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 June 30, 2008
 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 is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one)
  Large
accelerated filer    Accelerated
filer ü
Non-accelerated filer 
(Do not check if a smaller reporting company)  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
July 29, 2008, 136,795,546 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 Information
              3Item
      1.
              Financial Statements
              3Consolidated Balance Sheets– June 30, 2008
      (unaudited) and December 31, 2007
              3Consolidated Statements of Operations(unaudited) – Three and Six Months Ended June 30, 2008 and
      2007
              4Consolidated Statements of Cash Flows (unaudited) –
      Six Months Ended June 30, 2008 and 2007
              5Notes to Consolidated Financial Statements(unaudited)
              6Item
      2.
              Management’s Discussion and Analysis of Financial
      Condition and Resultsof
      Operations
              12Item
      3.
              Quantitative and Qualitative Disclosures about Market
      Risk
              20Item
      4.
              Controls and Procedures
              20Part II – Other
      Information
              21Item
      1A.
              Risk Factors
              21Item
      4.
              Submission of Matters to a Vote of Security
      Holders
              23Item
      6.
              Exhibits
              24Signatures
              25
 
 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
 TOC
  PartI – Financial Information
  Item1.
              Financial
      Statements
  Lexicon
Pharmaceuticals, Inc.
  ConsolidatedBalance Sheets
 (In
thousands, except par value)
  As
      of June 30,
              
              
              As
      of December 31,2008
              
              
              2007Assets
              
              (unaudited)Current
      assets:Cash
      and cash equivalents
              
              $
              109,649
              
              
              $
              22,938Short-term
      investments, including restricted investments of
      $430
              
              
              7,426
              
              
              
              199,171Short-term
      investments held by Symphony Icon, Inc.
              
              
              26,882
              
              
              
              36,666Accounts
      receivable, net of allowances of $35
              
              
              672
              
              
              
              1,763Prepaid
      expenses and other current assets
              
              
              8,321
              
              
              
              4,112Total
      current assets
              
              
              152,950
              
              
              
              264,650Long-term
      investments
              
              
              56,560
              
              
              
              —Property
      and equipment, net of accumulated depreciation and amortization of $67,858
      and $65,004, respectively
              
              
              68,104
              
              
              
              70,829Goodwill
              
              
              25,798
              
              
              
              25,798Other
      assets
              
              
              6,894
              
              
              
              8,019Total
      assets
              
              $
              310,306
              
              
              $
              369,296Liabilities,
      Noncontrolling Interest and Stockholders’ EquityCurrent
      liabilities:Accounts
      payable
              
              $
              7,920
              
              
              $
              7,344Accrued
      liabilities
              
              
              8,489
              
              
              
              9,093Current
      portion of deferred revenue
              
              
              10,323
              
              
              
              18,030Current
      portion of long-term debt
              
              
              924
              
              
              
              880Total
      current liabilities
              
              
              27,656
              
              
              
              35,347Deferred
      revenue, net of current portion
              
              
              14,212
              
              
              
              16,126Long-term
      debt
              
              
              30,018
              
              
              
              30,493Other
      long-term liabilities
              
              
              764
              
              
              
              759Total
      liabilities
              
              
              72,650
              
              
              
              82,725Noncontrolling
      interest in Symphony Icon, Inc.
              
              
              19,199
              
              
              
              30,271Commitments
      and contingenciesStockholders’
      equity:Preferred
      stock, $.01 par value; 5,000 shares authorized; no shares issued and
      outstanding
              
              
              —
              
              
              
              —Common
      stock, $.001 par value; 300,000 shares authorized; 136,796 and 136,795
      shares issued and outstanding, respectively
              
              
              137
              
              
              
              137Additional
      paid-in capital
              
              
              670,064
              
              
              
              666,702Accumulated
      deficit
              
              
              (448,519
              )
              
              
              (410,535
              )Accumulated
      other comprehensive loss
              
              
              (3,225
              )
              
              
              (4
              )Total
      stockholders’ equity
              
              
              218,457
              
              
              
              256,300Total
      liabilities and stockholders’ equity
              
              $
              310,306
              
              
              $
              396,296
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  3
 TOC
  Lexicon
Pharmaceuticals, Inc.
  Consolidated
Statementsof Operations
 (In
thousands, except per share amounts)
 (Unaudited)
  Three
      Months Ended June 30,
              
              
              Six
      Months Ended June 30,2008
              
              
              2007
              
              
              2008
              
              
              2007Revenues:Collaborative
      research
              
              $
              7,953
              
              
              $
              12,477
              
              
              $
              15,587
              
              
              $
              24,748Subscription
      and license fees
              
              
              1,613
              
              
              
              171
              
              
              
              2,872
              
              
              
              1,395Total
      revenues
              
              
              9,566
              
              
              
              12,648
              
              
              
              18,459
              
              
              
              26,143Operating
      expenses:Research
      and development, including stock-based compensation of $950, $1,044,
      $2,077 and $2,035, respectively
              
              
              30,349
              
              
              
              25,594
              
              
              
              58,151
              
              
              
              52,884General
      and administrative, including stock-based compensation of $633, $627,
      $1,285 and $1,195, respectively
              
              
              5,603
              
              
              
              5,004
              
              
              
              11,132
              
              
              
              10,304Total
      operating expenses
              
              
              35,952
              
              
              
              30,598
              
              
              
              69,283
              
              
              
              63,188Loss
      from operations
              
              
              (26,386
              )
              
              
              (17,950
              )
              
              
              (50,824
              )
              
              
              (37,045
              )Interest
      income
              
              
              1,418
              
              
              
              765
              
              
              
              4,199
              
              
              
              1,645Interest
      expense
              
              
              (675
              )
              
              
              (695
              )
              
              
              (1,345
              )
              
              
              (1,383
              )Other
      expense, net
              
              
              (539
              )
              
              
              (14
              )
              
              
              (1,086
              )
              
              
              (26
              )Loss
      before noncontrolling interest in Symphony Icon,
      Inc.
              
              
              (26,182
              )
              
              
              (17,894
              )
              
              
              (49,056
              )
              
              
              (36,809
              )Loss
      attributable to noncontrolling interest in Symphony Icon,
      Inc.
              
              
              6,148
              
              
              
              4,303
              
              
              
              11,072
              
              
              
              4,303Net
      loss
              
              $
              (20,034
              )
              
              $
              (13,591
              )
              
              $
              (37,984
              )
              
              $
              (32,506
              )Net
      loss per common share, basic and diluted
              
              $
              (0.15
              )
              
              $
              (0.17
              )
              
              $
              (0.28
              )
              
              $
              (0.41
              )Shares
      used in computing net loss per common share, basic and
      diluted
              
              
              136,796
              
              
              
              79,568
              
              
              
              136,795
              
              
              
              78,758
 
 
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  4
 TOC
 
 Lexicon
Pharmaceuticals, Inc.
  ConsolidatedStatements of Cash Flows
 (In
thousands)
 (Unaudited)
  Six
      Months Ended June 30,2008
              
              
              2007Cash
      flows from operating activities:Net
      loss
              
              $
              (37,984
              )
              
              $
              (32,506
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
              
              
              4,128
              
              
              
              4,915Amortization
      of Symphony Icon, Inc. purchase option
              
              
              1,071
              
              
              
              —Loss
      attributable to noncontrolling interest
              
              
              (11,072
              )
              
              
              (4,303
              )Stock-based
      compensation
              
              
              3,362
              
              
              
              3,230Changes
      in operating assets and liabilities:(Increase)
      decrease in accounts receivable
              
              
              1,091
              
              
              
              (171
              )(Increase)
      decrease in prepaid expenses and other current
assets
              
              
              (4,209
              )
              
              
              675Decrease
      in other assets
              
              
              54
              
              
              
              55Decrease
      in accounts payable and other liabilities
              
              
              (23
              )
              
              
              (1,571
              )Decrease
      in deferred revenue
              
              
              (9,621
              )
              
              
              (11,673
              )Net
      cash used in operating activities
              
              
              (53,203
              )
              
              
              (41,349
              )Cash
      flows from investing activities:Purchases
      of property and equipment
              
              
              (1,403
              )
              
              
              (938
              )Proceeds
      from disposal of property and equipment
              
              
              —
              
              
              
              1Purchases
      of investments held by Symphony Icon, Inc.
              
              
              —
              
              
              
              (44,991
              )Maturities
      of investments held by Symphony Icon, Inc.
              
              
              9,784
              
              
              
              —Purchases
      of investments
              
              
              (39,847
              )
              
              
              (15,997
              )Maturities
      of investments
              
              
              171,811
              
              
              
              38,123Net
      cash provided by (used in) investing activities
              
              
              140,345
              
              
              
              (23,802
              )Cash
      flows from financing activities:Proceeds
      from issuance of common stock to Symphony Holdings, LLC, net of
      fees
              
              
              —
              
              
              
              14,258Proceeds
      from exercise of stock options
              
              
              —
              
              
              
              881Repayment
      of debt borrowings
              
              
              (431
              )
              
              
              (402
              )Proceeds
      from purchase of noncontrolling interest by preferred shareholders of
      Symphony  Icon, Inc. (net of fees)
              
              
              —
              
              
              
              42,775Net
      cash provided by (used in) financing activities
              
              
              (431
              )
              
              
              57,512Net
      increase (decrease) in cash and cash equivalents
              
              
              86,711
              
              
              
              (7,639
              )Cash
      and cash equivalents at beginning of period
              
              
              22,938
              
              
              
              30,226Cash
      and cash equivalents at end of period
              
              $
              109,649
              
              
              $
              22,587Supplemental
      disclosure of cash flow information:Cash
      paid for interest
              
              $
              1,311
              
              
              $
              1,337Supplemental
      disclosure of non-cash investing and financing
      activities:Common
      stock issued for purchase option in conjunction with Symphony Icon, Inc.
      financing
              
              $
              —
              
              
              $
              8,564Unrealized
      gain (loss) on investments
              
              $
              (3,221
              )
              
              $
              7
 
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  5
 TOC
  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 six-month period ended June 30, 2008 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2008.
  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, 2007, 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 $1.6 million and
$1.7 million of stock-based compensation expense for the three months ended
June 30, 2008 and 2007, respectively, and $3.4 million and
$3.2 million of stock-based compensation expense for the six months ended
June 30, 2008 and 2007, respectively.  The Company utilized the
Black-Scholes valuation model for estimating the fair value of the stock
compensation granted, with the following weighted-average assumptions for
options granted in the six months ended June 30, 2008 and 2007,
respectively.
  Expected
      Volatility
              
              
              Risk-free
      Interest Rate
              
              
              Expected
      Term
              
              
              Estimated
      Forfeitures
              
              
              Dividend
                RateJune
      30, 2008:Employees
              
              
              66
              %
              
              
              2.9
              %
              
              
              6
              
              
              
              21
              %
              
              
              0
              %Officers
      and non-employee directors
              
              
              66
              %
              
              
              3.8
              %
              
              
              9
              
              
              
              4
              %
              
              
              0
              %June
      30, 2007:Employees
              
              
              67
              %
              
              
              4.5
              %
              
              
              6
              
              
              
              21
              %
              
              
              0
              %Officers
      and non-employee directors
              
              
              67
              %
              
              
              4.6
              %
              
              
              9
              
              
              
              4
              %
              
              
              0
              %
 
 6
 TOC
  The
following is a summary of option activity under Lexicon’s stock option plans for
the six months ended June 30, 2008:
  Options
              
              
              Weighted
      Average Exercise Price(in
      thousands)Outstanding
      at December 31, 2007
              
              
              16,351
              
              
              $
              5.65Granted
              
              
              3,987
              
              
              
              2.08Exercised
              
              
              —
              
              
              
              1.67Canceled
              
              
              (580
              )
              
              
              4.14Outstanding
      at June 30, 2008
              
              
              19,758
              
              
              
              4.97Exercisable
      at June 30, 2008
              
              
              13,077
              
              
              $
              6.02
 
 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 will be effective January 1, 2009 for non-financial assets and
liabilities.  The adoption of SFAS No. 157 for financial assets
and liabilities did not have an effect on the Company’s financial condition or
results of operations.  The Company is currently evaluating the
effect, if any, of the adoption of this statement for non-financial assets and
liabilities on its financial condition and results of operations.
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - including an amendment of FASB
Statement No. 115,” which provides a fair value option election that
permits entities to irrevocably elect to measure many financial instruments and
certain other items at fair value, with changes in fair value recognized in
earnings as they occur.  SFAS No. 159 also establishes presentation
and disclosure requirements designed to facilitate comparisons between entities
that choose different measurement attributes for similar types of assets and
liabilities.  SFAS No. 159 does not affect any existing accounting
literature that requires certain assets and liabilities to be carried at fair
value.  SFAS No. 159 is effective as of the beginning of an entity’s
first fiscal year that begins after November 15, 2007.  The
Company’s adoption of SFAS No. 159 on January 1, 2008 did not materially
affect its 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
Company expects to adopt this statement on January 1, 2009.  SFAS
No. 141(R)’s impact on accounting for business combinations is dependent upon
acquisitions, if any, made on or after that time.
  7
 TOC
 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 is currently
evaluating the effect, if any, of this statement on its financial condition and
results of operations.
  5.      Cash
and Cash Equivalents and Investments
  The fair
value of cash and cash equivalents and investments held at June 30, 2008
and December 31, 2007 are as follows:
  As
      of June 30, 2008Amortized
      Cost
              
              
              Gross
      Unrealized Gains
              
              
              Gross
      Unrealized Losses
              
              
              Estimated
      Fair Value(In
      thousands)Cash
      and cash equivalents
              
              $
              109,649
              
              
              $
              —
              
              
              $
              —
              
              
              $
              109,649Securities
      maturing within one year:Certificates
      of deposit
              
              
              609
              
              
              
              —
              
              
              
              —
              
              
              
              609Corporate
      debt securities
              
              
              6,801
              
              
              
              16
              
              
              
              —
              
              
              
              6,817Total
      short-term investments
              
              $
              7,410
              
              
              $
              16
              
              
              $
              —
              
              
              $
              7,426Short-term
      investments held by Symphony Icon, Inc.:Cash
      and cash equivalents
              
              
              26,882
              
              
              
              —
              
              
              
              —
              
              
              
              26,882Total
      short-term investments held by Symphony Icon, Inc.
              
              $
              26,882
              
              
              $
              —
              
              
              $
              —
              
              
              $
              26,882Securities
      maturing after ten years:Auction
      rate securities
              
              
              59,800
              
              
              
              —
              
              
              
              (3,240
              )
              
              
              56,560Total
      long-term investments
              
              $
              59,800
              
              
              $
              —
              
              
              $
              (3,240
              )
              
              $
              56,560Total
      cash and cash equivalents and investments
              
              $
              203,741
              
              
              $
              16
              
              
              $
              (3,240
              )
              
              $
              200,517
 
 
 8
 TOC
 
 As
      of December 31, 2007Amortized
      Cost
              
              
              Gross
      Unrealized Gains
              
              
              Gross
      Unrealized Losses
              
              
              Estimated
      Fair Value(In
      thousands)Cash
      and cash equivalents
              
              $
              22,950
              
              
              $
              —
              
              
              $
              (12
              )
              
              $
              22,938Securities
      maturing within one year:Certificates
      of deposit
              
              
              6,312
              
              
              
              —
              
              
              
              (3
              )
              
              
              6,309Corporate
      debt securities
              
              
              41,162
              
              
              
              12
              
              
              
              (51
              )
              
              
              41,123Commercial
      paper
              
              
              71,214
              
              
              
              47
              
              
              
              —
              
              
              
              71,261U.S.
      government agencies securities
              
              
              2,500
              
              
              
              3
              
              
              
              —
              
              
              
              2,503Total
      securities maturing within one year
              
              
              121,188
              
              
              
              62
              
              
              
              (54
              )
              
              
              121,196Securities
      maturing after ten years:Auction
      rate securities
              
              
              77,975
              
              
              
              —
              
              
              
              —
              
              
              
              77,975Total
      available-for-sale investments
              
              $
              199,163
              
              
              $
              62
              
              
              $
              (54
              )
              
              $
              199,171Short-term
      investments held by Symphony Icon, Inc.:Cash
      and cash equivalents
              
              
              36,666
              
              
              
              —
              
              
              
              —
              
              
              
              36,666Total
      short-term investments held by Symphony Icon, Inc.
              
              $
              36,666
              
              
              $
              —
              
              
              $
              —
              
              
              $
              36,666Total
      cash and cash equivalents and investments
              
              $
              258,779
              
              
              $
              62
              
              
              $
              (66
              )
              
              $
              258,775
 
 There
were $87,000 and $118,000 of realized gains for the three and six months ended
June 30, 2008, respectively.  There were no realized gains or
losses for the three and six months ended June 30, 2007.
  At
June 30, 2008, Lexicon held $59.8 million (par value), with an
estimated fair value of $56.6 million, of AAA-rated municipal note
investments with an auction interest rate reset feature, known as auction rate
securities.  These notes are issued by various state and local
municipal entities for the purpose of financing student loans, public projects
and other activities.  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.  As of
June 30, 2008, Lexicon classified its entire auction rate security
investment balance as long-term investments on its consolidated balance sheet
because of the Company’s inability to determine when its investments in auction
rate securities would 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
June 30, 2008, observable auction rate securities market information was
not available to determine the fair value of Lexicon’s investments. Therefore,
Lexicon estimated fair value using a discounted cash flow model incorporating
assumptions that market participants would use in their estimates of fair value.
Some of these assumptions include estimates for interest rates, timing and
amount of cash flows and expected holding periods of the auction rate
securities. Based on this assessment of fair value, as of June 30, 2008,
Lexicon determined there was a temporary decline in the fair value of its
auction rate securities of $3.2 million. If the current market conditions
deteriorate further, or a recovery in market values does not occur, Lexicon may
be required to record additional unrealized or realized losses in future
quarters.
 9
 TOC
  Excluding
auction rate securities, at June 30, 2008, Lexicon had approximately
$144.0 million in cash and cash equivalents and short-term investments,
including $26.9 million in investments held by Symphony
Icon.  Management believes that the working capital available to
Lexicon excluding the funds held in auction rate securities will be sufficient
to meet its cash requirements for at least the next 12 months.
  6.      Fair
Value of Financial Instruments
  The
Company uses various inputs in determining the fair value of its investments and
measures these assets on a quarterly basis.  Financial assets recorded
at fair value in the consolidated balance sheet 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.  Based on market conditions and the unavailability of
Level 1 inputs, during the six months ended June 30, 2008, the Company
adopted a discounted cash flow valuation methodology for its auction rate
securities.  Accordingly, the investments in auction rate securities
changed from Level 1 to Level 3 within SFAS No. 157’s valuation
levels since the Company’s initial adoption of SFAS No. 157 on
January 1, 2008.  The following table provides the fair value
measurements of applicable Company financial assets according to the fair value
levels defined by SFAS No. 157 as of June 30, 2008.
  Financial
      Assets at Fair Value
                as
      of June 30, 2008Level
      1
              
              
              Level
      2
              
              
              Level
      3(in
      thousands)Cash
      and cash equivalents
              
              $
              109,649
              
              
              $
              —
              
              
              $
              —Short-term
      investments
              
              
              7,426
              
              
              
              —
              
              
              
              —Short-term
      investments held by  Symphony Icon, Inc.
              
              
              26,882
              
              
              
              —
              
              
              
              —Long-term
      investments
              
              
              —
              
              
              
              —
              
              
              
              56,560Total
      cash and cash equivalents and investments
              
              $
              143,957
              
              
              $
              —
              
              
              $
              56,560
 
 
 Financial
      Assets at Fair Value
                as
      of December 31, 2007Level
      1
              
              
              Level
      2
              
              
              Level
      3(in
      thousands)Cash
      and cash equivalents
              
              $
              22,938
              
              
              $
              —
              
              
              $
              —Short-term
      investments
              
              
              199,171
              
              
              
              —
              
              
              
              —Short-term
      investments held by Symphony Icon, Inc.
              
              
              36,666
              
              
              
              —
              
              
              
              —Total
      cash and cash equivalents and investments
              
              $
              258,775
              
              
              $
              —
              
              
              $
              —
 
 10
 TOC
 The table
presented below summarizes the change in consolidated balance sheet carrying
value associated with Level 3 financial assets for the six months ended
June 30, 2008.
  Long-term
      Investments(in
      thousands)Balance
      at December 31, 2007
              
              $
              —Total
      unrealized losses included in other comprehensive
    loss
              
              
              (3,240
              )Net
      sales and settlements
              
              
              (18,250
              )Transfers
      into Level 3
              
              
              78,050Balance
      at June 30, 2008
              
              $
              56,560
 
 7.      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%.
  8.      Commitments
and Contingencies
  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 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 June 30, 2008 and
December 31, 2007.
  9.      Comprehensive
Loss
  Comprehensive
loss consists of:
  Three
      Months Ended June 30,2008
              
              
              2007(in
      thousands)Net
      loss
              
              $
              (20,034
              )
              
              $
              (13,591
              )Unrealized
      loss on short-term investments
              
              
              (190
              )
              
              
              (2
              )Unrealized
      loss on long-term investments
              
              
              (703
              )
              
              
              —Net
      comprehensive loss
              
              $
              (20,927
              )
              
              $
              (13,593
              )
 
 Six
      Months Ended June 30,2008
              
              
              2007(in
      thousands)Net
      loss
              
              $
              (37,984
              )
              
              $
              (32,506
              )Unrealized
      gain on short-term investments
              
              
              19
              
              
              
              7Unrealized
      loss on long-term investments
              
              
              (3,240
              )
              
              
              —Net
      comprehensive loss
              
              $
              (41,205
              )
              
              $
              (32,499
              )
 
 11
 TOC
  Item
      2.
              Management’sDiscussion and Analysis of Financial Condition
      and Results of Operations
  Overview
  We are a
biopharmaceutical company focused on discovering and developing breakthrough
treatments for human disease.  We use our proprietary gene knockout
technology to knock out, or disrupt, the function of genes in mice and then
employ an integrated platform of advanced medical technologies to systematically
discover the physiological and behavioral functions of the genes we have knocked
out and assess the utility of the proteins encoded by the corresponding human
genes as potential drug targets.  For targets that we believe have
high pharmaceutical value, we engage in programs for the discovery and
development of potential small molecule, antibody and protein
drugs.  We have advanced four drug candidates into human clinical
trials, with one additional drug candidate in preclinical development and
compounds from a number of additional programs in various stages of preclinical
research.  We believe that our systematic, target biology-driven
approach to drug discovery will enable us to substantially expand our clinical
pipeline, and we are engaged in efforts that we refer to as our 10TO10 program
with the goal of advancing ten drug candidates into human clinical trials by the
end of 2010.
  We are
working both independently and through strategic collaborations and alliances to
capitalize on our technology and drug target discoveries and to develop and
commercialize drug candidates emerging from our drug discovery and development
programs.  We have established alliances with Bristol-Myers Squibb
Company to discover and develop novel small molecule drugs in the neuroscience
field; with Genentech, Inc. for the discovery of therapeutic proteins and
antibody targets and the development of antibody and protein drugs based on
those targets; and with N.V. Organon for the discovery of another group of
therapeutic proteins and antibody targets and the development and
commercialization of antibody and protein drugs based on those
targets.  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.  Finally, we have
established a product development financing collaboration with Symphony Icon,
Inc. under which we have licensed to Symphony Icon our intellectual property
rights to our drug candidates LX6171, LX1031 and LX1032, subject to our
exclusive option to reacquire all rights to those drug candidates. We are
consolidating the financial condition and results of operations of Symphony Icon
in accordance with Financial Accounting Standards Board, or FASB, Interpretation
No. 46.
  We derive
substantially all of our revenues from drug discovery and development alliances,
target validation collaborations for the development and, in some cases,
analysis of the physiological effects of genes altered in knockout mice,
academic, non-profit and government arrangements, 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
collaborations, alliances and technology licenses, expirations of our
collaborations and alliances, the success rate of our discovery and development
efforts leading to opportunities for new collaborations, alliances 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,
alliances and academic, non-profit and government arrangements are uncertain
because our existing agreements have fixed terms or relate to specific projects
of limited duration. Our future revenues from technology licenses are uncertain
because they depend, in large part, on securing new agreements.  Our
ability to secure future revenue-generating agreements will depend upon our
ability to address the needs of our potential future collaborators, granting
agencies 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.
 12
 TOC
  Since our
inception, we have incurred significant losses and, as of June 30, 2008, we
had an accumulated deficit of $448.5 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 and our ongoing target validation
research efforts, we expect to incur increasing research and development and
general and administrative costs. As a result, we will need to generate
significantly higher revenues to achieve profitability.
  Critical
Accounting Policies
  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, 2007.
  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 will be effective January 1, 2009 for non-financial
assets and liabilities.  The adoption of SFAS No. 157 for
financial assets and liabilities did not have an effect on our financial
condition or results of operations.  We are currently evaluating the
effect, if any, of the adoption of this statement for non-financial assets and
liabilities on our financial condition and results of operations.
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - including an amendment of FASB
Statement No. 115,” which provides a fair value option election that
permits entities to irrevocably elect to measure many financial instruments and
certain other items at fair value, with changes in fair value recognized in
earnings as they occur.  SFAS No. 159 also establishes presentation
and disclosure requirements designed to facilitate comparisons between entities
that choose different measurement attributes for similar types of assets and
liabilities.  SFAS No. 159 does not affect any existing accounting
literature that requires certain assets and liabilities to be carried at fair
value.  SFAS No. 159 is effective as of the beginning of an entity’s
first fiscal year that begins after November 15, 2007.  Our adoption
of SFAS No. 159 on January 1, 2008 did not materially affect our
financial position or results of operations.
 13
 TOC
  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.  We expect to adopt this statement on January 1,
2009.  SFAS No. 141(R)’s impact on accounting for business
combinations is dependent upon acquisitions, if any, made on or after that
time.
  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. We are currently evaluating the
effect, if any, of this statement on our financial condition and results of
operations.
  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 June 30,
              
              Six
      Months Ended June 30,2008
              
              2007
              
              2008
              
              2007Total
      revenues
              
              $
              9.6
              
              
              $
              12.6
              
              $
              18.5
              
              
              $
              26.1Dollar
      decrease
              
              $
              3.0
              
              
              
              
              
              $
              7.6Percentage
      decrease
              
              
              24
              %
              
              
              
              
              
              29
              %
 
 14
 TOC
  ·
              Collaborative research
      – Revenue from collaborative research for the three months ended
      June 30, 2008 decreased 36% to $8.0 million, and for the six
      months ended June 30, 2008 decreased 37% to $15.6 million, as
      compared to the comparable period for the prior year, primarily due to the
      completion in 2007 of the project funded by our award from the Texas
      Enterprise Fund, the completion in 2007 of the target discovery portion of
      our alliance with Takeda Pharmaceutical Company Limited, and reduced
      revenues in the three and six months ended June 30, 2008 under our
      alliance with N.V. Organon due to our progress towards completing the
      target discovery portion of the
alliance.
  ·
              Subscription and license
      fees – Revenue from subscriptions and license fees for the three
      months ended June 30, 2008 increased 843% to $1.6 million, and
      for the six months ended June 30, 2008 increased 106% to
      $2.9 million, as compared to the comparable period for the prior
      year, primarily due to an increase in technology license
    fees.
  Research
and Development Expenses
  Research
and development expenses and dollar and percentage changes as compared to the
corresponding period in the prior year are as follows (dollar amounts are
presented in millions):
  Three
      Months Ended June 30,
              
              Six
      Months Ended June 30,2008
              
              2007
              
              2008
              
              2007Total
      research and development expense
              
              $
              30.3
              
              
              $
              25.6
              
              $
              58.2
              
              
              $
              52.9Dollar
      increase
              
              $
              4.7
              
              
              
              
              
              $
              5.3Percentage
      increase
              
              
              19
              %
              
              
              
              
              
              10
              %
 
 Research
and development expenses consist primarily of salaries and other
personnel-related expenses, facility and equipment costs, laboratory supplies,
third-party and other services principally related to preclinical and clinical
development activities, and stock-based compensation expenses.
  ·
              Personnel –Personnel
      costs for the three months ended June 30, 2008 increased 15% to
      $12.4 million, as compared to the comparable period for the prior
      year, primarily due to severance costs associated with a reduction in our
      personnel in May 2008.  Personnel costs for the six months ended
      June 30, 2008 increased 3% to $24.3 million, as compared to the
      comparable period for the prior year, primarily due to higher severance
      costs associated with reductions in our personnel.  Salaries,
      bonuses, employee benefits, payroll taxes, recruiting and relocation costs
      are included in personnel costs.
  ·
              Facilities and equipment –Facilities and equipment costs for the three months ended
      June 30, 2008 decreased 11% to $4.7 million,  and for
      the six months ended June 30, 2008 decreased 11% to
      $9.4 million, as compared to the comparable period for the prior
      year, primarily due to a decrease in depreciation
  expense.
  ·
              Laboratory supplies –Laboratory supplies expense for the three months ended
      June 30, 2008 decreased 25% to $2.1 million, and for the six
      months ended June 30, 2008 decreased 21% to $4.7 million, as
      compared to the comparable period for the prior year, primarily due to
      reallocating resources from genetic research to drug
      development.
  ·
              Third-party and other services
      –Third-party and other services for the three months ended
      June 30, 2008 increased 99% to $8.8 million, and for the six
      months ended June 30, 2008 increased 80% to $15.2 million, as
      compared to the comparable period for the prior year, primarily due to an
      increase in external preclinical and clinical research and development
      costs.
  15
 TOC
 ·
              Stock-based compensation
      – Stock-based compensation expense for the three months ended
      June 30, 2008 decreased 9% to $0.9 million, and for the six
      months ended June 30, 2008 increased 2% to $2.1 million, as
      compared to the comparable period for the prior
  year.
  ·
              Other –Other costs for
      the three months ended June 30, 2008 increased 15% to
      $1.4 million, and for the six months ended June 30, 2008
      increased 9% to $2.5 million, as compared to the comparable period
      for the prior year.
  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 June 30,
              
              Six
      Months Ended June 30,2008
              
              2007
              
              2008
              
              2007Total
      general and administrative expense
              
              $
              5.6
              
              
              $
              5.0
              
              $
              11.1
              
              
              $
              10.3Dollar
      increase
              
              $
              0.6
              
              
              
              
              
              $
              0.8Percentage
      increase
              
              
              12
              %
              
              
              
              
              
              8
              %
 
 General
and administrative expenses consist primarily of personnel costs to support our
research and development activities, facility and equipment costs, professional
fees such as legal fees, and stock-based compensation expenses.
  ·
              Personnel – Personnel
      costs for the three months ended June 30, 2008 increased 28% to
      $3.3 million, as compared to the comparable period for the prior
      year, primarily due to severance costs associated with a reduction in our
      personnel in May 2008.  Personnel costs for the six months ended
      June 30, 2008 increased 8% to $6.1 million, as compared to the
      comparable period for the prior year, primarily due to higher severance
      costs associated with reductions in our personnel.  Salaries,
      bonuses, employee benefits, payroll taxes, recruiting and relocation costs
      are included in personnel costs.
  ·
              Facilities and
      equipment – Facilities and equipment costs for the three months
      ended June 30, 2008 were $0.6 million, consistent with the
      comparable period for the prior year.  Facilities and equipment
      costs for the six months ended June 30, 2008 decreased 8% to
      $1.2 million, as compared to the comparable period for the prior
      year, primarily due to decreased depreciation and maintenance
      expense.
  ·
              Professional fees –
      Professional fees for the three months ended June 30, 2008 increased
      14% to $0.6 million, and for the six months ended June 30, 2008
      increased 52% to $1.5 million, as compared to the comparable period
      for the prior year, primarily due to increased market research and other
      consulting costs.
  ·
              Stock-based
      compensation – Stock-based compensation expense for the three
      months ended June 30, 2008 was $0.6 million, consistent with the
      comparable period for the prior year.  Stock-based compensation
      expense for the six months ended June 30, 2008 increased 8% to
      $1.3 million as compared to the comparable period for the prior
      year.
  ·
              Other –Other costs for
      the three months ended June 30, 2008 decreased 28% to
      $0.5 million, and for the six months ended June 30, 2008
      decreased 10% to $1.0 million, as compared to the comparable period for
      the prior year.
  16
 TOC
 Interest
Income, Interest Expense and Other Expense, Net
  Interest
Income.  Interest income for the three months ended
June 30, 2008 increased 85% to $1.4 million, and for the six months
ended June 30, 2008 increased 155% to $4.2 million, as compared to the
comparable period for the prior year, due to higher average cash and investment
balances.
  Interest
Expense.  Interest expense for the three months ended
June 30, 2008 was $0.7 million, consistent with the comparable period
for the prior year.  Interest expense for the six months ended
June 30, 2008 decreased 3% to $1.3 million as compared to the
comparable period for the prior year.
  Other Expense,
Net.  Other expense, net was $0.5 million and
$1.1 million in the three and six months ended June 30, 2008,
respectively, primarily due to the amortization of the asset related to the
option to purchase the equity of Symphony Icon.  We have recorded the
value of the purchase option as an asset, and we are amortizing this asset over
the four-year option period.
  Noncontrolling
Interest in Symphony Icon, Inc.
  For the
three months ended June 30, 2008 and 2007, the losses attributable to the
noncontrolling interest holders of Symphony Icon were $6.1 million and
$4.3 million, respectively.  For the six months ended
June 30, 2008 and 2007, the losses attributed to the noncontrolling
interest holders of Symphony Icon were $11.1 million and $4.3 million,
respectively.
  Net
Loss and Net Loss per Common Share
  Net loss
increased to $20.0 million in the three months ended June 30, 2008
from $13.6 million in the comparable period for the prior
year.  Net loss per common share decreased to $0.15 in the three
months ended June 30, 2008 from $0.17 in the comparable period for the
prior year.  Net loss increased to $38.0 million in the six
months ended June 30, 2008 from $32.5 million in the comparable period
for the prior year.  Net loss per common share decreased to $0.28 in
the six months ended June 30, 2008 from $0.41 in the comparable period for
the prior year.
  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
alliance, target validation, database subscription and license agreements,
government grants and contracts, and financing obtained under debt and lease
arrangements.  From our inception through June 30, 2008, 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 June 30,
2008, we received $433.7 million in cash payments from drug discovery and
development alliances, target validation collaborations, database subscription
and technology license fees, sales of compound libraries and reagents, and
government grants and contracts, of which $410.1 million had been
recognized as revenues through June 30, 2008.
  As of
June 30, 2008, we had $173.6 million in cash, cash equivalents and
investments, including $56.6 million in auction rate securities as
discussed below under “Disclosure about Market Risk,” and $26.9 million in
investments held by Symphony Icon.  As of December 31, 2007, we
had $222.1 million in cash, cash equivalents and short-term investments,
including $78.0 million in auction rate securities, and $36.7 million
in investments held by Symphony Icon.  We used cash of
$53.2 million in operations in the six months ended June 30, 2008.
This consisted primarily of the net loss for the period of $38.0 million,
an $11.1 million loss attributable to noncontrolling interest, a
$9.6 million decrease in deferred revenue, and a net increase in other
operating assets net of liabilities of $3.1 million, partially offset by
non-cash charges of $4.1 million related to depreciation expense,
$3.4 million related to stock-based compensation expense and
$1.1 million related to the amortization of the Symphony Icon purchase
option.  Investing activities provided cash of $140.3 million in
the six months ended June 30, 2008, primarily due to net maturities of
investments of $141.7 million, partially offset by purchases of property
and equipment of $1.4 million.  Financing activities used cash of
$0.4 million due to principal repayments of $0.4 million on the
mortgage loan.
 17
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  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.
  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 LX6171, 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, beginning on June 15, 2008 and ending on June 15,
2011 (subject to an earlier exercise right in limited circumstances) at an
exercise price of (a) $72 million, if the purchase option is exercised
on or after June 15, 2008 and before June 15, 2009, (b)
$81 million, if the purchase option is exercised on or after 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.
 18
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  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 alliance, collaboration and technology license
agreements, the amount and timing of payments under such agreements, the level
and timing of our research and development expenditures, market acceptance of
our products, the resources we devote to developing and supporting our products
and other factors.  Our capital requirements will also be affected by
any expenditures we make in connection with license agreements and acquisitions
of and investments in complementary technologies and businesses.  We
expect to devote substantial capital resources to continue our research and
development efforts, to expand our support and product development activities,
and for other general corporate activities. We believe that our current
unrestricted cash and investment balances and cash and revenues we expect to
derive from drug discovery and development alliances, target validation
collaborations, government grants and contracts, and technology licenses will be
sufficient to fund our operations for at least the next 12 months. During
or after this period, if cash generated by operations is insufficient to satisfy
our liquidity requirements, we will need to sell additional equity or debt
securities or obtain additional credit arrangements. Additional financing may
not be available on terms acceptable to us or at all. The sale of additional
equity or convertible debt securities may result in additional dilution to our
stockholders.
  Disclosure
about Market Risk
  We are
exposed to limited market and credit risk on our cash equivalents which have
maturities of three months or less at the time of purchase. We maintain a
short-term investment portfolio which consists of U.S. government agency debt
obligations, investment grade commercial paper and, 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
June 30, 2008, we held $59.8 million (par value), with an estimated
fair value of $56.6 million, of AAA-rated municipal note investments with
an auction interest rate reset feature, known as auction rate
securities.  These notes are issued by various state and local
municipal entities for the purpose of financing student loans, public projects
and other activities.  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, 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
June 30, 2008, 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.
 19
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  At
June 30, 2008, observable auction rate securities market information was
not available to determine the fair value of our investments. Therefore, we
estimated fair value using a discounted cash flow model incorporating
assumptions that market participants would use in their estimates of fair value.
Some of these assumptions include estimates for interest rates, timing and
amount of cash flows and expected holding periods of the auction rate
securities. Based on this assessment of fair value, as of June 30, 2008 we
determined there was a temporary decline in the fair value of our auction rate
securities of $3.2 million. If the current market conditions deteriorate
further, or a recovery in market values does not occur, we may be required to
record additional unrealized or realized losses in future quarters.
  Excluding
auction rate securities, at June 30, 2008, we had approximately
$144.0 million in cash and cash equivalents and short-term investments,
including $26.9 million in investments held by Symphony Icon.  We
believe that the working capital available to us excluding the funds held in
auction rate securities will be sufficient to meet our cash requirements for at
least the next 12 months.
  We have
operated primarily in the United States and substantially all sales to date have
been made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
  Item
      3.
              Quantitativeand 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.
  Item
      4.
              Controlsand
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.
  20
 TOC
 Part
      II
              OtherInformation
  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 LX6171, 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
      June 30, 2008, we held $59.8 million (par value), with an
      estimated fair value of $56.6 million, of auction rate securities for
      which auctions have failed and, as a result, we may not be able to access
      these funds without a loss of
principal
  ·
              our
      operating results have been and likely will continue to fluctuate, and we
      believe that period-to-period comparisons of our operating results are not
      a good indication of our future
performance
  Risks
Related to Discovery and Development of Our Drug Candidates
  ·
              we
      are an early-stage company, and have not proven our ability to
      successfully develop and commercialize drug candidates based on our drug
      target discoveries
  ·
              clinical
      testing of our drug candidates in humans is an inherently risky and
      time-consuming process that may fail to demonstrate safety and efficacy,
      which could result in the delay, limitation or prevention of regulatory
      approval
  Risks
Related to Our Relationships with Third Parties
  ·
              disagreements
      with Symphony Icon regarding the development of our drug candidates
      LX6171, 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
  ·
              conflicts
      with our collaborators could jeopardize the success of our collaborative
      agreements and harm our product development
  efforts
  21
 TOC
 ·
              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
  ·
              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
  22
 TOC
 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
  ·
              difficulties
      we may encounter managing our growth may divert resources and limit our
      ability to successfully expand our
operations
  ·
              security
      breaches may disrupt our operations and harm our operating
      results
  ·
              any
      contamination among our knockout mouse population could negatively affect
      the reliability of our scientific research or cause us to incur
      significant remedial costs
  ·
              because
      all of our target validation operations are located at a single facility,
      the occurrence of a disaster could significantly disrupt our
      business
  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, 2007, as filed with the Securities and Exchange
Commission.
  Item
4.                      Submissionof Matters to a Vote of Security
Holders
  Our
annual meeting of stockholders was held on April 23, 2008 to consider and vote
on the following proposals:
  (1)
              The
      following individuals were nominated and elected as Class II directors,
      with the following numbers of shares voted for and withheld for such
      directors:
  23
 TOC
 Name of Director
              
              For
              
              WithheldSamuel
      L. Barker, Ph.D.
              
              123,318,698
              
              1,379,408Christopher
      J. Sobecki
              
              123,318,698
              
              1,379,408Judith
      L. Swain, M.D.
              
              123,318,698
              
              1,379,408Kathleen
      M. Wiltsey
              
              123,318,698
              
              1,379,408
 
 (2)
              The
      following additional matters were considered and approved, with the
      following numbers of shares voted for, voted against and abstaining with
      respect to such matters:
  Matter
              
              For
              
              Against
              
              AbstainRatification
      and approval of the appointment of Ernst & Young LLP as our
      independent auditors for the fiscal year ending December 31,
      2008
              
              123,713,731
              
              834,891
              
              149,482
 
 There
were no broker non-votes with respect to any of the proposals.
 
 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
  24
 TOC
  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:  July
      30, 2008
              By:
              /s/
      Arthur T. SandsArthur
      T. Sands, M.D., Ph.D.President
      and Chief Executive Officer
 
 Date:  July
      30, 2008
              By:
              /s/
      James F. TessmerJames
      F. TessmerVice
      President, Finance and Accounting
 
 
 25
 TOC
 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