pharmaceuticals, Inc.
  Consolidated
Statements of Stockholders’ Equity
 (In
thousands)
 
 
 Lexicon
      Pharmaceuticals, Inc. StockholdersAdditional
      Paid-In Capital
                                  
                                  
                                  Accumulated
      Deficit
                                  
                                  
                                  Accumulated
      Other Comprehensive Loss
                                  
                                  
                                  Total
                                  
                                  
                                  Noncontrolling
      Interest
                                  
                                  
                                  Total
      EquityCommon
      StockShares
                                  
                                  
                                  Par
      ValueBalance
      at December 31, 2007
                                  
                                  
                                  136,796
                                  
                                  
                                  $
                                  137
                                  
                                  
                                  $
                                  666,702
                                  
                                  
                                  $
                                  (410,535
                                  )
                                  
                                  $
                                  (4
                                  )
                                  
                                  $
                                  256,300
                                  
                                  
                                  $
                                  30,271
                                  
                                  
                                  $
                                  286,571Stock-based
      compensation
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,779
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,779
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,779Net
      loss
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (17,950
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (17,950
                                  )
                                  
                                  
                                  (4,924
                                  )
                                  
                                  
                                  (22,874
                                  )Unrealized
      loss on investments
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (2,328
                                  )
                                  
                                  
                                  (2,328
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (2,328
                                  )Comprehensive
      loss
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (20,278
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  (25,202
                                  )Balance
      at March 31, 2008
                                  
                                  
                                  136,796
                                  
                                  
                                  $
                                  137
                                  
                                  
                                  $
                                  668,481
                                  
                                  
                                  $
                                  (428,485
                                  )
                                  
                                  $
                                  (2,332
                                  )
                                  
                                  $
                                  237,801
                                  
                                  
                                  $
                                  25,347
                                  
                                  
                                  $
                                  263,148Balance
      at December 31, 2008
                                  
                                  
                                  136,797
                                  
                                  
                                  $
                                  137
                                  
                                  
                                  $
                                  672,838
                                  
                                  
                                  $
                                  (487,395
                                  )
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  185,580
                                  
                                  
                                  $
                                  10,247
                                  
                                  
                                  $
                                  195,827Stock-based
      compensation
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,807
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,807
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,807Grant
      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
 
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
 
 5
 Table
of Contents
  Lexicon
Pharmaceuticals, Inc.
  Consolidated
Statements of CashFlows
 (In
thousands)
 (Unaudited)
  
 Three
      Months Ended March 31,2009
                            
                            
                            2008Cash
      flows from operating activities:Net
      loss attributable to Lexicon Pharmaceuticals, Inc.
                            
                            $
                            (21,560
                            )
                            
                            $
                            (17,950
                            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
                            
                            
                            1,772
                            
                            
                            
                            2,058Impairment
      of fixed assets
                            
                            
                            406
                            
                            
                            
                            —Amortization
      of Symphony Icon, Inc. purchase option
                            
                            
                            535
                            
                            
                            
                            535Loss
      attributable to noncontrolling interest
                            
                            
                            (2,777
                            )
                            
                            
                            (4,924
                            )Stock-based
      compensation
                            
                            
                            1,442
                            
                            
                            
                            1,779Impairment
      of long-term investments
                            
                            
                            41
                            
                            
                            
                            —Gain
      on ARS Rights
                            
                            
                            (558
                            )
                            
                            
                            —Loss
      on disposal of property and equipment
                            
                            
                            2
                            
                            
                            
                            —Changes
      in operating assets and liabilities:(Increase)
      decrease in accounts receivable
                            
                            
                            (680
                            )
                            
                            
                            519Decrease
      in prepaid expenses and other current assets
                            
                            
                            1,784
                            
                            
                            
                            489Decrease
      in other assets
                            
                            
                            26
                            
                            
                            
                            22Decrease
      in accounts payable and other liabilities
                            
                            
                            (6,024
                            )
                            
                            
                            (2,787
                            )Decrease
      in deferred revenue
                            
                            
                            (2,563
                            )
                            
                            
                            (6,296
                            )Net
      cash used in operating activities
                            
                            
                            (28,154
                            )
                            
                            
                            (26,555
                            )Cash
      flows from investing activities:Purchases
      of property and equipment
                            
                            
                            (156
                            )
                            
                            
                            (879
                            )Proceeds
      from disposal of property and equipment
                            
                            
                            36
                            
                            
                            
                            —Maturities
      of investments held by Symphony Icon, Inc.
                            
                            
                            4,778
                            
                            
                            
                            3,245Purchases
      of short-term investments
                            
                            
                            (59,955
                            )
                            
                            
                            (39,848
                            )Maturities
      of short-term investments
                            
                            
                            100
                            
                            
                            
                            100,773Net
      cash provided by (used in) investing activities
                            
                            
                            (55,197
                            )
                            
                            
                            63,291Cash
      flows from financing activities:Proceeds
      from debt borrowings
                            
                            
                            14,800
                            
                            
                            
                            —Repayment
      of debt borrowings
                            
                            
                            (369
                            )
                            
                            
                            (217
                            )Net
      cash provided by (used in) financing activities
                            
                            
                            14,431
                            
                            
                            
                            (217
                            )Net
      increase (decrease) in cash and cash equivalents
                            
                            
                            (68,920
                            )
                            
                            
                            36,519Cash
      and cash equivalents at beginning of period
                            
                            
                            85,873
                            
                            
                            
                            22,938Cash
      and cash equivalents at end of period
                            
                            $
                            16,953
                            
                            
                            $
                            59,457Supplemental
      disclosure of cash flow information:Cash
      paid for interest
                            
                            $
                            626
                            
                            
                            $
                            656Supplemental
      disclosure of non-cash investing and financing activities:Unrealized
      loss on investments
                            
                            $
                            (5
                            )
                            
                            $
                            (2,328
                            )
 
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  6
 Table
of Contents
  Lexicon
Pharmaceuticals, Inc.
  Notesto 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, 2009 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2009.
  The
accompanying consolidated financial statements include the accounts of Lexicon
and its wholly-owned subsidiaries, as well as one variable interest entity,
Symphony Icon, Inc. (“Symphony Icon”), for which the Company is the primary
beneficiary as defined by the Financial Accounting Standards Board (“FASB”)
Interpretation No. 46 (revised 2003), “Consolidation of Variable Interest
Entities” (“FIN 46R”).  Intercompany transactions and balances
are eliminated in consolidation.
  For
further information, refer to the financial statements and footnotes thereto
included in Lexicon’s annual report on Form 10-K for the year ended December 31,
2008, 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
  Under the
provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123
(Revised), “Share-Based Payment,” the Company recorded $1.4 million and
$1.8 million of stock-based compensation expense for the three months ended
March 31, 2009 and 2008, respectively.  The Company utilized the
Black-Scholes valuation model for estimating the fair value of the stock options
granted, with the following weighted-average assumptions for options granted in
the three months ended March 31, 2009 and 2008, respectively.
  Expected
      Volatility
                    
                    
                    Risk-free
      Interest Rate
                    
                    
                    Expected
      Term
                    
                    
                    Estimated
      Forfeitures
                    
                    
                    Dividend
                      RateMarch
      31, 2009:Employees
                    
                    
                    78
                    %
                    
                    
                    1.9
                    %
                    
                    
                    5
                    
                    
                    
                    23
                    %
                    
                    
                    0
                    %Officers
      and non-employee directors
                    
                    
                    76
                    %
                    
                    
                    2.6
                    %
                    
                    
                    8
                    
                    
                    
                    6
                    %
                    
                    
                    0
                    %March
      31, 2008:Employees
                    
                    
                    66
                    %
                    
                    
                    2.9
                    %
                    
                    
                    6
                    
                    
                    
                    20
                    %
                    
                    
                    0
                    %Officers
      and non-employee directors
                    
                    
                    66
                    %
                    
                    
                    3.8
                    %
                    
                    
                    9
                    
                    
                    
                    4
                    %
                    
                    
                    0
                    %
 
 7
 Table
of Contents
 The
following is a summary of option activity under Lexicon’s stock option plans for
the three months ended March 31, 2009:
  Options
                        
                        Weighted
      Average Exercise Price(in
      thousands)Outstanding
      at December 31, 2008
                        
                        
                        16,898
                        
                        $
                        5.13Granted
                        
                        
                        4,448
                        
                        
                        1.45Expired
                        
                        
                        (539
                        )
                        
                        4.37Forfeited
                        
                        
                        (392
                        )
                        
                        2.73Outstanding
      at March 31, 2009
                        
                        
                        20,415
                        
                        
                        4.39Exercisable
      at March 31, 2009
                        
                        
                        12,068
                        
                        $
                        6.01
 
 During
the three months ended March 31, 2009, Lexicon granted its officers
restricted stock bonus awards under the 2000 Equity Incentive Plan in lieu of
cash bonus awards.  The shares subject to the awards vest 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,
2009:
  Shares
                    
                    
                    Weighted
      Average Grant Date
                      Fair
      Value(in
      thousands)Outstanding
      at December 31, 2008
                    
                    
                    —
                    
                    
                    $
                    —Granted
                    
                    
                    534
                    
                    
                    
                    1.45Nonvested
      at March 31, 2009
                    
                    
                    534
                    
                    
                    $
                    1.45
 
 4.      Recent
Accounting Pronouncements
  In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements.”  The statement defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements.  This statement
applies under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement
attribute.  Accordingly, this statement does not require any new fair
value measurements.  More specifically, SFAS No. 157 emphasizes
that fair value is a market-based measurement, not an entity-specific
measurement, and sets out a fair value hierarchy, which ranks the quality and
reliability of the information used to determine fair values.  SFAS
No. 157 was effective January 1, 2008 for financial assets and
liabilities and January 1, 2009 for non-financial assets and
liabilities.  The adoption of SFAS No. 157 did not have an effect
on the Company’s financial position or results of operations.
  In
December 2007, the FASB issued SFAS No. 141(Revised), “Business Combinations,”
which replaces SFAS No. 141, “Business Combinations,” and requires an acquirer
to recognize the assets acquired, the liabilities assumed, and any
non-controlling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions. This statement also
requires the acquirer in a business combination achieved in stages to recognize
the identifiable assets and liabilities, as well as the non-controlling interest
in the acquiree, at the full amounts of their fair values. SFAS No. 141(R) makes
various other amendments to authoritative literature intended to provide
additional guidance or to confirm the guidance in that literature to that
provided in this statement. This statement applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008. The
adoption of SFAS No. 141(R) did not have an effect on the Company’s financial
position or results of operations.
  8
 Table
of Contents
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements,” which amends Accounting Research Bulletin
No. 51, “Consolidated Financial Statements,” to improve the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements. SFAS No. 160
establishes accounting and reporting standards that require the ownership
interests in subsidiaries not held by the parent to be clearly identified,
labeled and presented in the consolidated statement of financial position within
equity, but separate from the parent’s equity. This statement also requires the
amount of consolidated net income attributable to the parent and to the
non-controlling interest to be clearly identified and presented on the face of
the consolidated statement of income. Changes in a parent’s ownership interest
while the parent retains its controlling financial interest must be accounted
for consistently, and when a subsidiary is deconsolidated, any retained
non-controlling equity investment in the former subsidiary must be initially
measured at fair value. The gain or loss on the deconsolidation of the
subsidiary is measured using the fair value of any non-controlling equity
investment. The statement also requires entities to provide sufficient
disclosures that clearly identify and distinguish between the interests of the
parent and the interests of the non-controlling owners. This statement applies
prospectively to all entities that prepare consolidated financial statements and
applies prospectively for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008. The Company’s adoption of SFAS
No. 160 on January 1, 2009 did not materially affect its financial
position or results of operations, other than reclassifying the noncontrolling
interest in Symphony Icon to equity for all periods presented.
  In
December 2007, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No.
07-01, “Accounting for Collaborative Arrangements,” which provides guidance on
how the parties to a collaborative agreement should account for costs incurred
and revenue generated on sales to third parties, how sharing payments pursuant
to a collaboration agreement should be presented in the income statement and
certain related disclosure requirements.  The adoption of EITF No.
07-01 did not have an effect on the Company's financial position or results of
operations, other than requiring additional disclosures.  Most of the
required disclosures were included in the Company's annual report on Form 10-K
for the year ended December 31, 2008.  See note 12,
“Collaboration and License Agreements,” for additional required
disclosures.
  5.      Cash
and Cash Equivalents and Investments
  The fair
value of cash and cash equivalents and investments held at March 31, 2009
and December 31, 2008 are as follows:
  As
      of March 31, 2009Amortized
      Cost
                                                                  
                                                                  
                                                                  Gross
      Unrealized Gains
                                                                  
                                                                  
                                                                  Gross
      Unrealized Losses
                                                                  
                                                                  
                                                                  Estimated
      Fair Value(In
      Thousands)Cash
      and cash equivalents
                                                                  
                                                                  $
                                                                  16,953
                                                                  
                                                                  
                                                                  $
                                                                  —
                                                                  
                                                                  
                                                                  $
                                                                  —
                                                                  
                                                                  
                                                                  $
                                                                  16,953Securities
      maturing within one year:Certificates
      of deposit
                                                                  
                                                                  
                                                                  509
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  509U.S.
      treasury securities
                                                                  
                                                                  
                                                                  59,975
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  (5
                                                                  )
                                                                  
                                                                  
                                                                  59,970Total short-term
      investments
                                                                  
                                                                  $
                                                                  60,484
                                                                  
                                                                  
                                                                  $
                                                                  —
                                                                  
                                                                  
                                                                  $
                                                                  (5
                                                                  )
                                                                  
                                                                  $
                                                                  60,479Securities
      maturing after one year through five years:ARS
      Rights
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  12,618
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  12,618Securities
      maturing after ten years:Auction
      rate securities
                                                                  
                                                                  
                                                                  57,000
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  (13,415
                                                                  )
                                                                  
                                                                  
                                                                  43,585Total long-term
      investments
                                                                  
                                                                  $
                                                                  57,000
                                                                  
                                                                  
                                                                  $
                                                                  12,618
                                                                  
                                                                  
                                                                  $
                                                                  (13,415
                                                                  )
                                                                  
                                                                  $
                                                                  56,203Short-term
      investments held by Symphony Icon, Inc.:Cash
      and cash equivalents
                                                                  
                                                                  
                                                                  11,832
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  —
                                                                  
                                                                  
                                                                  
                                                                  11,832Total short-term investments
      held by Symphony Icon, Inc.
                                                                  
                                                                  $
                                                                  11,832
                                                                  
                                                                  
                                                                  $
                                                                  —
                                                                  
                                                                  
                                                                  $
                                                                  —
                                                                  
                                                                  
                                                                  $
                                                                  11,832Total
      cash and cash equivalents and investments
                                                                  
                                                                  $
                                                                  146,269
                                                                  
                                                                  
                                                                  $
                                                                  12,618
                                                                  
                                                                  
                                                                  $
                                                                  (13,420
                                                                  )
                                                                  
                                                                  $
                                                                  145,467
 
  9
 Table
of Contents
 
 As
      of December 31, 2008Amortized
      Cost
                                                                        
                                                                        
                                                                        Gross
      Unrealized Gains
                                                                        
                                                                        
                                                                        Gross
      Unrealized Losses
                                                                        
                                                                        
                                                                        Estimated
      Fair Value(In
      thousands)Cash
      and cash equivalents
                                                                        
                                                                        $
                                                                        85,873
                                                                        
                                                                        
                                                                        $
                                                                        —
                                                                        
                                                                        
                                                                        $
                                                                        —
                                                                        
                                                                        
                                                                        $
                                                                        85,873Securities
      maturing within one year:Certificates of
      deposit
                                                                        
                                                                        
                                                                        629
                                                                        
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        629Total short-term
      investments
                                                                        
                                                                        $
                                                                        629
                                                                        
                                                                        
                                                                        $
                                                                        —
                                                                        
                                                                        
                                                                        $
                                                                        —
                                                                        
                                                                        
                                                                        $
                                                                        629Securities
      maturing after one year through five years:ARS Rights
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        12,060
                                                                        
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        12,060Securities
      maturing after ten years:Auction rate
      securities
                                                                        
                                                                        
                                                                        57,000
                                                                        
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        (13,374
                                                                        )
                                                                        
                                                                        
                                                                        43,626Total long-term
      investments
                                                                        
                                                                        $
                                                                        57,000
                                                                        
                                                                        
                                                                        $
                                                                        12,060
                                                                        
                                                                        
                                                                        $
                                                                        (13,374
                                                                        )
                                                                        
                                                                        $
                                                                        55,686Short-term
      investments held by Symphony Icon, Inc.:Cash and cash
      equivalents
                                                                        
                                                                        
                                                                        16,610
                                                                        
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        —
                                                                        
                                                                        
                                                                        
                                                                        16,610Total short-term investments
      held by Symphony Icon, Inc.
                                                                        
                                                                        $
                                                                        16,610
                                                                        
                                                                        
                                                                        $
                                                                        —
                                                                        
                                                                        
                                                                        $
                                                                        —
                                                                        
                                                                        
                                                                        $
                                                                        16,610Total
      cash and cash equivalents and investments
                                                                        
                                                                        $
                                                                        160,112
                                                                        
                                                                        
                                                                        $
                                                                        12,060
                                                                        
                                                                        
                                                                        $
                                                                        (13,374
                                                                        )
                                                                        
                                                                        $
                                                                        158,798
 
 There
were no realized gains or losses for the three months ended March 31,
2009.  There were $31,000 of realized gains for the three months ended
March 31, 2008.
  At March
31, 2009, Lexicon held $57.0 million (par value), with an estimated fair value
of $43.6 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 Lexicon’s 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 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 classified its entire auction rate security investment balance as long-term
investments on its consolidated balance sheets because of the Company’s
inability to determine when its investments in auction rate securities will be
sold.  Lexicon has also 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, 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 $43.6 million as of
March 31, 2009 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, 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 $57.0 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 an affiliate of UBS at no net cost up to 75% of the
market value of the securities, as determined by such affiliate, which loans
would become payable upon the investment bank’s purchase or sale of the
securities (see note 8).
 10
 Table
of Contents
  The
enforceability of the ARS Rights results in a separate asset that will be
measured at its fair value.  Lexicon elected to measure the ARS Rights
under the fair value option of SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – including an amendment of FASB
Statement No. 115.”  As a result of accepting the ARS Rights,
Lexicon elected in 2008 to classify the ARS Rights and reclassify its
investments in auction rate securities as trading securities, as defined by SFAS
No. 115, “Accounting for Certain Investments in Debt and Equity
Securities.”  As a result, Lexicon will be 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.  During the three months ended March 31, 2009, Lexicon
recorded a loss of $41,000 to reflect the decline in fair value of the auction
rate securities, and recorded a gain of $558,000 to reflect the increase in fair
value of the ARS Rights, which are reflected in gain on long-term investments,
net, in the accompanying consolidated statement of
operations.  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.
  Excluding
auction rate securities and the ARS Rights, at March 31, 2009, Lexicon had
approximately $89.3 million in cash and cash equivalents and short-term
investments, including $11.8 million in investments held by Symphony
Icon.  Management believes that the working capital available to
Lexicon excluding the funds held in auction rate securities and the UBS credit
line entered into in January 2009 will be sufficient to meet its cash
requirements for at least the next 12 months.
  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.  SFAS No. 157 defines the following levels 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 defined by SFAS No. 157
as of March 31, 2009 and December 31, 2008.
  11
 Table
of Contents
 
 Financial Assets at Fair
      Value as of March
      31, 2009Level
      1
                            
                            Level
      2
                            
                            Level
      3
                            
                            
                            Total(in
      thousands)Cash
      and cash equivalents
                            
                            $
                            16,953
                            
                            
                            $
                            —
                            
                            
                            $
                            —
                            
                            
                            $
                            16,953Short-term
      investments
                            
                            
                            60,479
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            60,479Short-term
      investments held by  Symphony Icon, Inc.
                            
                            
                            11,832
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            11,832Long-term
      investments
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            56,203
                            
                            
                            
                            56,203Total
      cash and cash equivalents and investments
                            
                            $
                            89,264
                            
                            
                            $
                            —
                            
                            
                            $
                            56,203
                            
                            
                            $
                            145,467
 
 
 Financial Assets at Fair
      Value as of
      December 31, 2008Level
      1
                            
                            Level
      2
                            
                            Level
      3
                            
                            
                            Total(in
      thousands)Cash
      and cash equivalents
                            
                            $
                            85,873
                            
                            
                            $
                            —
                            
                            
                            $
                            —
                            
                            
                            $
                            85,873Short-term
      investments
                            
                            
                            629
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            629Short-term
      investments held by  Symphony Icon, Inc.
                            
                            
                            16,610
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            16,610Long-term
      investments
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            55,686
                            
                            
                            
                            55,686Total
      cash and cash equivalents and investments
                            
                            $
                            103,112
                            
                            
                            $
                            —
                            
                            
                            $
                            55,686
                            
                            
                            $
                            158,798
 
 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, 2009.
  Long-term
      Investments(in
      thousands)Balance
      at December 31, 2008
                            
                            $
                            55,686Unrealized
      gains included in earnings as gain on long-term investments,
      net
                            
                            
                            517Balance
      at March 31, 2009
                            
                            $
                            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.      Goodwill
  On July
12, 2001, Lexicon completed the acquisition of Coelacanth Corporation in a
merger. Coelacanth, now Lexicon Pharmaceuticals (New Jersey), Inc., forms the
core of the Company’s division responsible for small molecule compound
discovery.  The results of Lexicon Pharmaceuticals (New Jersey), Inc.
are included in the Company’s results of operations for the periods subsequent
to the acquisition.
  Goodwill
associated with the acquisition of $25.8 million, which represents the excess of
the $36.0 million purchase price over the fair value of the underlying net
identifiable assets, was assigned to the consolidated entity,
Lexicon.  In accordance with SFAS No. 142, “Goodwill and Other
Intangible Assets,” the goodwill balance is not subject to amortization, but is
tested at least annually for impairment at the reporting unit level, which is
the Company’s single operating segment.  During 2008, the Company
performed an impairment test of goodwill on its annual impairment assessment
date.  This test did not result in an impairment of
goodwill.
  As of
March 31, 2009, given the current global economic downturn and decrease in
the price of the Company’s common stock as listed on the Nasdaq Global Market on
such date, the Company performed an impairment test of goodwill and determined
that the goodwill balance is not impaired.  However, if in the future
the Company’s common stock price decreases further, the Company will reassess
the carrying value of goodwill and may record an impairment charge at that
time.
  12
 Table
of Contents
 To
perform an impairment test, the Company uses the market capitalization approach
to measure fair value of the reporting unit. Under this approach, fair value is
calculated as the average closing price of Lexicon’s common stock on the Nasdaq
Global Market for the 30 days preceding the date that the impairment test
is performed, multiplied by the number of outstanding shares on that
date.  A control premium, which is representative of premiums paid in
the marketplace to acquire a controlling interest in a company, is then added to
the market capitalization to determine the fair value of the reporting
unit.  The inputs used to calculate fair value are classified as
Level 3 under SFAS No. 157 due to the subjectivity in the determination of
the control premium.  The average closing price of Lexicon's common
stock is a Level 1 input; however the control premium is a Level 3
input as the control premium is determined using transactions within the
Company's industry in the market.  If the fair value exceeds the
carrying value, no further action is required and no impairment loss is
recognized.  There was no impairment of goodwill in the three months
ended March 31, 2009.
  8.      Debt
Obligations
  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%.
  In
January 2009, Lexicon entered into a credit line agreement with UBS Bank USA
that provides up to an aggregate amount of $37.9 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 $57.0 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 Lexicon on advances will not
exceed the interest or dividends paid to Lexicon by the issuer of the auction
rate securities.  As of March 31, 2009, Lexicon had
$14.7 million outstanding under this credit line.
  9.      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) $72 million, if the Purchase Option is exercised before
June 15, 2009, (ii) $81 million, if the Purchase Option is
exercised on or after June 15, 2009 and before June 15, 2010 and
(iii) $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 has
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.  The unamortized balance of
$4.7 million and $5.3 million is recorded in other assets in the
accompanying consolidated balance sheets as of March 31, 2009 and
December 31, 2008, respectively, and the amortization expense of $535,000
is recorded in other expense, net in the accompanying consolidated statements of
operations for the three months ended March 31, 2009 and 2008.
 13
 Table
of Contents
  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.
  In
accordance with FIN 46R, Lexicon has determined that Symphony Icon is 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 has determined it is 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 has determined that it is 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.  Symphony Icon’s cash and cash
equivalents have been recorded on Lexicon’s consolidated financial statements as
short-term investments held by Symphony Icon.  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
progresses, this line item will be reduced by Symphony Icon’s losses, which were
$2.8 million and $4.9 million in the three months ended March 31,
2009 and 2008, respectively. The reductions to the noncontrolling interest in
Symphony Icon will be reflected in Lexicon’s consolidated statements of
operations using a similar caption and will reduce the amount of Lexicon’s
reported net loss.  Through March 31, 2009, 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.
  14
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of Contents
 10.           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
$10.9 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, 2009 and December 31, 2008.
  Legal
Proceedings:  On October 20, 2008, Lexicon received
correspondence from counsel to the University of Utah Research Foundation
(“UURF”) alleging that Lexicon was in breach of certain obligations purported to
exist under its license agreement with GenPharm International, Inc., under which
Lexicon obtained a sublicense under certain patents exclusively licensed from
UURF by GenPharm, and related letter agreements between Lexicon and UURF
governing the payment of royalties.  The correspondence alleged that
Lexicon breached the relevant agreements by, among other things, purportedly
failing to pay all required royalties and ignoring obligations that UURF
contends are expressed or implied in the relevant agreements. On December 16,
2008, Lexicon filed a complaint against UURF in the District Court of Montgomery
County, Texas seeking a declaration that Lexicon is in full compliance with its
license and royalty obligations.  On January 26, 2009, UURF filed a
notice seeking to remove the case to the United States District Court for the
Southern District of Texas.  UURF filed an answer and counterclaims on
February 2, 2009 asserting breach of contract claims consistent with the claims
made by UURF in its October 2008 correspondence and patent infringement which it
claims has occurred since approximately December 17, 2008.  On February 23,
2009, Lexicon filed an answer to UURF’s counterclaims.
  Lexicon
believes that it has materially complied with all of its obligations under the
relevant agreements, including those relating to royalty payments due to UURF,
and that UURF’s claims are inconsistent with the express provisions of the
relevant agreements.  Lexicon accordingly believes UURF’s claims are
without merit.  While the litigation of these matters is at a very
early stage, Lexicon intends to vigorously pursue its complaint against UURF and
dispute UURF’s counterclaims.
  Lexicon
is from time to time party to other claims and legal proceedings that it
believes will not have, individually or in the aggregate, a material adverse
effect on its results of operations, financial condition or
liquidity.
  11.           Comprehensive
Loss
  Comprehensive
loss consists of:
  Three
      Months Ended March 31,2009
                        
                        
                        2008(in
      thousands)Net
      loss attributable to Lexicon Pharmaceuticals, Inc.
                        
                        $
                        (21,560
                        )
                        
                        $
                        (17,950
                        )Unrealized
      gain (loss) on short-term investments
                        
                        
                        (5
                        )
                        
                        
                        209Unrealized
      loss on long-term investments
                        
                        
                        —
                        
                        
                        
                        (2,537
                        )Net
      comprehensive loss attributable to Lexicon Pharmaceuticals,
      Inc.
                        
                        $
                        (21,565
                        )
                        
                        $
                        (20,278
                        )
 
 15
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of Contents
 12.           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 as defined by EITF No. 99-19,
“Reporting Revenue Gross as a Principal versus Net as an Agent.”
  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 $0.8 million
and $2.5 million for the three months ended March 31, 2009 and 2008,
respectively.
  Lexicon
established an alliance with Genentech in December 2002 to discover novel
therapeutic proteins and antibody targets.  Revenue recognized under
this agreement was none and $1.1 million for the three months ended
March 31, 2009 and 2008, 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 $1.5 million and $2.8 million for the three
months ended March 31, 2009 and 2008, respectively.
  16
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 Item2.                 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 technology 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 and commercializing drug candidates from such programs
internally and to collaborate with third parties with respect to the discovery,
development and commercialization of small molecule and biotherapeutics 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 receive 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 for use in the other organization’s own drug
discovery efforts.
  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 which may result in royalties, and general and
industry-specific economic conditions which may affect research and development
expenditures.  Our future revenues from collaborations and 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
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.
  17
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of Contents
 Since our
inception, we have incurred significant losses and, as of March 31, 2009,
we had an accumulated deficit of $509.0 million. Our losses have resulted
principally from costs incurred in research and development, general and
administrative costs associated with our operations, and non-cash stock-based
compensation expenses associated with stock options granted to employees and
consultants.  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, legal expenses resulting from intellectual property
prosecution and other expenses related to our drug discovery and development
programs, the development and analysis of knockout mice and our other target
validation research efforts, and the development of compound libraries. General
and administrative expenses consist primarily of salaries and related expenses
for executive and administrative personnel, professional fees and other
corporate expenses including information technology, facilities costs and
general legal activities.  In connection with the expansion of our
drug discovery 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, 2008.
  Recent Accounting Pronouncements
  In
September 2006, the FASB issued Statement of Financial Accounting Standards, or
SFAS, No. 157, “Fair Value Measurements.”  The statement defines
fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value
measurements.  This statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute.  Accordingly, this statement does not
require any new fair value measurements.  More specifically, SFAS
No. 157 emphasizes that fair value is a market-based measurement, not an
entity-specific measurement, and sets out a fair value hierarchy, which ranks
the quality and reliability of the information used to determine fair
value.  SFAS No. 157 was effective January 1, 2008 for financial
assets and liabilities and January 1, 2009 for non-financial assets and
liabilities.  The adoption of SFAS No. 157 did not have an effect
on our financial position or results of operations.
  In
December 2007, the FASB issued SFAS No. 141(Revised), “Business Combinations,”
which replaces SFAS No. 141, “Business Combinations,” and requires an acquirer
to recognize the assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions. This statement also
requires the acquirer in a business combination achieved in stages to recognize
the identifiable assets and liabilities, as well as the noncontrolling interest
in the acquiree, at the full amounts of their fair values. SFAS No. 141(R) makes
various other amendments to authoritative literature intended to provide
additional guidance or to confirm the guidance in that literature to that
provided in this statement. This statement applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15,
2008.  Our adoption of SFAS No. 141(R) on January 1, 2009 did not
have an effect on our financial position or results of operations.
  18
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of Contents
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements,” which amends Accounting Research Bulletin
No. 51, “Consolidated Financial Statements,” to improve the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements. SFAS No. 160
establishes accounting and reporting standards that require the ownership
interests in subsidiaries not held by the parent to be clearly identified,
labeled and presented in the consolidated statement of financial position within
equity, but separate from the parent’s equity. This statement also requires the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest to be clearly identified and presented on the face of
the consolidated statement of income. Changes in a parent’s ownership interest
while the parent retains its controlling financial interest must be accounted
for consistently, and when a subsidiary is deconsolidated, any retained
noncontrolling equity investment in the former subsidiary must be initially
measured at fair value. The gain or loss on the deconsolidation of the
subsidiary is measured using the fair value of any noncontrolling equity
investment. The statement also requires entities to provide sufficient
disclosures that clearly identify and distinguish between the interests of the
parent and the interests of the noncontrolling owners. This statement applies
prospectively to all entities that prepare consolidated financial statements and
applies prospectively for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008.  Our adoption of SFAS
No. 160 on January 1, 2009 did not materially affect our financial
position or results of operations, other than reclassifying the noncontrolling
interest in Symphony Icon to equity for all periods presented.
  In
December 2007, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No.
07-01, “Accounting for Collaborative Arrangements,” which provides guidance on
how the parties to a collaborative agreement should account for costs incurred
and revenue generated on sales to third parties, how sharing payments pursuant
to a collaboration agreement should be presented in the income statement and
certain related disclosure requirements.  The adoption of EITF No.
07-01 did not have an effect on our financial position or results of operations,
other than requiring additional disclosures.  Most of the required
disclosures were included in our annual report on Form 10-K for the year ended
December 31, 2008.  See note 12, “Collaboration and License
Agreements,” in the accompanying footnotes for additional required
disclosures.
  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 31,2009
                    
                    
                    2008Total
      revenues
                    
                    $
                    4.2
                    
                    
                    $
                    8.9Dollar
      decrease
                    
                    $
                    (4.7
                    )Percentage
      decrease
                    
                    
                    (53
                    )%
 
 ·
                    Collaborative research
      – Revenue from collaborative research decreased 53% to $3.6 million,
      primarily due to reduced revenues in the three months ended March 31,
      2009 under our alliance with Bristol-Myers Squibb, reduced revenues under
      our alliance with N.V. Organon due to our progress towards completing the
      target discovery portion of the alliance, and the completion in 2008 of
      the target discovery portion of our alliance with
    Genentech.
  ·
                    Subscription and license
      fees – Revenue from subscriptions and license fees decreased 55% to
      $0.6 million, primarily due to a decrease in technology license
      fees.
  19
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 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 31,2009
                    
                    
                    2008Total
      research and development expense
                    
                    $
                    23.0
                    
                    
                    $
                    27.8Dollar
      decrease
                    
                    $
                    (4.8
                    )Percentage
      decrease
                    
                    
                    (17
                    )%
 
 Research
and development expenses consist primarily of salaries and other
personnel-related expenses, facility and equipment costs, laboratory supplies,
third-party and other services and stock-based compensation
expenses.
  ·
                    Personnel –Personnel
      costs decreased 11% to $10.6 million, primarily due to reductions in
      our personnel in May 2008 and January 2009, offset in part by associated
      severance costs.  Salaries, bonuses, employee benefits, payroll
      taxes, recruiting and relocation costs are included in personnel
      costs.
  ·
                    Facilities and equipment –Facilities and equipment costs decreased 12% to $4.1 million,
      primarily due to a decrease in depreciation
  expense.
  ·
                    Laboratory supplies –Laboratory supplies expense decreased 35% to $1.7 million,
      primarily as a result of reductions in our personnel in May 2008 and
      January 2009.
  ·
                    Third-party and other services
      –Third-party and other services decreased 23% to
      $4.9 million, primarily due to a decrease in external preclinical
      research and development costs.
  ·
                    Stock-based compensation
      – Stock-based compensation expense decreased 26% to
      $0.8 million.
  ·
                    Other –Other costs
      decreased 27% to $0.8 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 31,2009
                    
                    
                    2008Total
      general and administrative expense
                    
                    $
                    4.8
                    
                    
                    $
                    5.5Dollar
      decrease
                    
                    $
                    (0.8
                    )Percentage
      decrease
                    
                    
                    (14
                    )%
 
 General
and administrative expenses consist primarily of personnel costs to support our
research activities, facility and equipment costs, professional fees such as
legal fees, and stock-based compensation expenses.
  ·
                    Personnel – Personnel
      costs decreased 12% to $2.5 million, primarily due to reductions in
      our personnel in May 2008 and January 2009.  Salaries, bonuses,
      employee benefits, payroll taxes, recruiting and relocation costs are
      included in personnel costs.
  ·
                    Facilities and
      equipment – Facilities and equipment costs increased 11% to
      $0.7 million.
  20
 Table
of Contents
 ·
                    Professional fees –
      Professional fees decreased 25% to $0.6 million, primarily due to
      decreased legal fees and market research
costs.
  ·
                    Stock-based
      compensation – Stock-based compensation expense decreased 6% to
      $0.6 million.
  ·
                    Other –Other costs
      decreased 42% to $0.3 million.
  Gain
on Long-Term Investments, Net, Interest Income, Interest Expense and Other
Expense, Net
  Gain on Long-Term Investments,
Net.  Gain on long-term investments was $558,000 for the three
months ended March 31, 2009, representing the increase in fair value of the
rights obtained from UBS AG, the investment bank that sold us our auction
rate securities.  This gain was partially offset by a loss on
long-term investments of $41,000 for the three months ended March 31, 2009,
representing the decline in fair value of our student loan auction rate
securities.
  Interest
Income.  Interest income decreased 88% to $0.3 million in
the three months ended March 31, 2009 from $2.8 million in the
corresponding period in 2008, due to lower yields on our investments as well as
lower average cash and investment balances.
  Interest
Expense.  Interest expense was $0.7 million in the three
months ended March 31, 2009, consistent with the prior year.
  Other Expense,
Net.  Other expense, net increased 73% to $0.9 million in
the three months ended March 31, 2009 from $0.5 million in the
corresponding period in 2008, primarily due to an impairment of surplus
equipment as a result of our restructuring in January 2009.
  Noncontrolling
Interest in Symphony Icon, Inc.
  For the
three months ended March 31, 2009 and 2008, the losses attributable to the
noncontrolling interest holders of Symphony Icon were $2.8 million and
$4.9 million, respectively.
  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 $21.6 million in the three months ended
March 31, 2009 from $18.0 million in the corresponding period in
2008.  Net loss attributable to Lexicon Pharmaceuticals, Inc. per
common share increased to $0.16 in the three months ended March 31, 2009
from $0.13 in the corresponding period in 2008.
  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, 2009,
we had received net proceeds of $550.0 million from issuances of common and
preferred stock, including $203.2 million of net proceeds from the initial
public offering of our common stock in April 2000, $50.1 million from our
July 2003 common stock offering, $37.5 million from our October 2006 common
stock offering and $198.0 million from our August 2007 sale of common stock
to Invus, L.P.  In addition, from our inception through March 31,
2009, we received $443.9 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 $428.2 million had been
recognized as revenues through March 31, 2009.
 21
 Table
of Contents
  As of
March 31, 2009, we had $133.6 million in cash, cash equivalents and
investments, including $56.2 million in auction rate securities and related
rights as discussed below under “Disclosure about Market Risk,” and
$11.8 million in investments held by Symphony Icon.  As of
December 31, 2008, we had $142.2 million in cash, cash equivalents and
investments, including $55.7 million of auction rate securities and related
rights, and $16.6 million in investments held by Symphony
Icon.  We used cash of $28.2 million in operations in the three
months ended March 31, 2009. This consisted primarily of the net loss for the
period of $21.6 million, a net increase in other operating assets net of
liabilities of $4.9 million, a $2.8 million loss attributable to
noncontrolling interest, and a $2.6 million decrease in deferred revenue,
partially offset by non-cash charges of $1.8 million related to
depreciation expense, $1.4 million related to stock-based compensation
expense and $0.5 million related to the amortization of the Symphony Icon
purchase option.  Investing activities used cash of $55.2 million
in the three months ended March 31, 2009, primarily due to purchases of
short-term investments of $60.0 million, partially offset by maturities of
short-term investments of $4.9 million.  Financing activities
provided cash of $14.4 million due to proceeds from debt borrowings of
$14.8 million, partially offset by repayment of debt borrowings of
$0.4 million.
  In
January 2009, we entered into a credit line agreement with UBS Bank USA that
provides up to an aggregate amount of $37.9 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 $57.0 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, 2009, we had $14.7 million
outstanding under this credit line.
  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.  This purchase resulted in Invus’
ownership of 40% of the post-transaction outstanding shares of our common
stock.  Pursuant to the securities purchase agreement, Invus, at its
option, also has the right to require us to initiate up to two pro rata rights
offerings 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 $344.5 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.  Invus may exercise its
right to require us to conduct the first rights offering by giving us notice
within a period of 90 days beginning on November 28, 2009 (which we
refer to as the first rights offering trigger date), although we and Invus may
agree to change the first rights offering trigger date to as early as
August 28, 2009 with the approval of the members of our board of directors
who are not affiliated with Invus.  Invus may exercise its right to
require us to conduct the second rights offering by giving us notice within a
period of 90 days beginning on the date that is 12 months after Invus’
exercise of its right to require us to conduct the first rights offering or, if
Invus does not exercise its right to require us to conduct the first rights
offering, within a period of 90 days beginning on the first anniversary of
the first rights offering trigger date.  The initial investment and
subsequent rights offerings, combined with any qualified offerings, were
designed to achieve up to $550 million in proceeds to us.  Invus
would participate in each rights offering for up to its pro rata portion of the
offering, and would commit to purchase the entire portion of the offering not
subscribed for by other stockholders.
 22
 Table
of Contents
  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.
  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) $72 million, if the purchase option is exercised before
June 15, 2009, (b) $81 million, if the purchase option is exercised on
or after the June 15, 2009 and before June 15, 2010 and (c)
$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.
  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%.  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, the UBS credit line entered into in
January 2009 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.
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  Disclosure
about Market Risk
  We are
exposed to limited market and credit risk on our cash equivalents which have
maturities of three months or less at the time of purchase.  We
maintain a short-term investment portfolio which consists of U.S. Treasury
bills, money market accounts, corporate debt securities and certificates of
deposit that mature three to 12 months from the time of purchase and a long-term
investment portfolio which consists of 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, 2009, we held $57.0 million (par value), with an estimated fair value of
$43.6 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.  As of March 31,
2009, we classified the entire auction rate security investment balance as
long-term investments on our consolidated balance sheet because of our inability
to determine when our investments in auction rate securities would be
sold.  We have also 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, 2009, 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 $43.6 million as of March 31, 2009 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,
2009.  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
$57.0 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.
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  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 the fair
value option of SFAS No. 159.  As a result of accepting the rights, we
elected in 2008 to classify the rights and reclassify our investments in auction
rate securities as trading securities, as defined by SFAS No. 115.  As
a result, we will be required to 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.  During the three months ended
March 31, 2009, we recorded a loss of $41,000 to reflect the decline in
fair value of the auction rate securities, and recorded a gain of $558,000 to
reflect the increase in fair value of the rights, which are reflected in gain on
long-term investments, net, in the accompanying consolidated statement of
operations.  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 related rights, at March 31, 2009, we had
approximately $89.3 million in cash and cash equivalents and short-term
investments, including $11.8 million in investments held by Symphony
Icon.  We believe that the working capital available to us excluding
the funds held in auction rate securities and the UBS credit line entered into
in January 2009 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.
  Item3.                 Quantitative
and Qualitative Disclosures about Market Risk
  See
“Disclosure about Market Risk” under “Item 2. Management’s Discussion and
Analysisof
Financial Condition and Results of Operations” for quantitative and qualitative
disclosures about market risk.
  Item4.                 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 sufficiently 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.
  25
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 PartII
                    Other
      Information
  Item
1A.               RiskFactors
  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; if it is unavailable, we will
      be forced to significantly curtail or cease operations and, 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, 2009, we held $57.0 million (par value), with an
      estimated fair value of $43.6 million, of auction rate securities for
      which auctions have failed and, as a result, we may not be able to access
      at least the portion of these funds for which alternative funding is not
      available through our credit line with UBS Bank USA 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 Our Relationships with Third Parties
  ·
                    multiple
      or alternative approaches may provide advantages or benefits in the
      development of certain drug candidates and 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, and if we are unable to achieve milestones under
      those 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
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 ·
                    conflicts
      with our collaborators could jeopardize the success of our collaborative
      agreements and harm our product development
  efforts
  ·
                    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
  ·
                    we
      rely on third parties to carry out drug development
    activities
  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 and technologies that make our products
      and technologies 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 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, and we may not prevail in any such litigation or other dispute
      or be able to obtain required
licenses
  ·
                    we
      use intellectual property that we license from third parties, and if we do
      not comply with these licenses, we could lose our rights under
      them
  ·
                    we
      have not sought patent protection outside of the United States for some of
      our inventions, and some of our licensed patents only provide coverage in
      the United States, and as a result, our international competitors could be
      granted foreign patent protection with respect to our
      discoveries
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 ·
                    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, and 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
  ·
                    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
  ·
                    Invus’
      ownership of our common stock and its other rights under the 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
  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, 2008, as filed with the Securities and Exchange
Commission.
  Item
6.                 Exhibits
  Exhibit No.
                        
                        Description31.1
                        —
                        Certification
      of Principal Executive Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200231.2
                        —
                        Certification
      of Principal Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1
                        —
                        Certification
      of Principal Executive and Principal Financial Officers Pursuant to
      Section 906 of the Sarbanes-Oxley Act of
2002
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 Signatures
  
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
  
 Lexicon
      Pharmaceuticals, Inc.Date:  April
      29, 2009
                    By:
                    /s/
      Arthur T. SandsArthur
      T. Sands, M.D., Ph.D.President
      and Chief Executive Officer
 
 Date:  April
      29, 2009
                    By:
                    /s/
      James F. TessmerJames
      F. TessmerVice
      President, Finance and Accounting
 
 
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  Index
to Exhibits
  
  Exhibit No.
                        
                        Description31.1
                        —
                        Certification
      of Principal Executive Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200231.2
                        —
                        Certification
      of Principal Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1
                        —
                        Certification
      of Principal Executive and Principal Financial Officers Pursuant to
      Section 906 of the Sarbanes-Oxley Act of
2002