Last weekend, Motley Fool Rule Breakers pick Exelixis (NASDAQ:EXEL) reported preliminary phase 1 results for three of its lead compounds: XL647, XL880, and XL999. All three of these oncology drugs showed at least some level of beneficial pharmacological activity for the patients who were treated with them. Considering that these were only small safety and tolerability studies, it's far too early to make much of any assessment on their prospects for regulatory or commercial success. Not knowing these drugs' chances of success is OK, though, since Exelixis has many drugs in the pipeline, and several of these compounds have been designed to hit the same targets as currently marketed oncology drugs.

Before I continue, it would be worthwhile to explain how most current drugs in development to treat cancer work. Many of these drugs in development today are what can be called "targeted therapies." To simplify things greatly, targeted therapies work by identifying certain characteristics that are present in cancer cells but not in normal cells. When they spot these identifying characteristics, the drugs go to work to attack the cancer. This differs greatly from other ways of treating cancer, like chemotherapy, which cannot differentiate between cancerous and normal cells. Targeted therapies thereby avoid some of the collateral damage to healthy cells that chemotherapy can't avoid, and they usually have fewer side effects as a result. This is somewhat analogous to thinking of chemotherapy as being like a nuclear bomb to eliminate cancerous cells, whereas targeted therapies are like smart bombs. This is a simplistic but easy to understand way of thinking about how most drugs to treat cancer work today. Drugs like Genentech's (NYSE:DNA) Avastin or Herceptin are examples of targeted therapies.

The good thing about Exelixis' drugs is that they're targeted therapies, and many of them are designed to hit the same targets as blockbuster drugs like Avastin or ImClone Systems' (NASDAQ:IMCL) Erbitux. This greatly reduces the risk that Exelixis' drugs will fail in development. I believe the flipside to this is that Exelixis' compounds will have to show superiority in either efficacy or safety if they are to become blockbusters, too.

Because it's not enough to come up with an alternative oncology treatment. Exelixis must come up with superior alternatives to existing treatments if it wants doctors to switch to using its drugs. One possible way that Exelixis' compounds may be superior, though, is that they hit multiple targets, whereas Avastin or Erbitux, for example, only hit one target. This is one avenue from which Exelixis' drugs could show a big competitive advantage if they can get approved.

One of the things that makes me the most leery of any potential investment in Exelixis, though, is the dizzying amount of drugs in development from other companies that are being designed to hit the same targets as Exelixis' drugs. Some of these drugs from companies like Amgen or Pfizer are further along in development than Exelixis' compounds and are being developed with more resources behind them. Some of these potential competing drugs will surely make it on the market, and as any student of economics will tell you: As competition increases, there will be less pricing power and profit potential for Exelixis' drugs. This just makes it all the more important that Exelixis' compounds show superior efficacy or safety.

Since almost all of Exelixis' compounds are no further along than phase 1 or phase 2 trials, it will be many years before the company could see meaningful sales from any of its products. Ensuring that it has enough cash to run all its clinical trials is important, and to that end, the company has lined up an impressive array of partners like Genentech, Motley Fool Income Investor pick GlaxoSmithKline (NYSE:GSK), and Bristol-Myers Squibb (NYSE:BMY) to help pay for these clinical trials. Another benefit to having so many biotech and pharmaceutical heavyweights collaborating with the company is the credibility it gives to the path that Exelixis' management is taking.

Despite all the cash that these partners have been providing, Exelixis is expected to reduce its cash hoard from $210 million at the end of 2005 to no lower than $130 million at the end of this year. The dwindling cash in the company's coffers means that investors should expect some sort of dilutive financing next year unless Exelixis enters new partnerships to help defray some of its research and development expenses.

By the end of 2006, Exelixis expects to have five drugs either in or beginning phase 2 trials, plus another three drugs entering phase 1 trials. This is quite a lot of shots on goal. When results from the phase 2 studies in XL880 and XL647 start to roll in throughout 2007, then the chances for success for the company's drugs should become much less murky. Until I see the results from these phase 2 trials, I chalk Exelixis up as a promising young biotech company whose successes I will patiently cheer for from the sidelines.

Exelixis is a Motley Fool Rule Breakers pick, while GlaxoSmithKline is a Motley Fool Income Investor pick. Take the newsletter service that best fits your investing style for a 30-day free trial.

Fool contributor Brian Lawler does not own shares of Exelixis. He welcomes your feedback .