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 September 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 ofIncorporation
      or Organization)
              (I.R.S.
      EmployerIdentification
      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.
  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
October 29, 2008, 136,796,154 shares of the registrant’s common stock, par
value $0.001 per share, were outstanding.
  
 Table of Contents
 
 Lexicon
Pharmaceuticals, Inc.
  Tableof Contents
    PageFactors Affecting Forward-Looking
      Statements
              2Part I – Financial Information
              3Item
      1.
              Financial Statements
              3Consolidated Balance Sheets – September 30, 2008
      (unaudited) and December 31, 2007
              3Consolidated Statements of Operations (unaudited) –
      Three and Nine Months Ended September 30, 2008 and
      2007
              4Consolidated Statements of Cash Flows (unaudited) – Nine
      Months Ended September 30, 2008 and 2007
              5Notes to Consolidated Financial Statements(unaudited)
              6Item
      2.
              Management’s Discussion and Analysis of Financial Condition
      and Resultsof
      Operations
              13Item
      3.
              Quantitative and Qualitative Disclosures about Market
      Risk
              22Item
      4.
              Controls and Procedures
              22Part II – Other Information
              23Item
      1A.
              Risk Factors
              23Item
      6.
              Exhibits
              25Signatures
              26
 
  The
Lexicon name and logo, LexVision® and
OmniBank® are
registered trademarks and Genome5000TM,
e-BiologyTM and
10to10TM are
trademarks of Lexicon Pharmaceuticals, Inc.
  ——————
 
 FactorsAffecting Forward-Looking Statements
  This
quarterly report on Form 10-Q contains forward-looking
statements.  These statements relate to future events or our future
financial performance. We have attempted to identify forward-looking statements
by terminology including “anticipate,” “believe,” “can,” “continue,” “could,”
“estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “should”
or “will” or the negative of these terms or other comparable terminology. These
statements are only predictions and involve known and unknown risks,
uncertainties and other factors, including the risks outlined under
“Part II, Item 1A. – Risk Factors,” that may cause our or our industry’s
actual results, levels of activity, performance or achievements to be materially
different from any future results, levels or activity, performance or
achievements expressed or implied by these forward-looking
statements.
  Although
we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. We are not under any duty to update any of the forward-looking
statements after the date of this quarterly report on Form 10-Q to conform these
statements to actual results, unless required by law.
   2
 Table of Contents
 PartI – Financial Information
  Item1.
              Financial
      Statements
  Lexicon
Pharmaceuticals, Inc.
  Consolidated
BalanceSheets
 (In
thousands, except par value)
  As
      of September 30,
              
              
              As
      of December 31,2008
              
              
              2007Assets
              
              (unaudited)Current
      assets:Cash and cash equivalents
              
              $
              100,209
              
              
              $
              22,938Short-term investments,
      including restricted investments of $430
              
              
              2,230
              
              
              
              199,171Short-term investments held by
      Symphony Icon, Inc.
              
              
              21,147
              
              
              
              36,666Accounts receivable, net of
      allowance for doubtful accounts of $35
              
              
              770
              
              
              
              1,763Prepaid expenses and other
      current assets
              
              
              7,069
              
              
              
              4,112Total current assets
              
              
              131,425
              
              
              
              264,650Long-term
      investments
              
              
              53,678
              
              
              
              —Property
      and equipment, net of accumulated depreciationand
      amortization of $69,714 and $65,004, respectively
              
              
              66,444
              
              
              
              70,829Goodwill
              
              
              25,798
              
              
              
              25,798Other
      assets
              
              
              6,358
              
              
              
              8,019Total assets
              
              $
              283,703
              
              
              $
              369,296Liabilities, Noncontrolling Interest and
      Stockholders’ EquityCurrent
      liabilities:Accounts payable
              
              $
              8,055
              
              
              $
              7,344Accrued liabilities
              
              
              9,338
              
              
              
              9,093Current portion of deferred
      revenue
              
              
              6,670
              
              
              
              18,030Current portion of long-term
      debt
              
              
              944
              
              
              
              880Total current liabilities
              
              
              25,007
              
              
              
              35,347Deferred
      revenue, net of current portion
              
              
              14,212
              
              
              
              16,126Long-term
      debt
              
              
              29,779
              
              
              
              30,493Other
      long-term liabilities
              
              
              764
              
              
              
              759Total liabilities
              
              
              69,762
              
              
              
              82,725Noncontrolling
      interest in Symphony Icon, Inc.
              
              
              14,260
              
              
              
              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
              
              
              671,484
              
              
              
              666,702Accumulated deficit
              
              
              (471,978
              )
              
              
              (410,535
              )Accumulated other comprehensive
      gain (loss)
              
              
              38
              
              
              
              (4
              )Total stockholders’ equity
              
              
              199,681
              
              
              
              256,300Total liabilities and
      stockholders’ equity
              
              $
              283,703
              
              
              $
              369,296
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
 3
 Table of Contents
  Lexicon
Pharmaceuticals, Inc.
  Consolidated
Statementsof Operations
 (In
thousands, except per share amounts)
 (Unaudited)
  
 Three
      Months Ended September 30,
              
              
              Nine
      Months Ended
                September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007Revenues:Collaborative research
              
              $
              7,202
              
              
              $
              9,712
              
              
              $
              22,789
              
              
              $
              34,460Subscription and license fees
              
              
              310
              
              
              
              455
              
              
              
              3,182
              
              
              
              1,850Total revenues
              
              
              7,512
              
              
              
              10,167
              
              
              
              25,971
              
              
              
              36,310Operating
      expenses:Research and development,
      including stock-basedcompensation
      of $836, $965, $2,913 and$3,000,
      respectively
              
              
              27,642
              
              
              
              24,518
              
              
              
              85,793
              
              
              
              77,402General and administrative,
      including stock-basedcompensation
      of $583, $635, $1,868 and $1,830,respectively
              
              
              4,692
              
              
              
              5,091
              
              
              
              15,824
              
              
              
              15,395Total operating expenses
              
              
              32,334
              
              
              
              29,609
              
              
              
              101,617
              
              
              
              92,797Loss
      from operations
              
              
              (24,822
              )
              
              
              (19,442
              )
              
              
              (75,646
              )
              
              
              (56,487
              )Impairment
      of long-term investments
              
              
              (3,322
              )
              
              
              —
              
              
              
              (3,322
              )
              
              
              —Interest
      income
              
              
              956
              
              
              
              2,166
              
              
              
              5,155
              
              
              
              3,811Interest
      expense
              
              
              (675
              )
              
              
              (694
              )
              
              
              (2,020
              )
              
              
              (2,077
              )Other
      expense, net
              
              
              (535
              )
              
              
              (8
              )
              
              
              (1,621
              )
              
              
              (34
              )Loss
      before noncontrolling interest in SymphonyIcon,
      Inc.
              
              
              (28,398
              )
              
              
              (17,978
              )
              
              
              (77,454
              )
              
              
              (54,787
              )Loss
      attributable to noncontrolling interest inSymphony
      Icon, Inc.
              
              
              4,939
              
              
              
              3,867
              
              
              
              16,011
              
              
              
              8,170Net
      loss
              
              $
              (23,459
              )
              
              $
              (14,111
              )
              
              $
              (61,443
              )
              
              $
              (46,617
              )Net
      loss per common share, basic and diluted
              
              $
              (0.17
              )
              
              $
              (0.14
              )
              
              $
              (0.45
              )
              
              $
              (0.53
              )Shares
      used in computing net loss per common share,basic
      and diluted
              
              
              136,796
              
              
              
              104,196
              
              
              
              136,796
              
              
              
              87,331
 
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
   4
 Table of Contents
 
 Lexicon
Pharmaceuticals, Inc.
  Consolidated
Statements of CashFlows
 (In
thousands)
 (Unaudited)
  Nine
      Months Ended September 30,2008
              
              
              2007Cash
      flows from operating activities:Net loss
              
              $
              (61,443
              )
              
              $
              (46,617
              )Adjustments to reconcile net
      loss to net cash used in operating activities:Depreciation
              
              
              6,057
              
              
              
              7,138Amortization of Symphony Icon
      purchase option
              
              
              1,606
              
              
              
              —Loss attributable to
      noncontrolling interest
              
              
              (16,011
              )
              
              
              (8,170
              )Stock-based compensation
              
              
              4,781
              
              
              
              4,830Impairment of long-term
      investments
              
              
              3,322
              
              
              
              —Changes in operating assets and
      liabilities:(Increase) decrease in accounts
      receivable
              
              
              993
              
              
              
              (561
              )(Increase) decrease in prepaid
      expenses and other current assets
              
              
              (2,957
              )
              
              
              627Decrease in other assets
              
              
              55
              
              
              
              82Increase (decrease) in accounts
      payable and other liabilities
              
              
              961
              
              
              
              (317
              )Decrease in deferred revenue
              
              
              (13,274
              )
              
              
              (17,021
              )Net cash used in operating
      activities
              
              
              (75,910
              )
              
              
              (60,009
              )Cash
      flows from investing activities:Purchases of property and
      equipment
              
              
              (1,672
              )
              
              
              (1,297
              )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.
              
              
              15,519
              
              
              
              5,421Purchases of investments
              
              
              (39,847
              )
              
              
              (192,982
              )Maturities of investments
              
              
              179,830
              
              
              
              58,985Net cash provided by (used in)
      investing activities
              
              
              153,830
              
              
              
              (174,863
              )Cash
      flows from financing activities:Proceeds from issuance of common
      stock to Invus, L. P., net of fees
              
              
              —
              
              
              
              198,135Proceeds from issuance of common
      stock to Symphony Holdings,LLC,
      net of fees
              
              
              —
              
              
              
              14,238Proceeds from exercise of stock
      options
              
              
              1
              
              
              
              884Repayment of debt borrowings
              
              
              (650
              )
              
              
              (604
              )Proceeds from purchase of
      noncontrolling interest bypreferred
      shareholders of Symphony Icon, Inc., net of fees
              
              
              —
              
              
              
              42,714Net cash provided by (used in)
      financing activities
              
              
              (649
              )
              
              
              255,367Net
      increase in cash and cash equivalents
              
              
              77,271
              
              
              
              20,495Cash
      and cash equivalents at beginning of period
              
              
              22,938
              
              
              
              30,226Cash
      and cash equivalents at end of period
              
              $
              100,209
              
              
              $
              50,721Supplemental
      disclosure of cash flow information:Cash paid for interest
              
              $
              1,962
              
              
              $
              2,004Supplemental
      disclosure of non-cash investing and financing activities:Common stock issued for purchase
      option in conjunction withSymphony
      Icon, Inc. financing
              
              $
              —
              
              
              $
              8,564Unrealized gain (loss) on
      investments
              
              $
              42
              
              
              $
              (146
              )
  The
accompanying notes are an integral part of these consolidated financial
statements.
   5
 Table of Contents
  Lexicon
Pharmaceuticals, Inc.
  Notesto Consolidated Financial Statements
 (Unaudited)
  1.      Basis
of Presentation
  The
accompanying unaudited consolidated financial statements of Lexicon
Pharmaceuticals, Inc. (“Lexicon” or the “Company”) have been prepared in
accordance with accounting principles generally accepted in the United States
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 nine-month period ended September 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 $1.4 million and
$1.6 million of stock-based compensation expense for the three months ended
September 30, 2008 and 2007, respectively, and $4.8 million of
stock-based compensation expense for the nine months ended September 30,
2008 and 2007.  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 nine months
ended September 30, 2008 and 2007, respectively.
  Expected
      Volatility
              
              
              Risk-free
      Interest Rate
              
              
              Expected
      Term
              
              
              Estimated
      Forfeitures
              
              
              Dividend
                RateSeptember
      30, 2008:Employees
              
              
              66
              %
              
              
              2.9
              %
              
              
              6
              
              
              
              22
              %
              
              
              0
              %Officers
      and non-employee directors
              
              
              66
              %
              
              
              3.8
              %
              
              
              9
              
              
              
              6
              %
              
              
              0
              %September
      30, 2007:Employees
              
              
              67
              %
              
              
              4.5
              %
              
              
              6
              
              
              
              21
              %
              
              
              0
              %Officers
      and non-employee directors
              
              
              67
              %
              
              
              4.6
              %
              
              
              9
              
              
              
              4
              %
              
              
              0
              %
  
 6
 Table of Contents
 The
following is a summary of option activity under Lexicon’s stock option plans for
the nine months ended September 30, 2008:
  Options
              
              
              Weighted
      Average Exercise Price(in
      thousands)Outstanding
      at December 31, 2007
              
              
              16,351
              
              
              $
              5.65Granted
              
              
              4,060
              
              
              
              2.08Exercised
              
              
              (1
              )
              
              
              1.89Canceled
              
              
              (3,091
              )
              
              
              3.84Outstanding
      at September 30, 2008
              
              
              17,319
              
              
              
              5.14Exercisable
      at September 30, 2008
              
              
              11,377
              
              
              $
              6.34
 
 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
 Table of Contents
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements,” which amends Accounting Research Bulletin
No. 51, “Consolidated Financial Statements,” to improve the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements. SFAS No. 160
establishes accounting and reporting standards that require the ownership
interests in subsidiaries not held by the parent to be clearly identified,
labeled and presented in the consolidated statement of financial position within
equity, but separate from the parent’s equity. This statement also requires the
amount of consolidated net income attributable to the parent and to the
non-controlling interest to be clearly identified and presented on the face of
the consolidated statement of income. Changes in a parent’s ownership interest
while the parent retains its controlling financial interest must be accounted
for consistently, and when a subsidiary is deconsolidated, any retained
non-controlling equity investment in the former subsidiary must be initially
measured at fair value. The gain or loss on the deconsolidation of the
subsidiary is measured using the fair value of any non-controlling equity
investment. The statement also requires entities to provide sufficient
disclosures that clearly identify and distinguish between the interests of the
parent and the interests of the non-controlling owners. This statement applies
prospectively to all entities that prepare consolidated financial statements and
applies prospectively for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008. The Company 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 September 30,
2008 and December 31, 2007 are as follows:
  As
      of September 30, 2008Amortized
      Cost
              
              
              Gross
      Unrealized Gains
              
              
              Gross
      Unrealized Losses
              
              
              Estimated
      Fair Value(In
      thousands)Cash
      and cash equivalents
              
              $
              100,171
              
              
              $
              38
              
              
              $
              —
              
              
              $
              100,209Securities
      maturing within one year:Certificates
      of deposit
              
              
              630
              
              
              
              —
              
              
              
              —
              
              
              
              630Corporate
      debt securities
              
              
              1,600
              
              
              
              —
              
              
              
              —
              
              
              
              1,600Total
      short-term investments
              
              $
              2,230
              
              
              $
              —
              
              
              $
              —
              
              
              $
              2,230Short-term
      investments held by Symphony Icon, Inc.:Cash
      and cash equivalents
              
              
              21,147
              
              
              
              —
              
              
              
              —
              
              
              
              21,147Total
      short-term investments held by Symphony Icon, Inc.
              
              $
              21,147
              
              
              $
              —
              
              
              $
              —
              
              
              $
              21,147Securities
      maturing after ten years:Auction
      rate securities
              
              
              57,000
              
              
              
              —
              
              
              
              (3,322
              )
              
              
              53,678Total
      long-term investments
              
              $
              57,000
              
              
              $
              —
              
              
              $
              (3,322
              )
              
              $
              53,678Total
      cash and cash equivalents and investments
              
              $
              180,548
              
              
              $
              38
              
              
              $
              (3,322
              )
              
              $
              177,264
 
 
 8
 Table of Contents
 
 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 $5,000 and $123,000 of realized gains for the three and nine months ended
September 30, 2008, respectively.  There were no realized gains
or losses for the three and nine months ended September 30,
2007.
  At
September 30, 2008, Lexicon held $57.0 million (par value), with an
estimated fair value of $53.7 million, of AAA-rated investments with an
auction interest rate reset feature, known as auction rate
securities.  These notes are issued by various state agencies for the
purpose of financing student loans.  The securities have historically
traded at par and are redeemable at par plus accrued interest at the option of
the issuer. Interest is typically paid at the end of each auction period or
semiannually.  Until February 2008, the market for Lexicon’s auction
rate securities was highly liquid. Starting in February 2008, a substantial
number of auctions “failed,” meaning that there was not enough demand to sell
all of the securities that holders desired to sell at auction. The immediate
effect of a failed auction is that such holders cannot sell the securities at
auction and the interest rate on the security generally resets to a maximum
interest rate. In the case of funds invested by Lexicon in auction rate
securities which are the subject of a failed auction, Lexicon may not be able to
access the funds without a loss of principal, unless a future auction on these
investments is successful or the issuer redeems the security.  As of
September 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
September 30, 2008, observable auction rate securities market information
was not available to determine the fair value of Lexicon’s investments. Lexicon
has estimated the fair value of these securities at $53.7 million as of
September 30, 2008 using models of the expected future cash flows related
to the securities and taking into account probability-weighted assumptions about
the cash flows of the underlying student loans.  For each of its
auction rate securities, Lexicon evaluated the risks related to the structure,
collateral and liquidity of the investment, and forecasted the probability of a
successful auction or redemption at par, issuer default and auction failure for
each future auction period.  The assumptions used in preparing the
discounted cash flow model include estimates of interest rates, timing and
amount of cash flows, liquidity premiums and expected holding periods of the
auction rate securities, based on data available as of September 30,
2008.  These assumptions are volatile and subject to change as the
underlying sources of these assumptions and market conditions
change.  Because Lexicon does not intend to hold these securities
until the par value is recoverable and management believes the decline in fair
value is other-than-temporary, Lexicon recorded a loss of $3.3 million in
the three and nine months ended September 30, 2008 to reflect the decline
in value of these securities.  This loss is shown as impairment of
long-term investments in the consolidated statements of
operations.  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
 Table of Contents
  In August
2008, the investment bank that sold Lexicon the auction rate securities it
currently holds announced a settlement, in principle, with the Securities and
Exchange Commission and other state regulatory agencies pursuant
to which it has offered Lexicon rights to require the bank to purchase such
auction rate securities from Lexicon at par value beginning in June
2010.  Lexicon is also eligible to borrow from an affiliate of the
bank at no net cost up to 75% of the market value of the auction rate
securities, which loans would become payable upon the bank’s purchase of the
auction rate securities.  Lexicon is currently evaluating its options
with respect to such offer.
  Excluding
auction rate securities, at September 30, 2008, Lexicon had approximately
$123.6 million in cash and cash equivalents and short-term investments,
including $21.1 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 nine months ended September 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 tables provide the fair value
measurements of applicable Company financial assets according to the fair value
levels defined by SFAS No. 157 as of September 30, 2008 and
December 31, 2007.
  10
 Table of Contents
  Financial
      Assets at Fair Value
                as
      of September 30, 2008Level
      1
              
              
              Level
      2
              
              
              Level
      3(in
      thousands)Cash
      and cash equivalents
              
              $
              100,209
              
              
              $
              —
              
              
              $
              —Short-term
      investments
              
              
              2,230
              
              
              
              —
              
              
              
              —Short-term
      investments held by  Symphony Icon, Inc.
              
              
              21,147
              
              
              
              —
              
              
              
              —Long-term
      investments
              
              
              —
              
              
              
              —
              
              
              
              53,678Total
      cash and cash equivalents and investments
              
              $
              123,586
              
              
              $
              —
              
              
              $
              53,678
 
 
 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
              
              
              $
              —
              
              
              $
              —
 
 The table
presented below summarizes the change in consolidated balance sheet carrying
value associated with Level 3 financial assets for the nine months ended
September 30, 2008.
  Long-term
      Investments(in
      thousands)Balance
      at December 31, 2007
              
              $
              —Unrealized
      losses included in earnings as impairment of long-term
      investments
              
              
              (3,322
              )Net
      sales and settlements
              
              
              (21,050
              )Transfers
      into Level 3
              
              
              78,050Balance
      at September 30, 2008
              
              $
              53,678
  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 September 30, 2008 and
December 31, 2007.
  11
 Table of Contents
  9.      Comprehensive
Loss
  Comprehensive
loss consists of:
  Three
      Months Ended September 30,2008
              
              
              2007(in
      thousands)Net
      loss
              
              $
              (23,459
              )
              
              $
              (14,111
              )Unrealized
      gain (loss) on short-term investments
              
              
              23
              
              
              
              (153
              )Net
      recognized loss on long-term investments included in
      earnings
              
              
              3,322
              
              
              
              —Net
      unrealized change in value of long-term investments
              
              
              82
              
              
              
              —Net
      comprehensive loss
              
              $
              (20,196
              )
              
              $
              (14,264
              )
 
 Nine
      Months Ended September 30,2008
              
              
              2007(in
      thousands)Net
      loss
              
              $
              (61,443
              )
              
              $
              (46,617
              )Unrealized
      gain (loss) on short-term investments
              
              
              42
              
              
              
              (146
              )Net
      comprehensive loss
              
              $
              (61,401
              )
              
              $
              (46,763
              )
   12
 Table of Contents
  Item2.
              Management’s
      Discussion 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 additional drug candidates 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.
 13
 Table of Contents
  Since our
inception, we have incurred significant losses and, as of September 30,
2008, we had an accumulated deficit of $472.0 million. Our losses have
resulted principally from costs incurred in research and development, general
and administrative costs associated with our operations, and non-cash
stock-based compensation expenses associated with stock options granted to
employees and consultants.  Research and development expenses consist
primarily of salaries and related personnel costs, external research costs
related to our preclinical and clinical efforts, material costs, facility costs,
depreciation on property and equipment, legal expenses resulting from
intellectual property prosecution and other expenses related to our drug
discovery and development programs, the development and analysis of knockout
mice and our other target validation research efforts, and the development of
compound libraries. General and administrative expenses consist primarily of
salaries and related expenses for executive and administrative personnel,
professional fees and other corporate expenses, including information
technology, facilities costs and general legal activities.  In
connection with the expansion of our drug discovery and development programs 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.
 14
 Table of Contents
  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 September 30,
              
              Nine
      Months Ended September 30,2008
              
              2007
              
              2008
              
              2007Total
      revenues
              
              $
              7.5
              
              
              $
              10.2
              
              $
              26.0
              
              
              $
              36.3Dollar
      decrease
              
              $
              (2.7
              )
              
              
              
              
              $
              (10.3
              )Percentage
      decrease
              
              
              (26
              )%
              
              
              
              
              
              (28
              )%
   15
 Table of Contents
  ·
              Collaborative research
      – Revenue from collaborative research for the three months ended
      September 30, 2008 decreased 26% to $7.2 million, and for the
      nine months ended September 30, 2008 decreased 34% to
      $22.8 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 nine months ended
      September 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 September 30, 2008 decreased 32% to $0.3 million,
      as compared to the comparable period for the prior year. Revenue from
      subscriptions and license fees for the nine months ended
      September 30, 2008 increased 72% to $3.2 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 September 30,
              
              Nine
      Months Ended September 30,2008
              
              2007
              
              2008
              
              2007Total
      research and development expense
              
              $
              27.6
              
              
              $
              24.5
              
              $
              85.8
              
              
              $
              77.4Dollar
      increase
              
              $
              3.1
              
              
              
              
              
              $
              8.4Percentage
      increase
              
              
              13
              %
              
              
              
              
              
              11
              %
 
 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 September 30, 2008 decreased 16% to
      $8.8 million, and for the nine months ended September 30, 2008
      decreased 3% to $33.1 million, as compared to the comparable period
      for the prior year, primarily due to lower salary and benefit
      costs.  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
      September 30, 2008 decreased 1% to $4.7 million,  and
      for the nine months ended September 30, 2008 decreased 8% to
      $14.1 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
      September 30, 2008 decreased 29% to $2.0 million, and for the
      nine months ended September 30, 2008 decreased 24% to
      $6.7 million, as compared to the comparable period for the prior
      year, primarily due to reallocating resources from genetic research to
      drug development and as a result of the reduction in our personnel in May
      2008.
  ·
              Third-party and other services
      –Third-party and other services for the three months ended
      September 30, 2008 increased 132% to $10.1 million, and for the
      nine months ended September 30, 2008 increased 98% to
      $25.3 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.
  16
 Table of Contents
 ·
              Stock-based compensation
      – Stock-based compensation expense for the three months ended
      September 30, 2008 decreased 13% to $0.8 million, and for the
      nine months ended September 30, 2008 decreased 3% to
      $2.9 million, as compared to the comparable period for the prior
      year.
  ·
              Other –Other costs for
      the three months ended September 30, 2008 were $1.2 million,
      consistent with the comparable period for the prior year. Other costs for
      the nine months ended September 30, 2008 increased 6% to
      $3.7 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 September 30,
              
              Nine
      Months Ended September 30,2008
              
              2007
              
              2008
              
              2007Total
      general and administrative expense
              
              $
              4.7
              
              
              $
              5.1
              
              $
              15.8
              
              
              $
              15.4Dollar
      increase (decrease)
              
              $
              (0.4
              )
              
              
              
              
              $
              0.4Percentage
      increase (decrease)
              
              
              (8
              )%
              
              
              
              
              
              3
              %
 
 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 September 30, 2008 decreased 7% to
      $2.3 million, as compared to the comparable period for the prior
      year, primarily due to lower salary and benefit costs associated with a
      reduction in our personnel in May 2008.  Personnel costs for the
      nine months ended September 30, 2008 increased 4% to
      $8.4 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 September 30, 2008 increased 11% to $0.7 million, as
      compared to the comparable period for the prior
      year.  Facilities and equipment costs for the nine months ended
      September 30, 2008 were $1.9 million, consistent with the
      comparable period for the prior
year.
  ·
              Professional fees –
      Professional fees for the three months ended September 30, 2008
      decreased 10% to $0.7 million, as compared to the comparable period
      for the prior year.  Professional fees for the nine months ended
      September 30, 2008 increased 24% to $2.2 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 September 30, 2008 was $0.6 million, consistent
      with the comparable period for the prior year.  Stock-based
      compensation expense for the nine months ended September 30, 2008
      increased 2% to $1.9 million as compared to the comparable period for
      the prior year.
  ·
              Other –Other costs for
      the three months ended September 30, 2008 decreased 26% to
      $0.4 million, and for the nine months ended September 30, 2008
      decreased 16% to $1.5 million, as compared to the comparable period
      for the prior year.
  17
 Table of Contents
 Impairment
of Long-term Investments, Interest Income, Interest Expense and Other Expense,
Net
  Impairment of Long-Term
Investments.  Impairment of long-term investments was
$3.3 million for the three and nine months ended September 30, 2008,
representing the other-than-temporary decline in fair value of our student loan
auction rate securities.
  Interest
Income.  Interest income for the three months ended
September 30, 2008 decreased 56% to $1.0 million, as compared to the
comparable period for the prior year, primarily due to lower average cash and
investment balances as well as lower yields on our investments. Interest income
for the nine months ended September 30, 2008 increased 35% to
$5.2 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
September 30, 2008 was $0.7 million, consistent with the comparable
period for the prior year.  Interest expense for the nine months ended
September 30, 2008 decreased 3% to $2.0 million as compared to the
comparable period for the prior year.
  Other Expense,
Net.  Other expense, net was $0.5 million and
$1.6 million in the three and nine months ended September 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 September 30, 2008 and 2007, the losses attributable to
the noncontrolling interest holders of Symphony Icon were $4.9 million and
$3.9 million, respectively.  For the nine months ended
September 30, 2008 and 2007, the losses attributed to the noncontrolling
interest holders of Symphony Icon were $16.0 million and $8.2 million,
respectively.
  Net
Loss and Net Loss per Common Share
  Net loss
increased to $23.5 million in the three months ended September 30,
2008 from $14.1 million in the comparable period for the prior
year.  Net loss per common share increased to $0.17 in the three
months ended September 30, 2008 from $0.14 in the comparable period for the
prior year.  Net loss increased to $61.4 million in the nine
months ended September 30, 2008 from $46.6 million in the comparable
period for the prior year.  Net loss per common share decreased to
$0.45 in the nine months ended September 30, 2008 from $0.53 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 September 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
September 30, 2008, we received $437.4 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 $417.6 million
had been recognized as revenues through September 30, 2008.
 18
 Table of Contents
  As of
September 30, 2008, we had $177.3 million in cash, cash equivalents
and investments, including $53.7 million in auction rate securities as
discussed below under “Disclosure about Market Risk,” and $21.1 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
$75.9 million in operations in the nine months ended September 30,
2008. This consisted primarily of the net loss for the period of
$61.4 million, a $16.0 million loss attributable to noncontrolling
interest, a $13.3 million decrease in deferred revenue, and a net increase
in other operating assets net of liabilities of $0.9 million, partially
offset by non-cash charges of $6.1 million related to depreciation expense,
$4.8 million related to stock-based compensation expense, $3.3 million
related to impairment of long-term investments and $1.6 million related to
the amortization of the Symphony Icon purchase option.  Investing
activities provided cash of $153.8 million in the nine months ended
September 30, 2008, primarily due to net maturities of investments of
$155.5 million, partially offset by purchases of property and equipment of
$1.7 million.  Financing activities used cash of
$0.6 million primarily due to principal repayments of $0.7 million on
the mortgage loan.
  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.
 19
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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. Treasury bills, money
market accounts, corporate debt securities and certificates of deposit that
mature three to 12 months from the time of purchase and a long-term
investment portfolio which consists of auction rate securities that mature
greater than 12 months from the time of purchase, which we believe are
subject to limited market and credit risk, other than as discussed
below.  We currently do not hedge interest rate exposure or hold any
derivative financial instruments in our investment portfolio.
 20
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  At
September 30, 2008, we held $57.0 million (par value), with an
estimated fair value of $53.7 million, of AAA-rated investments with an
auction interest rate reset feature, known as auction rate
securities.  These notes are issued by various state agencies for the
purpose of financing student loans.  The securities
have historically traded at par and are redeemable at par plus accrued interest
at the option of the issuer. Interest is typically paid at the end of each
auction period or semiannually.  Until February 2008, the market for
our auction rate securities was highly liquid. Starting in February 2008, a
substantial number of auctions “failed,” meaning that there was not enough
demand to sell all of the securities that holders desired to sell at auction.
The immediate effect of a failed auction is that such holders cannot sell the
securities at auction and the interest rate on the security generally resets to
a maximum interest rate. In the case of funds invested by 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
September 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.
  At
September 30, 2008, observable auction rate securities market information
was not available to determine the fair value of our investments. We have
estimated the fair value of these securities at $53.7 million as of
September 30, 2008 using models of the expected future cash flows related to the
securities and taking into account probability-weighted assumptions about the
cash flows of the underlying student loans.  For each of our auction
rate securities, we evaluated the risks related to the structure, collateral and
liquidity of the investment, and forecasted the probability of a successful
auction or a redemption at par, issuer default and auction failure for each
future auction period.  The assumptions used in preparing the
discounted cash flow model include estimates of interest rates, timing and
amount of cash flows, liquidity premiums and expected holding periods of the
auction rate securities, based on data available as of September 30,
2008.  These assumptions are volatile and subject to change as the
underlying sources of these assumptions and market conditions
change.  Because we do not intend to hold these securities until the
par value is recoverable and we believe the decline in fair value is
other-than-temporary, we recorded a loss of $3.3 million in the three and
nine months ended September 30, 2008 to reflect the decline in value of these
securities.  This loss is shown as impairment of long-term investments
in the consolidated statements of operations.  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.
  In August
2008, the investment bank that sold us the auction rate securities we currently
hold announced a settlement, in principle, with the Securities and Exchange
Commission and other state regulatory agencies pursuant to which it has offered
us rights to require the bank to purchase such auction rate securities from us
at par value beginning in June 2010.  We are also eligible to borrow
from an affiliate of the bank at no net cost up to 75% of the market value of
the auction rate securities, which loans would become payable upon the bank’s
purchase of the auction rate securities.  We are currently evaluating
our options with respect to such offer.
  Excluding
auction rate securities, at September 30, 2008, we had approximately
$123.6 million in cash and cash equivalents and short-term investments,
including $21.1 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.
 21
 Table of Contents
  We have
operated primarily in the United States and substantially all sales to date have
been made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
  Item3.
              Quantitative
      and Qualitative Disclosures about Market
Risk
  See
“Disclosure about Market Risk” under “Item 2. Management’s Discussion and
Analysisof
Financial Condition and Results of Operations” for quantitative and qualitative
disclosures about market risk.
  Item4.
              Controls
      and Procedures
  Our
principal executive officer and principal financial officer have concluded that
our disclosure controls and procedures (as defined in rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are sufficiently effective
to ensure that the information required to be disclosed by us in the reports we
file under the Securities Exchange Act is gathered, analyzed and disclosed with
adequate timeliness, accuracy and completeness, based on an evaluation of such
controls and procedures as of the end of the period covered by this
report.
  Subsequent
to our evaluation, there were no significant changes in internal controls or
other factors that could significantly affect internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
  22
 Table of Contents
  PartII
              Other
      Information
  Item1A.                      Risk
Factors
  The
following risks and uncertainties are important factors that could cause actual
results or events to differ materially from those indicated by forward-looking
statements.  The factors described below are not the only ones we face
and additional risks and uncertainties not presently known to us or that we
currently deem immaterial also may impair our business operations.
  Risks
Related to Our Need for Additional Financing and Our Financial
Results
  ·
              we
      will need additional capital in the future; 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
      September 30, 2008, we held $57.0 million (par value), with an
      estimated fair value of $53.7 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
  23
 Table of Contents
  ·
              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
  24
 Table of Contents
  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.
  Item6.                                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
  25
 Table of Contents
 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:  October
      31, 2008
              By:
              /s/
      Arthur T. SandsArthur
      T. Sands, M.D., Ph.D.President
      and Chief Executive Officer
 
 Date:  October
      31, 2008
              By:
              /s/
      James F. TessmerJames
      F. TessmerVice
      President, Finance and Accounting
 
 
 26
 Table of Contents
 Indexto Exhibits
  
  Exhibit No.
              
              Description31.1
              —
              Certification of Principal Executive
      OfficerPursuant to Section 302 of the Sarbanes-Oxley Act of
      200231.2
              —
              Certification of Principal Financial
      OfficerPursuant 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