UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarterly period ended June 30, 2000.
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
1-9813
GENENTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2347624
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
1 DNA Way, South San Francisco, California 94080-4990
(Address of principal executive offices and zip code)
(650) 225-1000
(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 X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Number of Shares Outstanding
- ----- -----------------------------
Common Stock $0.02 par value 260,881,413
Outstanding at June 30, 2000
GENENTECH, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Condensed Consolidated Statements of Operations -
for the three months and six months ended June 30, 2000 and 1999 3
Condensed Consolidated Statements of Cash Flows -
for the three months and six months ended June 30, 2000 and 1999 4
Condensed Consolidated Balance Sheets -
June 30, 2000 and December 31, 1999 5
Notes to Condensed Consolidated Financial Statements 6-13
Independent Accountants' Review Report 14
Financial Review 15-37
PART II. OTHER INFORMATION 38
SIGNATURES 40
In this report, "Genentech," "we," "us" and "our" refer to Genentech, Inc.
"Common Stock" refers to Genentech's Common Stock, par value $0.02 per share
and "Special Common Stock" refers to Genentech's callable putable common
stock, par value $0.02 per share. All numbers related to the number of
shares, price per share and per share amounts of Common and Special Common
Stock give effect to the two-for-one split of our Common Stock in November
1999.
We own or have rights to various copyrights, trademarks and trade names used
in our business including the following: Actimmune, registered trademark,
interferon gamma-1b; Activase, registered trademark, (alteplase, recombinant)
tissue plasminogen activator; Herceptin, registered trademark, (trastuzumab)
anti-HER2 antibody; Nutropin, registered trademark, (somatropin (rDNA origin)
for injection) growth hormone; Nutropin AQ, registered trademark, (somatropin
(rDNA origin) injection) liquid formulation growth hormone; Nutropin Depot,
trademark, (somatropin (rDNA origin) for injectable suspension) encapsulated
sustained-release growth hormone; Protropin, registered trademark, (somatrem
for injection) growth hormone; Pulmozyme, registered trademark, (dornase
alfa, recombinant) inhalation solution; Rituxan, registered trademark,
(rituximab) antibody; TNKase, trademark, (tenecteplase) second generation
tissue plasminogen activator; and Xubix, trademark, (sibrafiban) oral
IIb/IIIa antagonist. This report also includes trademarks, service marks and
trade names of other companies.
Page 2
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(thousands, except per share amounts)
(unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
------------------------ ------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
Revenues:
Product sales (including amounts from
related parties: three months -
2000-$17,639; 1999-$13,374; six months -
2000-$41,766; 1999-$26,998) $ 309,414 $ 269,355 $ 592,592 $ 503,424
Royalties (including amounts from related
parties: three months - 2000-$11,021;
1999-$8,870; six months - 2000-$21,826;
1999-$20,111) 49,643 45,986 96,987 92,604
Contract and other (including amounts from
related parties: three months -
2000-$1,489; 1999-$15,675; six months -
2000-$1,489; 1999-$19,944) 32,349 57,915 66,045 77,181
Interest 22,262 21,986 43,736 44,385
---------- ----------- ----------- -----------
Total revenues 413,668 395,242 799,360 717,594
Costs and expenses:
Cost of sales (including amounts from
related parties: three months -
2000-$15,439; 1999-$11,145; six months -
2000-$35,329; 1999-$21,931) 97,657 52,681 203,792 98,404
Research and development (including
contract related: three months -
2000-$6,114; 1999-$6,566; six months -
2000-$10,671; 1999-$14,426) 115,563 94,211 226,969 184,951
Marketing, general and administrative 117,156 117,372 219,103 214,573
Special charges:
Legal settlement - - - 50,000
Related to redemption - 1,147,304 - 1,147,304
Recurring charges related to redemption 98,072 - 196,619 -
Interest 1,240 1,356 2,526 2,719
---------- ----------- ----------- -----------
Total costs and expenses 429,688 1,412,924 849,009 1,697,951
Income (loss) before taxes (16,020) (1,017,682) (49,649) (980,357)
Income tax (benefit) provision (1,860) (94,490) (9,584) (71,580)
----------- ----------- ----------- -----------
Net income (loss) $ (14,160) $ (923,192) $ (40,065) $ (908,777)
=========== =========== =========== ===========
Earnings (loss) per share:
Basic $ (0.05) $ (3.59) $ (0.15) $ (3.55)
=========== =========== =========== ===========
Diluted $ (0.05) $ (3.59) $ (0.15) $ (3.55)
=========== =========== =========== ===========
Weighted average shares used to compute
earnings (loss) per share:
Basic 260,616 256,961 260,091 256,184
=========== =========== =========== ===========
Diluted 260,616 256,961 260,091 256,184
=========== =========== =========== ===========
See Notes to Condensed Consolidated Financial Statements.
Page 3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
(unaudited)
Six Months
Ended June 30,
---------------------
2000 1999
--------- ---------
Cash flows from operating activities:
Net (loss) $ (40,065) $(908,777)
Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 237,832 44,317
In-process research and development - 752,500
Non-cash compensation related to stock options,
net of tax - 61,353
Write-up of securities available-for-sale - (20,337)
Amortization of inventory write-up 74,652 -
Deferred income taxes (79,647) (114,672)
Gain on sales of securities available-for-sale (55,683) (12,283)
Loss on sales of securities available-for-sale 2,554 921
Write down of securities available-for-sale - 8,467
Write down of non-marketable equity securities - 432
Loss (gain) on fixed asset dispositions 500 (16)
Changes in assets and liabilities:
Investments in trading securities (13,947) (4,944)
Receivables and other current assets 6,079 (38,643)
Inventories (39,596) 10,333
Accounts payable, other current liabilities
and other long-term liabilities (107,087) 344,920
--------- ----------
Net cash (used) provided by operating activities (14,408) 123,571
Cash flows from investing activities:
Purchases of securities held-to-maturity - (186,612)
Proceeds from maturities of securities held-to-maturity - 150,357
Purchases of securities available-for-sale (196,990) (300,254)
Proceeds from sales of securities available-for-sale 190,986 257,752
Purchases of non-marketable equity securities (1,660) (39,177)
Capital expenditures (53,571) (41,513)
Change in other assets (20,357) (17,721)
--------- ----------
Net cash used in investing activities (81,592) (177,168)
Cash flows from financing activities:
Stock issuances 95,150 64,291
--------- ----------
Net cash provided by financing activities 95,150 64,291
--------- ----------
Net (decrease) increase in cash and cash equivalents (850) 10,694
Cash and cash equivalents at beginning of period 337,682 281,162
--------- ----------
Cash and cash equivalents at end of period $ 336,832 $ 291,856
========= ==========
See Notes to Condensed Consolidated Financial Statements.
Page 4
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands)
(unaudited)
June 30, December 31,
2000 1999
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 336,832 $ 337,682
Short-term investments 429,619 405,003
Accounts receivable, net (including amounts
from related party: 2000-$58,142; 1999-$33,234) 262,140 214,785
Inventories 240,190 275,245
Deferred tax assets 114,275 81,922
Prepaid expenses and other current assets 28,981 11,870
------------ ------------
Total current assets 1,412,037 1,326,507
Long-term marketable securities 1,334,683 1,214,757
Property, plant and equipment (net of accumulated
depreciation: 2000-$562,955; 1999-$519,496) 739,698 730,086
Goodwill (net of accumulated amortization:
2000-$768,208; 1999-$690,887) 1,551,401 1,628,722
Other intangible assets (net of accumulated
amortization: 2000-$1,178,704; 1999-$1,062,181) 1,353,040 1,453,268
Other long-term assets 170,293 201,101
------------ ------------
Total assets $ 6,561,152 $ 6,554,441
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 40,570 $ 33,123
Accrued liabilities - related party 12,854 14,960
Other accrued liabilities 242,197 436,044
------------ ------------
Total current liabilities 295,621 484,127
Long-term debt 149,692 149,708
Deferred tax liabilities 629,810 626,466
Other long-term liabilities 19,334 11,335
------------ ------------
Total liabilities 1,094,457 1,271,636
Commitments and contingencies
Stockholders' equity:
Preferred stock - -
Common stock 5,218 5,162
Additional paid-in capital 7,351,854 7,191,766
Retained earnings (accumulated deficit) (2,213,687) (2,173,622)
Accumulated other comprehensive income 323,310 259,499
------------ ------------
Total stockholders' equity 5,466,695 5,282,805
------------ ------------
Total liabilities and stockholders' equity $ 6,561,152 $ 6,554,441
============ ============
See Notes to Condensed Consolidated Financial Statements.
Page 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Statement of Accounting Presentation and Significant Accounting
Policies
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
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 only
of adjustments of a normal recurring nature) considered necessary for a fair
presentation have been included. Operating results for the three- and six-
month periods ended June 30, 2000 and 1999 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2000. The
condensed consolidated balance sheet as of December 31, 1999 has been derived
from the audited financial statements as of that date. For further
information, refer to the consolidated financial statements and notes thereto
included in our Annual Report to Stockholders for the year ended December 31,
1999.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Revenue Recognition: Revenue is generally recognized when all significant
contractual obligations have been satisfied and collection of the resulting
receivable is reasonably assured. Revenue from product sales is recognized
at the time products are shipped to customers, with allowances established
for estimated product returns and discounts. Royalties from licensees based
on third parties sales are recorded as earned. Research and development
contract revenues from cost-reimbursement agreements are recorded as the
related expenses are incurred, up to the contractual limits. Payments
received that are related to future performance are deferred and recorded as
revenues as they are earned over specified future performance periods.
Research and development payments for which no services are required to be
performed in the future are recognized as revenues upon receipt of such
payments. Revenues related to nonrefundable, upfront fees are recognized
over the period of the contractual arrangements as performance obligations
related to the services to be provided have been satisfied or products have
been delivered. Rental revenue is recognized proportionately over the
contract term.
Recent Pronouncements: In July 1999, the Financial Accounting Standards
Board, or FASB, announced the delay of the effective date of Statement of
Financial Accounting Standards 133, or FAS 133, "Accounting for Derivative
Instruments and Hedging Activities," for one year, to the first quarter of
2001. Also, in June 2000, the FASB issued FAS 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities." FAS 133 as amended
by FAS 138 is intended to be comprehensive guidance on accounting for
derivatives and hedging activities. It requires companies to recognize all
Page 6
derivatives as either assets or liabilities on the balance sheet and measure
those instruments at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use
of the derivative and whether it qualifies for hedge accounting under FAS 133
and 138. The impact of FAS 133 and 138 on our financial position and results
of operations is not expected to be material.
On March 31, 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation," which provides guidance
on several implementation issues related to Accounting Principles Board
Opinion No. 25. The most significant of which are clarification of the
definition of employee for purposes of applying Opinion 25 and the accounting
for options that have been repriced. Under the interpretation, the employer-
employee relationship would be based on case law and Internal Revenue Service
regulations. The FASB granted an exception to this definition for outside
directors. Under the interpretation, a modification that reduces the
exercise price of a fixed stock option award, commonly referred to as
repricing, effectively changes the terms of the award to a variable award
subject to compensation expense. We currently do not have any options that
have been repriced. The impact of the interpretation on our financial
position and results of operations is not material.
In June 2000, the Securities and Exchange Commission delayed the
implementation date of Staff Accounting Bulletin No. 101, or SAB 101,
"Revenue Recognition in Financial Statements," until no later than the fourth
quarter of 2000. SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition issues in financial statements.
We will adopt SAB 101 as required in the fourth quarter of 2000 and we are
currently evaluating the effect that such adoption, and the related
"Frequently Asked Questions" document, may have our financial position and
results of operations.
Note 2. Redemption of Our Special Common Stock
Basis of Presentation
On June 30, 1999, we redeemed all of our outstanding Special Common Stock
held by stockholders other than Roche Holdings, Inc., commonly known as
Roche, at a price of $41.25 per share in cash with funds deposited by Roche
for that purpose. We refer to this event as the "Redemption." As a result,
Roche's percentage ownership of our outstanding Common Stock increased from
65% to 100%. Roche accounted for the Redemption as a purchase of a business.
Consequently, push-down accounting was required under generally accepted
accounting principles to reflect in our consolidated financial statements the
amounts paid for our stock in excess of our net book value at the date of the
Redemption. Under this method of accounting, our assets and liabilities,
including other intangible assets, were recorded at their fair values not to
exceed the aggregate purchase price plus Roche's transaction costs at June
30, 1999. Roche purchased 60% in 1990 and 5% in 1991 through 1997 of our
outstanding stock. In June 1999, we redeemed all of our Special Common Stock
held by stockholders other than Roche resulting in Roche owning 100% of our
Common Stock. The push-down effect of Roche's aggregate purchase price and
the Redemption price in our consolidated balance sheet as of June 30, 1999
was allocated based on Roche's ownership percentages as if the purchases
occurred at the original purchase dates for the 1990 and 1991 through 1997
purchases, and at June 30, 1999 for the Redemption. Management of Genentech
Page 7
determined the values of tangible and intangible assets, including in-process
research and development, used in allocating the purchase prices. The
aggregate purchase prices for the acquisition of all our outstanding shares,
including Roche's estimated transaction costs of $10.0 million, was $6,604.9
million, consisting of approximately $2,843.5 million for the 1990 and 1991
through 1997 purchases and approximately $3,761.4 million for the Redemption.
The following table shows details of the excess of purchase price over net
book value (in millions):
Purchase Period
--------------------
1990-1997 1999 Total
--------- --------- ---------
Total purchase price $ 2,843.5 $ 3,761.4 $ 6,604.9
Less portion of net book value purchased 566.6 836.4 1,403.0
--------- --------- ---------
Excess of purchase price over net book value $ 2,276.9 $ 2,925.0 $ 5,201.9
========= ========= =========
The following table shows the allocation of the excess of the purchase price
over net book value (in millions):
Purchase Period
--------------------
1990-1997 1999 Total
--------- --------- ---------
Inventories $ 102.0 $ 186.2 $ 288.2
Land - 16.6 16.6
In-process research and development 500.5 752.5 1,253.0
Developed product technology 429.0 765.0 1,194.0
Core technology 240.5 203.0 443.5
Developed license technology 292.5 175.0 467.5
Trained and assembled workforce 32.5 49.0 81.5
Tradenames 39.0 105.0 144.0
Key distributor relationships 6.5 73.5 80.0
Goodwill 1,091.2 1,228.4 2,319.6
Deferred tax liability (456.8) (629.2) (1,086.0)
--------- --------- ---------
Total $ 2,276.9 $ 2,925.0 $ 5,201.9
========= ========= =========
Push-Down Accounting Adjustments
The following is a description of accounting adjustments that reflect push-
down accounting in our financial statements. These adjustments were based on
management's estimates of the value of the tangible and intangible assets
acquired:
- - The estimated useful life of the inventory adjustment to fair value
resulting from the Redemption is approximately one year based upon the
expected time to sell inventories on hand at June 30, 1999. We recorded
amortization expense of $31.4 million in the second quarter of 2000 and
$74.7 million in the first six months of 2000 related to the inventory
adjustment. The entire inventory adjustment related to Roche's 1990
through 1997 purchases was reflected as a charge to retained earnings.
Page 8
- - We recorded $1,091.2 million of goodwill less accumulated amortization of
$613.6 million through June 30, 1999, as a result of Roche's 1990 through
1997 purchases. The accumulated amortization was charged to retained
earnings at June 30, 1999. We also recorded $1,228.4 million of goodwill
as a result of the Redemption.
- - We recorded $1,040.0 million of other intangible assets less accumulated
amortization of $911.5 million through June 30, 1999, as a result of
Roche's 1990 through 1997 purchases. The accumulated amortization was
charged to retained earnings at June 30, 1999. We also recorded $1,370.5
million of other intangible assets as a result of the Redemption.
- - We recorded amortization expense related to goodwill and other intangible
assets of $95.3 million during the second quarter of 2000 and $190.5
million in the first six months of 2000.
- - We recorded $500.5 million of in-process research and development, or
IPR&D, as a result of Roche's 1990 through 1997 purchases as a charge to
retained earnings at June 30, 1999. An additional $752.5 million of IPR&D
as a result of the Redemption was charged to operations at June 30, 1999.
At the date of each purchase, we concluded that technological feasibility
of the acquired IPR&D was not established and that it had no future
alternative uses.
- - In connection with the Redemption, options under the 1996 Stock
Option/Stock Incentive Plan, or the Plan, were cancelled. Alternative
arrangements were provided for certain holders of some of the unvested
options under the Plan. We recorded compensation expense related to these
alternative arrangements of $2.8 million in the second quarter of 2000 and
$6.1 million in the first six months of 2000.
Note 3. Relationship with Roche
On June 30, 1999, Roche exercised its option to cause us to redeem all of our
Special Common Stock held by stockholders, other than Roche, at a price of
$41.25 per share in cash with funds deposited by Roche for such purpose and
we retired all of the shares of Special Common Stock including those held by
Roche. As a result, Roche owned 100% of our outstanding Common Stock. On
July 23, 1999, Roche completed a public offering of 44 million shares of our
Common Stock. On October 26, 1999, Roche completed a public offering of 40
million shares of our Common Stock. On January 19, 2000, Roche completed an
offering of zero-coupon notes that are exchangeable for an aggregate of
6,517,309 shares of our Common Stock held by Roche. On March 29, 2000, Roche
completed a public offering of 17.3 million shares of our Common Stock.
Roche's percentage ownership of our Common Stock was 58.8% at June 30, 2000.
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in
connection with our stock option and stock purchase plans, and we may issue
additional shares for other purposes. Our affiliation agreement with Roche
requires us to, among other things, establish a stock repurchase program
designed to maintain Roche's percentage ownership interest in our common
stock. In addition, Roche will have a continuing option to buy stock from us
at prevailing market prices to maintain its percentage ownership interest.
To ensure that, with respect to any issuance of common stock by Genentech in
Page 9
the future, the percentage of Genentech common stock owned by Roche
immediately after such issuance will be no lower than Roche's lowest
percentage ownership of Genentech common stock at any time after the offering
of common stock occurring in July 1999 and prior to the time of such
issuance, except that Genentech may issue shares up to an amount that would
cause Roche's lowest percentage ownership to be no more than 2% below the
"Minimum Percentage." The Minimum Percentage equals the lowest number of
shares of Genentech common stock owned by Roche since the July 1999 offering
(to be adjusted in the future for dispositions of shares of Genentech common
stock by Roche) divided by 254,597,176 (to be adjusted in the future for
stock splits or stock combinations), which is the number of shares of
Genentech common stock outstanding at the time of the July 1999 offering
adjusted for the two-for-one split of Genentech common stock in November
1999. As long as Roche's percentage ownership is greater than 50%, prior to
issuing any shares, Genentech must repurchase a sufficient number of shares
of its common stock to ensure that, immediately after its issuance of shares,
Roche's percentage ownership will be greater than 50%. Genentech has also
agreed, upon Roche's request, to repurchase shares of its common stock to
increase Roche's ownership to the Minimum Percentage.
Note 4. Earnings (Loss) Per Share
We excluded potentially dilutive securities composed of incremental common
shares issuable upon the exercise of stock options from the diluted loss per
share for the three- and six-month periods ended June 30, 2000 and 1999
because of their anti-dilutive effect.
Note 5. Comprehensive Income
Comprehensive income is comprised of net income and other comprehensive
income. Other comprehensive income includes certain changes in equity that
are excluded from net income. Specifically, unrealized holding gains and
losses on our available-for-sale securities, which were reported separately
in stockholders' equity, are included in accumulated other comprehensive
income. Comprehensive income (loss) and its components for the three- and
six-month periods ended June 30, 2000 and June 30, 1999 are as follows (in
thousands):
Three Months Six Months
Ended June 30, Ended June 30,
-------------------- --------------------
2000 1999 2000 1999
-------- --------- -------- ---------
Net (loss) $(14,160) $(923,192) $(40,065) $(908,777)
Change in unrealized
gain (loss) on securities
available-for-sale 27,055 (11,586) 63,811 (21,495)
-------- --------- -------- ---------
Comprehensive income (loss) $ 12,895 $(934,778) $ 23,746 $(930,272)
======== ========= ======== =========
Note 6. Legal Proceedings
We are a party to various legal proceedings, including patent infringement
litigation relating to our human growth hormone products and antibody
products, licensing and contract disputes, and other matters.
Page 10
On May 28, 1999, Glaxo Wellcome Inc. filed a patent infringement lawsuit
against us in the U.S. District Court in Delaware. The suit asserts that we
infringe four U.S. patents owned by Glaxo Wellcome. Two of the patents
relate to the use of specific kinds of monoclonal antibodies for the
treatment of human disease, including cancer. The other two patents asserted
against us relate to preparations of specific kinds of monoclonal antibodies
which are made more stable and the methods by which such preparations are
made. We have been served with the complaint. The complaint fails to
specify which of our products or methods of manufacture are allegedly
infringing the four patents at issue. However, we believe that the suit
relates to the manufacture, use and sale of our Herceptin and Rituxan
antibody products. On July 19, 1999, we filed our answer to Glaxo's
complaint, and in our answer we also stated counterclaims against Glaxo. The
judge has scheduled the trial of this suit to begin January 29, 2001. On or
about January 10, 2000, Glaxo filed a request with the Court to add
additional patent infringement claims to the suit under Glaxo's U.S. Patent
No. 5,633,162. On March 15, 2000, the Court denied that request.
We and the City of Hope Medical Center are parties to a 1976 agreement
relating to work conducted by two City of Hope employees, Arthur Riggs and
Keiichi Itakura, and patents that resulted from that work, which are referred
to as the "Riggs/Itakura Patents." Since that time, Genentech has entered
into license agreements with various companies to make, use and sell the
products covered by the Riggs/Itakura Patents. On August 13, 1999 the City
of Hope filed a complaint against us in the Superior Court in Los Angeles
County, California alleging that we owe royalties to the City of Hope in
connection with these license agreements, as well as product license
agreements that involve the grant of licenses under the Riggs/Itakura
Patents. The complaint states claims for declaratory relief, breach of
contract, breach of implied covenant of good faith and fair dealing, and
breach of fiduciary duty. On December 15, 1999, we filed our answer to the
City of Hope's complaint. The judge has scheduled the trial of this suit to
begin February 5, 2001.
On December 1, 1994, Genentech filed suit against Bio-Technology General
Corporation, or BTG, in the United States District Court in Delaware charging
BTG with infringement of two Genentech patents applicable to its human growth
hormone product. On February 28, 1995, Genentech filed an Amended Complaint
against BTG alleging infringement of an additional Genentech patent. On
January 6, 1995, BTG filed suit against Genentech in the United States
District Court for the Southern District of New York seeking declaratory
judgements that those patents and another Genentech patent are invalid and
not infringed by BTG. Genentech's suit in Delaware was then transferred to
New York and consolidated with BTG's suit there.
At the time of filing its suit and thereafter, BTG alleged various
antitrust, abuse of process, civil rights, malicious prosecution, and unfair
competition claims against Genentech. All of those claims were dismissed by
the District Court.
On August 10, 1995, the District Court issued a preliminary injunction
which prohibited BTG, pending the Court's final determination of the action,
from importing, making, using, selling, offering for sale or distributing in
the United States BTG's human growth hormone products except for certain
Page 11
ongoing U.S. Food and Drug Administration, or FDA, approved clinical trials.
BTG filed an appeal from the District Court's issuance of the preliminary
injunction to the United States Court of Appeals for the Federal Circuit. On
April 8, 1996, the Federal Circuit affirmed the preliminary injunction
granted by the District Court. On May 20, 1996, the Federal Circuit denied
BTG's petition for rehearing, and on October 7, 1996, the United States
Supreme Court declined to review the case.
In 1999, the case was transferred to a different judge of the District
Court for further proceedings. A jury trial of BTG's patent invalidity claim
began on January 10, 2000. On January 18, 2000, the jury returned a verdict
in Genentech's favor on a certain factual issue underlying BTG's invalidity
claim, but the judge nevertheless entered judgement in favor of BTG and
lifted the preliminary injunction that had been in effect against BTG since
1995. On February 23, 2000, we filed a motion with the Federal Circuit
requesting that the injunction against BTG be reinstated pending appeal and
for an expedited appeal. On May 8, 2000, the Federal Circuit denied our
motion.
Genentech and BTG each filed appeals with the Federal Circuit relating
to the proceedings in the District Court, and those appeals are now pending.
Genentech filed its appeal brief with the Federal Circuit on May 15, 2000.
BTG filed its appeal brief on July 11, 2000. In it, BTG included a request
that its antitrust claims against Genentech (which previously had been
dismissed by the District Court) be reinstated. The Federal Circuit has not
yet scheduled a date for hearing the appeals.
On June 7, 2000, Chiron Corporation filed a patent infringement suit against
us in the U.S. District Court in the Eastern District of California
(Sacramento), alleging that the manufacture, use, sale, and offer for sale of
our Herceptin antibody product infringes Chiron's U.S. Patent No. 6,054,561.
This patent relates to certain antibodies that bind to breast cancer cells
and/or other cells. On August 4, 2000, we filed our answer to Chiron's
complaint, and in our answer we also stated counterclaims against Chiron.
The judge has not yet scheduled the trial of this suit.
Based upon the nature of the claims made and the information available to
date to us and our counsel through investigations and otherwise, we believe
the outcome of these actions is not likely to have a material adverse effect
on our financial position, result of operations or cash flows. However, were
an unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the operating results of that period.
In addition to the above, in April 1999, we agreed to pay $50.0 million to
settle a federal investigation relating to our past clinical, sales and
marketing activities associated with human growth hormone.
Note 7. Inventories
We recognized expense of $31.4 million in the second quarter and $74.7
million in the first six months of 2000 related to the sale of inventory that
was written up as a result of the Redemption and push-down accounting.
Inventories are summarized below (in thousands):
Page 12
June 30, December 31,
2000 1999
------------ ------------
Raw materials and supplies $ 20,076 $ 19,903
Work in process 185,996 228,092
Finished goods 34,118 27,250
------------ ------------
Total $240,190 $275,245
============ ============
Page 13
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors and Stockholders
Genentech, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Genentech, Inc. as of June 30, 2000, and the related condensed consolidated
statements of operations for the three-month and six-month periods ended June
30, 2000 and 1999 and the condensed consolidated statements of cash flows for
the six-month periods ended June 30, 2000 and 1999. These financial
statements are the responsibility of Genentech's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data, and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with auditing standards generally accepted in the
United States, which will be performed for the full year with the objective
of expressing an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial
statements referred to above for them to be in conformity with accounting
principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Genentech,
Inc. as of December 31, 1999, and the related consolidated statements of
income, stockholders' equity, and cash flows for the year then ended (not
presented herein) and in our report dated January 18, 2000, we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 1999, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has
been derived.
ERNST & YOUNG LLP
San Jose, California
July 12, 2000
Page 14
GENENTECH, INC.
FINANCIAL REVIEW
Overview
Genentech is a leading biotechnology company that uses human genetic
information to discover, develop, manufacture and market human
pharmaceuticals for significant unmet medical needs. Fourteen of the
approved products of biotechnology stem from our science. We co-developed
Rituxan with IDEC Pharmaceuticals Corporation from whom we license Rituxan.
We manufacture and market nine products directly in the United States.
- - Herceptin (trastuzumab) antibody for the treatment of certain patients
with metastatic breast cancer whose tumors overexpress the human epidermal
growth factor receptor2, or HER2, protein;
- - Rituxan (rituximab) antibody for the treatment of patients with relapsed
or refractory low-grade or follicular, CD20-positive B-cell non-Hodgkin's
lymphoma;
- - Activase (alteplase) tissue plasminogen activator, or t-PA, for the
treatment of acute myocardial infarction, acute ischemic stroke within
three hours of the onset of symptoms, and acute massive pulmonary
embolism;
- - TNKase (tenecteplase) single-bolus thrombolytic agent for the treatment of
acute myocardial infarction;
- - Protropin (somatrem for injection) growth hormone for the treatment of
inadequate endogenous growth hormone secretion, or growth hormone
deficiency, in children;
- - Nutropin [somatropin (rDNA origin) for injection] growth hormone for the
treatment of growth hormone deficiency in children and adults, growth
failure associated with chronic renal insufficiency prior to kidney
transplantation and short stature associated with Turner syndrome;
- - Nutropin AQ [somatropin (rDNA origin) injection] liquid formulation growth
hormone for the same indications as Nutropin;
- - Nutropin Depot [somatropin (rDNA origin) for injectable suspension]
encapsulated long-acting growth hormone for the treatment of pediatric
growth hormone deficiency; and
- - Pulmozyme (dornase alfa, recombinant) inhalation solution for the
management of cystic fibrosis.
We receive royalties on sales of rituximab outside of the United States
(excluding Japan), on sales of Pulmozyme and Herceptin outside of the United
States and on sales of certain products in Canada from F. Hoffmann-La Roche
Ltd, an affiliate of Roche Holdings, Inc., that is commonly known as
Hoffmann-La Roche. We receive royalties on sales of growth hormone products
and t-PA outside of the United States and Canada, and we will receive
royalties on sales of rituximab in Japan through other licensees. We also
receive worldwide royalties on seven additional licensed products that are
marketed by other companies. Six of these products originated from our
technology.
Page 15
Redemption of Our Special Common Stock
On June 30, 1999, we redeemed all of our outstanding Special Common Stock
held by stockholders other than Roche Holdings, Inc., commonly known as
Roche, at a price of $41.25 per share in cash with funds deposited by Roche
for that purpose. We refer to this event as the "Redemption." As a result
of the Redemption, Roche's percentage ownership of our outstanding Common
Stock increased from 65% to 100%. Consequently, under U.S. generally
accepted accounting principles, we were required to use push-down accounting
to reflect in our financial statements the amounts paid for our stock in
excess of our net book value. Push-down accounting required us to record
$1,706.0 million of goodwill and $1,499.0 million of other intangible assets
onto our balance sheet in the second quarter of 1999. For more information
about push-down accounting, you should read the "Redemption of Our Special
Common Stock" note in the Notes to Condensed Consolidated Financial
Statements.
Relationship with Roche
On July 23, 1999, October 26, 1999, and March 29, 2000, Roche completed
public offerings of our Common Stock. We did not receive any of the net
proceeds from the offerings. On January 19, 2000, Roche completed an
offering of zero-coupon notes that are exchangeable for an aggregate of
6,517,309 shares of our Common Stock held by Roche. As a result of the
public offerings, Roche's percentage ownership of our outstanding Common
Stock was reduced to approximately 58.8% at June 30, 2000.
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in
connection with our stock option and stock purchase plans, and we may issue
additional shares for other purposes. The affiliation agreement requires us
to, among other things, establish a stock repurchase program designed to
maintain Roche's percentage ownership interest in our common stock. In
addition, Roche will have a continuing option to buy stock from us at
prevailing market prices to maintain its percentage ownership interest. To
ensure that, with respect to any issuance of common stock by Genentech in the
future, the percentage of Genentech common stock owned by Roche immediately
after such issuance will be no lower than Roche's lowest percentage ownership
of Genentech common stock at any time after the offering of common stock
occurring in July 1999 and prior to the time of such issuance, except that
Genentech may issue shares up to an amount that would cause Roche's lowest
percentage ownership to be no more than 2% below the "Minimum Percentage."
The Minimum Percentage equals the lowest number of shares of Genentech common
stock owned by Roche since the July 1999 offering (to be adjusted in the
future for dispositions of shares of Genentech common stock by Roche) divided
by 254,597,176 (to be adjusted in the future for stock splits or stock
combinations), which is the number of shares of Genentech common stock
outstanding at the time of the July 1999 offering adjusted for the two-for-
one split of our common stock in November 1999. As long as Roche's
percentage ownership is greater than 50%, prior to issuing any shares,
Genentech must repurchase a sufficient number of shares of its common stock
to ensure that, immediately after its issuance of shares, Roche's percentage
ownership will be greater than 50%. We have also agreed, upon Roche's
request, to repurchase shares of our common stock to increase Roche's
ownership to the Minimum Percentage.
Page 16
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Three Months Ended
June 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
REVENUES Actual Pro Forma Actual Pro Forma % Change
- ------------------- ------ --------- ------ --------- --------
Revenues $413.6 $413.6 $395.2 $374.9 10%
====== ========= ====== ========= ========
PRODUCT SALES
- -------------------
Herceptin $ 66.7 $ 66.7 $ 46.2 46.2 44%
Rituxan 102.8 102.8 74.4 74.4 38
Lytic 56.8 56.8 58.1 58.1 (2)
Growth hormone 49.9 49.9 59.3 59.3 (16)
Pulmozyme 32.3 32.3 30.6 30.6 6
Actimmune 0.9 0.9 0.7 0.7 29
------ --------- ------ --------- --------
Total product sales $309.4 $309.4 $269.3 $269.3 15%
====== ========= ====== ========= ========
Six Months Ended
June 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
REVENUES Actual Pro Forma Actual Pro Forma % Change
- -------------------- ------ --------- ------ --------- ---------
Revenues $799.3 $799.3 $717.5 $697.2 15%
====== ========= ====== ========= =========
PRODUCT SALES
- --------------------
Herceptin $135.4 $135.4 $ 86.1 86.1 57%
Rituxan 187.9 187.9 131.5 131.5 43
Lytic 104.3 104.3 110.1 110.1 (5)
Growth hormone 105.0 105.0 115.5 115.5 (9)
Pulmozyme 59.1 59.1 58.8 58.8 1
Actimmune 0.9 0.9 1.4 1.4 (36)
------ --------- ------ --------- ---------
Total product sales $592.6 $592.6 $503.4 $503.4 18%
====== ========= ====== ========= =========
Revenues increased 10% in the second quarter of 2000 and 15% in the first six
months of 2000 from the comparable periods in 1999 primarily as a result of
higher product sales. These increases are further discussed below.
Total product sales increased 15% in the second quarter of 2000 and 18% in
the first six months of 2000 from the comparable periods in 1999 primarily as
a result of higher sales from our bio-oncology products, Rituxan and
Herceptin.
Page 17
Herceptin: Net sales of Herceptin increased 44% in the second quarter of 2000
and 57% in the first six months of 2000 from the comparable periods in 1999.
Since the launch of Herceptin in the fourth quarter of 1998, an increase in
penetration into the breast cancer market has contributed to a positive sales
trend.
On May 3, 2000, we sent a letter to physicians advising them of some
serious adverse events that have been reported related to the use of
Herceptin and that have occurred subsequent to its approval. In 15 patients
who experienced such serious adverse events following Herceptin therapy,
death ensued. Nine of these patients died within 24 hours after Herceptin
administration. Most of these patients had significant pre-existing
pulmonary compromise as a consequence of lung disease or malignancies that
had spread to the lung. We are amending the package insert for Herceptin to
include this information.
Rituxan: Net sales of Rituxan increased 38% in the second quarter of 2000 and
43% in the first six months of 2000 from the comparable periods in 1999.
These increases were primarily due to increased market penetration for the
treatment of B-cell non-Hodgkin's lymphoma.
Lytic: Net sales of Lytic, our two cardiovascular products, Activase and
TNKase, were $56.8 million in the second quarter of 2000 and $104.3 million
in the first six months of 2000. TNKase received U.S. Food and Drug
Administration, or FDA, approval in early June 2000 and was launched in mid-
June 2000. The full impact of TNKase sales has not yet been realized. Sales
of Activase decreased in the second quarter and first six months of 2000 due
to continued competition from Centocor, Inc.'s Retavase, registered
trademark, and a decline in the overall size of the acute myocardial
infarction market as a result of mechanical reperfusion and early
intervention with other therapies.
Growth Hormone: Net sales of our four growth hormone products, Protropin,
Nutropin, Nutropin AQ and Nutropin Depot, decreased 16% in the second quarter
of 2000 and 9% in the first six months of 2000 from the comparable periods in
1999. These decreases were due primarily to fluctuations in distributor
ordering patterns. Distributors reduced inventory levels in the second
quarter partially in anticipation of the launch of Nutropin Depot. The
launch occurred on June 28, 2000, therefore, Nutropin Depot sales had minimal
impact on the quarter and on the first six months of 2000.
Pulmozyme: Net sales of Pulmozyme in the second quarter of 2000 were
slightly higher than the comparable period of 1999. Sales of Pulmozyme in
the first six months of 2000 were comparable to the first six months of 1999.
Three Months Ended
June 30,
-------------------------------------
2000 1999
ROYALTIES, CONTRACT AND ----------------- ----------------- Pro Forma
OTHER, AND INTEREST INCOME Actual Pro Forma Actual Pro Forma % Change
- -------------------------- ------ --------- ------ --------- ---------
Royalties $ 49.6 $ 49.6 $ 46.0 $ 46.0 8%
Contract and other 32.3 32.3 57.9 37.6 (14)
Interest income 22.3 22.3 22.0 22.0 1
Page 18
Six Months Ended
June 30,
-------------------------------------
2000 1999
ROYALTIES, CONTRACT, AND ----------------- ----------------- Pro Forma
OTHER, AND INTEREST INCOME Actual Pro Forma Actual Pro Forma % Change
- -------------------------- ------ --------- ------ --------- ---------
Royalties $ 97.0 $ 97.0 $ 92.6 $ 92.6 5%
Contract and other 66.0 66.0 77.1 56.8 16
Interest income 43.7 43.7 44.4 44.4 (2)
Royalty Income: Royalty income increased 8% in the second quarter of 2000
and increased 5% in the first six months of 2000 from the comparable periods
in 1999. These increases were due to higher third-party sales from various
licensees.
Contract and Other Revenues: Contract and other revenues in the second
quarter and first six months of 2000 decreased from the comparable periods in
1999 primarily as a result of higher revenues in the second quarter of 1999.
In the second quarter of 1999, we recognized $20.3 million of gains related
to the write-up of marketable securities as a result of push-down accounting
as described above in the "Redemption of Our Special Common Stock" note in
the Notes to Condensed Consolidated Financial Statements.
Pro forma contract and other revenues decreased 14% in the second
quarter of 2000 from the comparable period in 1999. This decrease was due to
lower revenues from our strategic alliances with third-party collaborators.
In the second quarter of 1999 we received an initial license fee and
retroactive royalties pursuant to a licensing agreement with Immunex
Corporation for Enbrel, registered trademark, a milestone payment from
Schwarz Pharma AG related to a FDA filing for Nutropin Depot and higher
revenues from Roche primarily related to Herceptin. This decrease was offset
in part by higher gains from the sale of biotechnology equity securities.
Pro forma contract and other revenues increased 16% in the first six months
of 2000 from the comparable period in 1999 primarily due to a greater amount
of gains from sales of biotechnology equity securities, offset in part by
lower revenues from our strategic alliances as discussed above.
Interest Income: Interest income in the second quarter and first six months
of 2000 was comparable to the same periods in 1999.
Three Months Ended
June 30,
---------------------------------------
2000 1999
----------------- ------------------- Pro Forma
COST AND EXPENSES Actual Pro Forma Actual Pro Forma % Change
- ------------------------- ------ --------- -------- --------- ---------
Cost of sales $ 97.6 $ 66.3 $ 52.7 $ 52.7 26%
Research and development 115.5 115.5 94.2 94.2 23
Marketing, general and
administrative 117.2 117.2 117.4 117.4 -
Special charge:
Related to redemption - - 1,147.3 - -
Recurring charges related
to redemption 98.1 - - - -
Interest expense 1.2 1.2 1.3 1.3 (8)
------ --------- -------- --------- ---------
Total costs and expenses $429.6 $300.2 $1,412.9 $265.6 13%
====== ========= ======== ========= =========
Page 19
Six Months Ended
June 30,
--------------------------------------
2000 1999
----------------- ------------------ Pro Forma
COST AND EXPENSES Actual Pro Forma Actual Pro Forma % Change
- ------------------------- ------ --------- -------- --------- ---------
Cost of sales $203.8 $129.1 $ 98.4 $ 98.4 31%
Research and development 227.0 227.0 184.9 184.9 23
Marketing, general and
administrative 219.1 219.1 214.6 214.6 2
Special charges:
Legal settlements - - 50.0 - -
Related to redemption - - 1,147.3 - -
Recurring charges related
to redemption 196.6 - - - -
Interest expense 2.5 2.5 2.7 2.7 (7)
------ --------- -------- --------- ---------
Total costs and expenses $849.0 $577.7 $1,697.9 $500.6 15%
====== ========= ======== ========= =========
Cost of Sales: Cost of sales increased 85% in the second quarter of 2000 and
increased 107% in the first six months of 2000 from the comparable periods in
1999. This increase largely reflects the costs related to the sale of
inventory that was written up at the Redemption due to push-down accounting
and higher product sales. The remaining inventory that was written up is
expected to be sold during the second half of this year.
Pro forma cost of sales, exclusive of the expense related to the sale of
the inventory written up at the Redemption, increased 26% in the second
quarter and 31% in the first six months of 2000 from the comparable periods
in 1999. Pro forma cost of sales as a percent of net sales was 21% in the
second quarter of this year compared to 20% in the prior year. Pro forma
cost of sales as a percent of net sales was 22% in the first six months of
1999 compared to 20% in 1999. These increases primarily reflect higher sales
volume, including higher sales to Hoffmann-La Roche.
Research and Development: Research and development, or R&D, expenses
increased 23% in the second quarter and first six months of 2000 from the
comparable periods in 1999. The second quarter increase is partially related
to a milestone payment made under a collaboration contract. The increase in
the first six months primarily reflect a $15 million upfront payment for the
purchase of in-process research and development, or IPR&D, under an in-
licensing agreement with Actelion Ltd., for the rights to develop and co-
promote tezosentan in the United States for the potential treatment of acute
heart failure. We determined that the acquired IPR&D was not yet
technologically feasible and that it had no future alternative uses.
Actelion is leading the development effort of tezosentan and the project is
currently in Phase III clinical trials. For the second quarter and first six
months of 2000, we invested 28% of pro forma revenues into R&D compared to
25% for the second quarter in 1999 and 27% in the first six months of 1999.
R&D expenses as a percent of revenues are expected to vary over the next
several periods dependent on possible in-licensing agreements and as products
progress through late-stage clinical trials.
Marketing, General and Administrative: Overall marketing, general and
administrative expenses in the second quarter and first six months of 2000
were comparable to 1999. However, marketing and sales expenses increased in
Page 20
2000 while general and administrative expenses decreased. The marketing and
sales increases were driven by the continued support of our growing bio-
oncology business and the launch of TNKase and prelaunch of anti-IgE (rhuMAb-
E25), a recombinant humanized monoclonal antibody to IgE for the potential
treatment of allergic asthma and seasonal allergic rhinitis. The decrease in
general and administrative expenses was mostly due to the write-down of
certain biotechnology investments and higher legal expenses in the prior
year.
Special Charges: The second quarter of 1999 included a $1,147.3 million
special charge related to the Redemption and the application of push-down
accounting. This charge included a non-cash charge of $752.5 million for in-
process research and development, $284.5 million for the cash-out of Special
Common Stock options and $102.3 million as a non-cash charge for the
remeasurement of the value of continuing employee stock options. The first
six months of 1999 also included a $50.0 million legal settlement related to
a federal investigation of our past clinical, sales and marketing activities
associated with human growth hormone.
Recurring Charges Related to Redemption: We began recording recurring
charges related to the Redemption and push-down accounting in the third
quarter of 1999. These charges were approximately $98.1 million in the
second quarter of 2000 and were comprised of $95.3 million for the
amortization of intangibles and goodwill, and $2.8 million of compensation
expense related to alternative arrangements provided at the time of the
Redemption for certain holders of some of the unvested options under the 1996
Stock Option/Stock Incentive Plan. These charges were approximately $196.6
million in the first six months of 2000 and were comprised of $190.5 million
for the amortization of intangibles and goodwill, and $6.1 million of
compensation expense related to alternative arrangements provided at the time
of the Redemption for certain holders of some of the unvested options under
the 1996 Stock Option/Stock Incentive Plan.
Interest Expense: Interest expense will fluctuate depending on the amount of
capitalized interest related to the amount of construction projects.
Interest expense, net of amounts capitalized, relates to interest on our 5%
convertible subordinated debentures.
Three Months Ended
June 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
INCOME TAX Actual Pro Forma Actual Pro Forma % Change
- -------------------------------- ------ --------- ------ --------- ---------
Income tax (benefit) provision $ (1.8) $ 35.2 $(94.5) $ 36.1 (2)%
Six Months Ended
June 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
INCOME TAX Actual Pro Forma Actual Pro Forma % Change
- -------------------------------- ------ --------- ------ --------- ---------
Income tax (benefit) provision $ (9.6) $ 68.7 $(71.6) $ 64.9 6%
Page 21
Income Tax: The income tax provision benefit of $1.8 million for the second
quarter of 2000 consists of tax expense of $35.2 million on pretax income
excluding the impact of push-down accounting, and tax benefits of $37.0
million related to push-down accounting. The tax provision benefit of $9.6
million for the first six months of 2000 consists of tax expense of $68.7
million on pretax income excluding the impact of push-down accounting, and
tax benefits of $78.3 million related to push-down accounting. The tax
provision benefit of $94.5 million for the second quarter and $71.6 million
for the first six months of 1999 consisted of tax expense of $51.8 million
and $80.6 million, respectively, on pretax income excluding special charges
and legal settlement and tax benefits of $146.3 million for the second
quarter and $152.2 million for the first six months of 1999 related to the
income and deductions attributable to push-down accounting and legal
settlement.
Our effective tax rate was approximately 12% for the second quarter and
19% for the first six months of 2000, which reflects the non-deductibility of
goodwill amortization. The effective tax rate on pretax income excluding
special charges and the legal settlement was 47% for the second quarter and
41% for the first six months of 1999, which reflected the anticipated impact
of non-deductible goodwill amortization on the full year 1999 effective tax
rate.
The pro forma effective tax rate of 31% in the second quarter and first
six months of 2000 is lower than the 33% tax rate in the comparable periods
of 1999. The decrease in the tax rate is primarily due to increased R&D tax
credits.
Three Months Ended
June 30,
---------------------------------------
2000 1999
----------------- ------------------- Pro Forma
NET INCOME (LOSS) Actual Pro Forma Actual Pro Forma % Change
- ------------------------- ------ --------- -------- --------- ---------
Net income (loss) $(14.2) $ 78.2 $ (923.2) $ 73.2 7%
Earnings (loss) per share:
Basic (0.05) 0.30 (3.59) 0.28 7
Diluted (0.05) 0.29 (3.59) 0.27 7
Six Months Ended
June 30,
---------------------------------------
2000 1999
----------------- ------------------- Pro Forma
NET INCOME (LOSS) Actual Pro Forma Actual Pro Forma % Change
- ------------------------- ------ --------- -------- --------- ---------
Net income (loss) $(40.1) $152.9 $ (908.8) $131.7 16%
Earnings (loss) per share:
Basic (0.15) 0.59 (3.55) 0.51 16
Diluted (0.15) 0.57 (3.55) 0.50 14
The net loss for the second quarter and first six months of 2000 primarily
reflects recurring charges for the amortization of goodwill and other
intangible assets related to the Redemption and push-down accounting, and
costs related to the sale of inventory that was written up at the Redemption.
The net loss in the second quarter and first six months of 1999 was due to
Page 22
special charges related to the Redemption and push-down accounting, and the
legal settlement recorded in the first quarter of 1999. For further
information, read "Redemption of our Special Common Stock" note in the Notes
to Condensed Consolidated Financial Statements and the Special Charges and
Recurring Charges Related to Redemption sections above.
Pro forma net income, which excludes ongoing charges related to the
Redemption and push-down accounting, for the second quarter of 2000 was $78.2
million and for the first six months of 2000 was $152.9 million. The
increases from the prior year were largely due to higher sales of our bio-
oncology products, partly offset by higher cost of sales and R&D expenses.
In-Process Research and Development: At June 30, 1999, the Redemption date,
we determined that the acquired in-process technology was not technologically
feasible and that the in-process technology had no future alternative uses.
As a result, $500.5 million of in-process research and development, or IPR&D,
related to Roche's 1990 through 1997 purchases of our Common Stock was
charged to retained earnings, and $752.5 million of IPR&D related to the
Redemption was charged to operations at June 30, 1999.
The amounts of IPR&D were determined based on an analysis using the
risk-adjusted cash flows expected to be generated by the products that result
from the in-process projects. The forecast data used in the analysis was
based on internal product level forecast information maintained by our
management in the ordinary course of managing the business. The inputs used
by us in analyzing IPR&D were based on assumptions, which we believed to be
reasonable but which were inherently uncertain and unpredictable. These
assumptions may be incomplete or inaccurate, and no assurance can be given
that unanticipated events and circumstances will not occur.
A brief description of projects that were included in the IPR&D charge
is set forth below, including an estimated percentage of completion as of
June 30, 1999, the Redemption date. Projects subsequently added to the
research and development pipeline are not included. Except as otherwise
noted below, there have been no significant changes to the projects since the
Redemption date. We do not track all costs associated with research and
development on a project-by-project basis. Therefore, we believe a
calculation of cost incurred as a percentage of total incurred project cost
as of the FDA approval is not possible. We estimate, however, that the
research and development expenditures that will be required to complete the
in-process projects will total at least $650.0 million, as compared to $700.0
million as of the Redemption date. This estimate reflects discontinued
projects and decreases in cost to complete estimates for other projects,
partially offset by an increase in certain cost estimates related to early
stage projects.
The foregoing discussion of our IPR&D projects, and in particular the
following table and subsequent paragraphs regarding the future of these
projects, our additional product programs and our process technology program
include forward-looking statements that involve risks and uncertainties, and
actual results may vary materially. For a discussion of risk factors that
may affect projected completion dates and the progress of research and
development, see "Forward-Looking Information and Cautionary Factors that May
Affect Future Results - The Results of Our Research and Development Are
Unpredictable," "- Protecting Our Proprietary Rights Is Difficult and Costly"
and "- Our Products Are Subject to Governmental Regulations and Approvals."
Page 23
As of the Redemption Date, June 30, 1999
--------------------------------------------
PHASE OF SUBSTANTIAL
PROJECT DESCRIPTION/INDICATION DEVELOPMENT COMPLETION DATE % COMPLETE
- -------------------------------- ---------------------------------- ------------- --------------- ----------
Nutropin Depot long-acting dosage form of Awaiting 2000 85%
recombinant growth hormone Regulatory
Approval
TNKase second acute myocardial infarction Awaiting 2000 90%
generation t-PA Regulatory
Approval
Anti-IgE antibody allergic asthma, seasonal Phase III 2001 75%
allergic rhinitis
Pulmozyme early-stage cystic fibrosis Phase III 2003 75%
Dornase alfa AERx, trademark, cystic fibrosis Preparing for 2003 45%
Delivery System clinical
testing
Rituxan antibody intermediate- and high-grade Phase III 2004 60%
non-Hodgkin's lymphoma
Xubix (sibrafiban) orally administered inhibitor of Phase III 2000 65%
oral IIb/IIIa antagonist platelet aggregation
Activase t-PA intravenous catheter clearance Preparing 1999 90%
for Phase III
Anti-CD11a antibody (hull24) psoriasis Preparing 2003 50%
For Phase III
Herceptin antibody adjuvant therapy for breast Preparing 2007 45%
cancer for Phase III
Thrombopoietin (TPO) thrombocytopenia related to Preparing 2002 55%
cancer treatment for Phase III
Anti-CD18 antibody acute myocardial infarction Phase II 2004 55%
Anti-VEGF antibody colorectal and lung cancer Phase II 2003 35-40%
Herceptin antibody other tumors Phase II 2004 40-45%
AMD Fab age-related macular degeneration Preparing 2004 20%
for Phase I
LDP-02 inflammatory bowel disease Phase Ib/IIa 2005 30%
Our IPR&D at the Redemption date included a process technology program.
The process technology program included the research and development of ideas
and techniques that could improve the bulk production of antibodies,
including cell culture productivity, and streamlined and improved recovery
processes, and improvements in various areas of pharmaceutical manufacturing.
We estimated that the process technology program was approximately 50%
complete at the Redemption date.
The significant changes to the projects in the IPR&D charge since the
Redemption date through June 30, 2000, include:
- - Nutropin Depot long-acting growth hormone - project received FDA approval
in December 1999.
- - TNKase second generation t-PA - project received FDA approval in June
2000.
Page 24
- - Anti-IgE antibody - project has moved from Phase III studies to filing for
FDA approval.
- - Xubix (sibrafiban) oral IIb/IIIa antagonist - project has been
discontinued.
- - Anti-CD18 antibody - project has been discontinued.
- - Anti-VEGF antibody - project has moved from Phase II studies to preparing
for Phase III studies.
- - Dornase alfa AERx - project has moved to Phase IIa studies.
- - Activase t-PA - project has completed one Phase III trial and regulatory
filings are being prepared.
- - Anti-CD11a antibody - project has moved to Phase III.
- - Herceptin antibody for adjuvant therapy for breast cancer - project has
moved to Phase III.
- - Thrombopoietin (TPO) - project has moved to Phase III.
- - AMD Fab - project has moved to Phase I trials.
- - LDP-02 - project has moved to Phase II studies.
LIQUIDITY AND CAPITAL RESOURCES June 30, 2000 December 31, 1999
- -------------------------------------- ------------- -----------------
Cash and cash equivalents, short-term
investments and long-term marketable
securities $ 2,101.1 $ 1,957.4
Working capital $ 1,116.4 842.4
We used cash generated from operations, income from investments and proceeds
from stock issuances to fund operations, purchase marketable securities and
make capital and equity investments.
Cash and cash equivalents, short-term investments and long-term marketable
securities at June 30, 2000, increased from December 31, 1999. Working
capital increased by $274.0 million in the second quarter of 2000 from
December 31, 1999.
Capital expenditures totaled $53.6 million in the first six months of 2000
compared to $41.5 million in the comparable period of 1999. The increase in
2000 compared to 1999 was primarily due to an increase in equipment
purchases, an initial payment for an additional manufacturing facility and an
increase in construction and plant validation activity related to
manufacturing facilities.
We believe that our cash, cash equivalents and short-term investments,
together with funds provided by operations and leasing arrangements, will be
sufficient to meet our foreseeable operating cash requirements. In addition,
we believe we could access additional funds from the debt and, under certain
circumstances, capital markets. See also "A Variety of Factors Could Affect
Our Cash Position" below for factors that could negatively affect our cash
position.
FORWARD-LOOKING INFORMATION AND CAUTIONARY FACTORS THAT MAY AFFECT FUTURE
RESULTS
The following section contains forward-looking information based on our
current expectations. Because our actual results may differ materially from
this and any other forward-looking statements made by or on behalf of
Genentech, this section also includes a discussion of important factors that
could affect our actual future results, including our product sales,
royalties, contract revenues, expenses and net income.
Page 25
Our Operating Results May Fluctuate from Period to Period
Our operating results may vary from period to period for several reasons
including:
- - The overall competitive environment for our products.
For example, sales of our Activase product decreased in 1998 from 1997
primarily due to competition from Centocor Inc.'s competing product which
received FDA approval in October 1996.
- - The amount and timing of sales to customers in the United States.
For example, sales of our three growth hormone products increased in 1999
due to fluctuations in distributor ordering patterns.
- - The amount and timing of our sales to Hoffmann-La Roche of products for
sale outside of the United States and the amount and timing of its sales
to its customers, which directly impact both our product sales and royalty
revenues.
- - The timing and volume of bulk shipments to licensees.
- - The availability of third-party reimbursements for the cost of therapy.
- - The effectiveness and safety of our various products as determined both in
clinical testing and by the accumulation of additional information on each
product after it is approved for sale.
- - The rate of adoption and use of our products for approved indications and
additional indications.
For example, sales of Pulmozyme increased in 1998 due, in part, to new
patients who were attracted to our product as a result of an FDA approval
for a label extension to include cystic fibrosis patients under the age of
five.
- - The potential introduction of new products and additional indications for
existing products in 2000 and beyond.
- - The ability to manufacture sufficient quantities of any particular
marketed product.
These fluctuations may not match the expectations of securities analysts and
investors. This could cause the trading price of our common stock to
decline.
The Successful Development of Pharmaceutical Products is Highly Uncertain
Successful pharmaceutical product development is highly uncertain and is
dependent on numerous factors, many of which are beyond our control.
Products that appear promising in the early phases of development may fail to
reach the market for several reasons including:
- - preclinical and clinical trails that may show the product to be
ineffective or to have harmful side effects;
- - failure to receive the necessary regulatory approvals;
Page 26
- - manufacturing costs or other factors that make the product uneconomical;
or
- - the proprietary rights of others and their competing products and
technologies that may prevent the product from being commercialized.
Success in preclinical and early clinical trials does not ensure that large-
scale clinical trials will be successful. Clinical results are frequently
susceptible to varying interpretations that may delay, limit or prevent
regulatory approvals. The length of time necessary to complete clinical
trials and to submit an application for marketing approval for a final
decision by a regulatory authority varies significantly and may be difficult
to predict.
Factors affecting our research and development expenses include, but are not
limited to:
- - The number of and the outcome of clinical trials currently being conducted
by us and/or our collaborators.
For example, in June 2000, we announced that the preliminary results from
our 415-patient Phase II clinical trial of our recombinant humanized anti-
CD18 monoclonal antibody fragment, which is known as rhuMAb CD18, for the
treatment of myocardial infarction, more commonly known as a heart attack,
did not meet its primary objectives.
- - The number of products entering into development from late-stage research.
For example, there is no guarantee that internal research efforts will
succeed in generating sufficient data for us to make a positive
development decision or that an external candidate will be available on
terms acceptable to us. In the past, promising candidates have not
yielded sufficiently positive pre-clinical results to meet our stringent
development criteria.
- Hoffmann-La Roche's decisions whether to exercise its options to develop
and sell our future products in non-U.S. markets and the timing and
amount of any related development cost reimbursements.
- - In-licensing activities, including the timing and amount of related
development funding or milestone payments.
For example, in February 2000, we entered into an agreement with Actelion
Ltd. for the development and co-promotion in the United States of
tezosentan, and paid Actelion an upfront fee of $15 million.
- - Future levels of revenue.
Roche, Our Controlling Stockholder, May Have Interests That Are Adverse to
Other Stockholders
As our majority stockholder, Roche controls the outcome of actions requiring
the approval of our stockholders. Our bylaws provide, among other things,
that the composition of our board of directors shall consist of two Roche
directors, three independent directors nominated by a nominating committee
and one Genentech employee nominated by the nominating committee. As long as
Roche owns in excess of 50% of our common stock, Roche directors will
Page 27
comprise two of the three members of the nominating committee. However, at
any time until Roche owns less than 5% of our stock, Roche will have the
right to obtain proportional representation on our board. Roche intends to
continue to allow our current management to conduct our business and
operations as we have done in the past. However, we cannot assure
stockholders that Roche will not institute a new business plan in the future.
Roche's interests may conflict with stockholders' interests.
Our Affiliation Agreement with Roche Could Limit Our Ability to Make
Acquisitions and Could Have A Material Impact on Our Liquidity
The affiliation agreement between us and Roche contain provisions that:
- - requires the approval of the directors designated by Roche to make any
acquisition or any sale or disposal of all or a portion of our business
representing 10% or more of our assets, net income or revenues;
- - enable Roche to maintain its percentage ownership interest in our common
stock; and
- - establish a stock repurchase program designed to maintain Roche's
percentage ownership interest in our common stock.
These provisions may have the effect of limiting our ability to make
acquisitions and while the dollar amounts associated with the stock
repurchase program cannot currently be estimated, those stock repurchases
could have a material adverse impact on our liquidity.
Our Stockholders May Be Unable to Prevent Transactions That are Favorable to
Roche but Adverse to Us
Our certificate of incorporation includes provisions relating to:
- - competition by Roche with us;
- - offering of corporate opportunities;
- - transactions with interested parties;
- - intercompany agreements; and
- - provisions limiting the liability of specified employees.
Our certificate of incorporation provides that any person purchasing or
acquiring an interest in shares of our capital stock shall be deemed to have
consented to the provisions in the certificate of incorporation relating to
competition with Roche, conflicts of interest with Roche, the offer of
corporate opportunities to Roche and intercompany agreements with Roche.
This deemed consent may restrict stockholders' ability to challenge
transactions carried out in compliance with these provisions.
Potential Conflicts of Interest Could Limit Our Ability to Act on
Opportunities that are Adverse to Roche
Persons who are directors and/or officers of Genentech and who are also
directors and/or officers of Roche may decline to take action in a manner
that might be favorable to us but adverse to Roche. Two of our directors,
Page 28
Dr. Franz B. Humer and Dr. Jonathan K.C. Knowles, currently serve as
directors, officers and employees of Roche Holding Ltd and its affiliates.
We May be Unable to Retain Skilled Personnel and Maintain Key Relationships
The success of our business depends, in large part, on our continued ability
to attract and retain highly qualified management, scientific, manufacturing
and sales and marketing personnel, and on our ability to develop and maintain
important relationships with leading research institutions and key
distributors. Competition for these types of personnel and relationships is
intense.
Roche has the right to maintain its percentage ownership interest in our
common stock. Our affiliation agreement with Roche requires us to, among
other things, establish a stock repurchase program designed to maintain
Roche's percentage ownership in our common stock if we issue or sell any
shares. This right of Roche may limit our flexibility as to the number of
shares we are able to grant under our stock option plans. We therefore
cannot assure stockholders that we will be able to attract or retain skilled
personnel or maintain key relationships.
We Face Growing and New Competition
We face growing competition in two of our therapeutic markets and expect new
competition in a third market. First, in the thrombolytic market, Activase
has lost market share and could lose additional market share to Centocor,
Inc.'s Retavase, registered trademark, (reteplase), either alone or in
combination with the use of another Centocor, Inc. product, ReoPro,
registered trademark, (abciximab); the resulting adverse effect on sales
could be material. Retavase received approval from the U.S. Food and Drug
Administration, commonly known as the FDA, in October 1996 for the treatment
of acute myocardial infarction. There is also an increasing use of
mechanical reperfusion in lieu of thrombolytic therapy for the treatment of
acute myocardial infarction, which we expect to continue.
Second, in the growth hormone market, we continue to face increased
competition from four other companies currently selling growth hormone and an
additional company which may enter the market in the near future. As a
result of that competition, we have experienced a loss in new patient market
share. The four competitors have also received approval to market their
existing human growth hormone products for additional indications. As a
result of this competition, our sales of Protropin, Nutropin and Nutropin AQ
may decline, perhaps significantly.
Third, in the non-Hodgkin's lymphoma market, Coulter Pharmaceuticals
Inc., or Coulter, is expected to file a revised Biologics License
Application, or BLA, in 2000 for a product that would compete with our
product Rituxan. We are also aware of other potentially competitive biologic
therapies for non-Hodgkin's lymphoma in development.
Other Competitive Factors Could Affect Our Product Sales
Other competitive factors that could affect our product sales include, but
are not limited to:
- - The timing of FDA approval, if any, of competitive products.
Page 29
For example, in June 2000 one of our competitors, Novo Nordisk, received
FDA approval for a liquid formulation of its growth hormone product that
will directly compete with our liquid formulation, Nutropin AQ. And in
June 2000, another of our competitors, Serono, received FDA approval to
deliver its competitive growth hormone product in a needle-free device.
- - Our pricing decisions and the pricing decisions of our competitors.
For example, we raised the prices of Rituxan in May 2000 and Pulmozyme in
June 2000 by approximately 5%.
- - The degree of patent protection afforded to particular products.
For example, in January 2000, a federal court judge lifted a preliminary
injunction that had been in effect since 1995 against Bio-technology
General Corporation, more commonly known as BTG. BTG is now permitted to
sell its competitive growth hormone product in the United States.
- - The outcome of litigation involving our patents and patents of other
companies for products and processes related to production and formulation
of those products.
For example, as further described in "Protecting Our Proprietary Rights is
Difficult and Costly," in May 2000 and June 2000, two complaints were
filed against us by companies which alleged that we infringed their
patents by the manufacture and sale of our products.
- - The increasing use and development of alternate therapies.
For example, the overall size of the market for thrombolytic therapies,
such as our Activase product, continues to decline as a result of the
increasing use of mechanical reperfusion.
- - The rate of market penetration by competing products.
For example, in the past, we have lost market share to new competitors in
the thrombolytic and growth hormone markets.
In Connection with the Redemption of Our Special Common Stock, We Recorded
Substantial Goodwill and Other Intangibles, the Amortization of Which Will
Adversely Affect Our Earnings
As a result of the redemption of our special common stock, Roche owned all of
our outstanding common stock. Consequently, push-down accounting under
generally accepted accounting principles was required. Push-down accounting
required us to establish a new accounting basis for our assets and
liabilities, based on Roche's cost in acquiring all of our stock. In other
words, Roche's cost of acquiring Genentech was "pushed down" to us and
reflected on our financial statements. Push-down accounting required us to
record goodwill and other intangible assets of approximately $1,706.0 million
and $1,499.0 million, respectively, during the second quarter of 1999. The
amortization of this goodwill and other intangible assets will have a
significant negative impact on our financial results in future years. In
addition, we will continuously evaluate whether events and circumstances have
occurred that indicate the remaining balance of this and other intangible
assets may not be recoverable. If our assets need to be evaluated for
possible impairment, we may have to reduce the carrying value of our
intangible assets. This could have a material adverse effect on our
Page 30
financial condition and results of operations during the periods in which we
recognize a reduction. We may have to write down intangible assets in future
periods. For more information about push-down accounting, see the notes to
our consolidated financial statements included in our annual report on Form
10-K for the year ended December 31, 1999, which we have incorporated by
reference into this prospectus.
Our Royalty and Contract Revenues Could Decline
Royalty and contract revenues in future periods could vary significantly.
Major factors affecting these revenues include, but are not limited to:
- - Hoffmann-La Roche's decisions whether to exercise its options and option
extensions to develop and sell our future products in non-U.S. markets and
the timing and amount of any related development cost reimbursements.
- - Variations in Hoffmann-La Roche's sales and other licensees' sales of
licensed products.
For example, we began receiving royalty revenues from Immunex
Corporation's sale of Enbrel in 1999.
- - The conclusion of existing arrangements with other companies and Hoffmann-
La Roche.
For example, royalty revenues decreased in 1998 from 1997 due to the
expiration of royalties primarily on sales of human insulin, from Eli
Lilly and Company in August 1998.
- - The timing of non-U.S. approvals, if any, for products licensed to
Hoffmann-La Roche and other licensees.
For example, we expect the timing of the approval of Herceptin outside the
United States to have an impact on royalties.
- - Fluctuations in foreign currency exchange rates.
- - The initiation of new contractual arrangements with other companies.
For example, license fees from Immunex and Schwarz Pharma increased
contract revenues in 1999.
- - Whether and when contract benchmarks are achieved.
For example, milestone payments from Pharmacia & Upjohn increased contract
revenue in 1997.
- - The failure of or refusal of a licensee to pay royalties.
- - The expiration or invalidation of patents or other licensed intellectual
property.
Protecting Our Proprietary Rights is Difficult and Costly
The patent positions of pharmaceutical and biotechnology companies can be
highly uncertain and involve complex legal and factual questions.
Accordingly, we cannot predict the breadth of claims allowed in these
Page 31
companies' patents. Patent disputes are frequent and can preclude the
commercialization of products. We have in the past been, are currently, and
may in the future be involved in material patent litigation. Patent
litigation is costly in its own right and could subject us to significant
liabilities to third-parties. In addition, an adverse decision could force
us to either obtain third-party licenses at a material cost or cease using
the technology or product in dispute. For example, in late 1999 we settled a
patent infringement lawsuit brought against us by the Regents of the
University of California in which the University alleged that the manufacture
and sale of our Protropin and Nutropin growth hormone products infringed a
patent owned by the University. In connection with that settlement we paid
the University of California $150 million and donated $50 million for the
construction of a new life sciences building on the University of California,
San Francisco campus. The presence of patents or other proprietary rights
belonging to other parties may lead to the termination of the research and
development of a particular product.
We believe that we have strong patent protection or the potential for
strong patent protection for a number of our products that generate sales and
royalty revenue or that we are developing. However, the courts will
determine the ultimate strength of patent protection of our products and
those on which we earn royalties.
Two lawsuits have been filed against us in which the companies involved
allege that we have infringed their patents by the manufacture and sale of
our products:
- - In May 2000, GlaxoWellcome filed a lawsuit in which it alleged that our
manufacture and sale of Rituxan and Herceptin infringed the claims of
GlaxoWellcome patents that have claims relating to the use of monoclonal
antibodies as human therapeutics.
- - In June 2000, Chiron Corporation filed a lawsuit in which it alleged that
our manufacture and sale of Herceptin infringed a patent it owned.
We May Incur Material Litigation Costs
Litigation to which we are currently or have been subjected relates to, among
other things, our patent and intellectual property rights, licensing
arrangements with other persons, product liability and financing activities.
We cannot predict with certainty the eventual outcome of pending litigation,
and we might have to incur substantial expense in defending these lawsuits.
We have in the past taken substantial special charges relating to litigation,
including special charges of $230.0 million in 1999.
We May Incur Material Product Liability Costs
The testing and marketing of medical products entail an inherent risk of
product liability. Pharmaceutical product liability exposures could be
extremely large and pose a material risk. Our business may be materially and
adversely affected by a successful product liability claim in excess of any
insurance coverage that we may have.
We May be Unable to Obtain Regulatory Approvals for Our Products
The pharmaceutical industry is subject to stringent regulation with respect
to product safety and efficacy by various federal, state and local
Page 32
authorities. Of particular significance are the FDA's requirements covering
research and development, testing, manufacturing, quality control, labeling
and promotion of drugs for human use. A pharmaceutical product cannot be
marketed in the United States until it has been approved by the FDA, and then
can only be marketed for the indications and claims approved by the FDA. As
a result of these requirements, the length of time, the level of expenditures
and the laboratory and clinical information required for approval of a New
Drug Application, or NDA, or a BLA, are substantial and can require a number
of years. In addition, after any of our products receive regulatory
approval, it is subject to ongoing FDA regulation, including, for example,
changes to its label and product recall.
We cannot be sure that we can obtain necessary regulatory approvals on a
timely basis, if at all, for any of the products we are developing or that we
can maintain necessary regulatory approvals for our existing products, and
all of the following could have a material adverse effect on our business:
- - Significant delays in obtaining or failing to obtain required approvals.
For example:
- in 1999, our Phase III clinical trial of recombinant human nerve
growth factor, which is known as rhNGF, for use in diabetic
peripheral neuropathy did not meet its objectives and we decided not
to file for product approval with the FDA;
- in 1999, our Phase II clinical study of recombinant human vascular
endothelial growth factor, which is known as VEGF, protein failed to
meet the primary endpoints of the study; and
- in June 2000, our Phase II clinical of recombinant humanized anti-
CD18 monoclonal antibody fragment, which is known as rhuMAb CD 18 for
treatment of myocardial infarction, more commonly known as a heart
attack, did not meet its primary study objectives.
- - Loss of or changes to previously obtained approvals.
For example, in May 2000, we changed the warning section of the package
insert for Herceptin and sent letters to physicians advising them of some
deaths associated with the administration of that product.
- - Failing to comply with existing or future regulatory requirements.
For example, in 1999, we paid a $50 million settlement in connection with
a federal investigation of our former clinical, sale and marketing
activities associated with our human growth hormone products.
Moreover, it is possible that the current regulatory framework could
change or additional regulations could arise at any stage during our product
development, which may affect our ability to obtain approval of our products.
Difficulties or Delays in Product Manufacturing Could Harm Our Business
We currently produce all of our products at our manufacturing facilities
located in South San Francisco, California and Vacaville, California or
through various contract manufacturing arrangements. Problems with any of
our or our contractor's manufacturing processes could result in product
defects, which could require us to delay shipment of products or recall
products previously shipped.
Page 33
For example, in March 2000, we issued an important drug notification
regarding a defect in the packaging of our Pulmozyme product. During a
quality assurance inspection, we had discovered that there was a defect in
the packaging of Pulmozyme which occasionally caused a small puncture in
ampules of that product. We suspended shipping the product while we
determined the source and extent of the defect. We ultimately recalled some
of the product.
In addition, any prolonged interruption in the operations of our or our
contractor's manufacturing facilities could result in cancellations of
shipments. A number of factors could cause interruptions, including
equipment malfunctions or failures, or damage to a facility due to natural
disasters or otherwise. Because our manufacturing processes and those of our
contractor's are highly complex and are subject to a lengthy FDA approval
process, we cannot assure stockholders that alternative qualified production
capacity would be available on a timely basis or at all. Difficulties or
delays in our and our contractor's manufacturing of existing or new products
could increase our costs, cause us to lose revenue or market share and damage
our reputation.
Our Stock Price, Like That of Many Biotechnology Companies, Is Highly
Volatile
The market prices for securities of biotechnology companies in general have
been highly volatile and may continue to be highly volatile in the future.
In addition, due to the absence of the put and call that were associated with
our special common stock and the reduction in the number of shares of our
publicly traded stock, the market price of our common stock has been and may
continue to be more volatile than our special common stock was in the past.
In addition, the following factors may have a significant impact on the
market price of our common stock:
- - Announcements of technological innovations or new commercial products by
us or our competitors.
For example, our stock increased by approximately 4% on the day we
announced FDA approval for our Nutropin Depot product.
- - Developments concerning proprietary rights, including patents.
For example, our stock price decreased by approximately 4% on the day one
of our competitors, Chiron, announced a patent infringement suit against
us.
- - Publicity regarding actual or potential medical results relating to
products under development by us or our competitors.
For example, our stock price increased by approximately 9% on the day we
announced positive preliminary phase III results from the Anti IgE asthma
clinic.
- - Regulatory developments in the United States and foreign countries.
- - Public concern as to the safety of biotechnology products.
Page 34
For example, on May 8, 2000 we issued a warning concerning our Herceptin
drug after 15 deaths resulted from the administration of Herceptin. Our
stock price decreased by approximately 2% at that time.
- - Economic and other external factors or other disaster or crisis.
For example, our stock hit a high of $245 per share in March 2000 and
decreased, as the biotech sector and stock market in general decreased, to
a low of $85 per share in late May 2000.
- - Period-to-period fluctuations in financial results.
For example, our stock price has historically been effected by whether we
met or exceeded analyst expectations.
Our Affiliation Agreement With Roche Could Adversely Affect Our Cash Position
Our affiliation agreement with Roche requires us to, among other things,
establish a stock repurchase program designed to maintain Roche's percentage
ownership interest in our common stock. While the dollar amounts associated
with these future purchases cannot currently be estimated, those stock
repurchases could have a material adverse effect on our cash position and may
have the effect of limiting our ability to use our capital stock as
consideration for acquisitions.
Future Sales by Roche Could Cause the Price of Our Common Stock to Decline
As of June 30, 2000, Roche owned 153,297,176 shares of our common stock or
approximately 59% of our outstanding shares. All of our shares owned by
Roche are eligible for sale in the public market subject to compliance with
the applicable securities laws. We have agreed that, upon Roche's request,
we will file one or more registration statements under the Securities Act in
order to permit Roche to offer and sell shares of our common stock. We have
agreed to use our best efforts to facilitate the registration and offering of
those shares designated for sale by Roche. Sales of a substantial number of
shares of our common stock in the public market following this offering could
adversely affect the market price of our common stock.
We Are Exposed to Market Risk
We are exposed to market risk, including changes to interest rates, foreign
currency exchange rates and equity investment prices. To reduce the
volatility relating to these exposures, we enter into various derivative
investment transactions pursuant to our investment and risk management
policies and procedures in areas such as hedging and counterparty exposure
practices. We do not use derivatives for speculative purposes.
We maintain risk management control systems to monitor the risks
associated with interest rates, foreign currency exchange rates and equity
investment price changes, and our derivative and financial instrument
positions. The risk management control systems use analytical techniques,
including sensitivity analysis and market values. Though we intend for our
risk management control systems to be comprehensive, there are inherent risks
that may only be partially offset by our hedging programs should there be
unfavorable movements in interest rates, foreign currency exchange rates or
equity investment prices.
Page 35
Our Interest Income is Subject to Fluctuations in Interest Rates
Our interest income is sensitive to changes in the general level of interest
rates, primarily U.S. interest rates. In this regard, changes in U.S.
interest rates affect the interest earned on our cash equivalents, short-term
investments, convertible preferred stock investments, convertible loans and
long-term investments. To mitigate the impact of fluctuations in U.S.
interest rates, we may enter into swap transactions, which involve the
receipt of fixed rate interest and the payment of floating rate interest
without the exchange of the underlying principal.
We Are Exposed to Risks Relating to Foreign Currency Exchange Rates and
Foreign Economic Conditions
We receive royalty revenues from licensees selling products in countries
throughout the world. As a result, our financial results could be
significantly affected by factors such as changes in foreign currency
exchange rates or weak economic conditions in the foreign markets in which
our licensed products are sold. We are exposed to changes in exchange rates
in Europe, Asia (primarily Japan) and Canada. Our exposure to foreign
exchange rates primarily exists with the euro. When the U.S. dollar
strengthens against the currencies in these countries, the U.S. dollar value
of non-U.S. dollar-based revenue decreases; when the U.S. dollar weakens, the
U.S. dollar value of the non-U.S. dollar-based revenues increases.
Accordingly, changes in exchange rates, and in particular a strengthening of
the U.S. dollar, may adversely affect our royalty revenues as expressed in
U.S. dollars. In addition, as part of our overall investment strategy, a
portion of our portfolio is primarily in non-dollar denominated investments.
As a result, we are exposed to changes in the exchange rates of the countries
in which these non-dollar denominated investments are made.
To mitigate this risk, we hedge certain of our anticipated revenues by
purchasing option contracts with expiration dates and amounts of currency
that are based on 25% to 90% of probable future revenues so that the
potential adverse impact of movements in currency exchange rates on the non-
dollar denominated revenues will be at least partly offset by an associated
increase in the value of the option. Currently, the duration of these
options is generally one to three years. We may also enter into foreign
currency forward contracts to lock in the dollar value of a portion of these
anticipated revenues. To hedge the non-dollar denominated investment
portfolio, we enter into forward contracts.
Our Investments in Equity Securities Are Subject to Market Risks
As part of our strategic alliance efforts, we invest in equity instruments of
biotechnology companies. These investments are subject to fluctuations from
market value changes in stock prices. To mitigate this risk, certain equity
securities are hedged with costless collars and equity swaps. A costless
collar is a purchased put option and a written call option in which the cost
of the purchased put and the proceeds of the written call offset each other;
therefore, there is no initial cost or cash outflow for these instruments at
the time of purchase. The purchased put protects us from a decline in the
market value of the security below a certain minimum level (the put "strike"
level); while the call effectively limits our potential to benefit from an
increase in the market value of the security above a certain maximum level
(the call "strike" level). An equity swap is a derivative instrument where
Genentech pays the counterparty the total return of the security above the
Page 36
current spot price and receives interest income on the notional amount for
the swap term. The equity swap protects us from a decline in the market
value of the security below the spot price and limits our potential benefit
from an increase in the market value of the security above the spot price.
In addition, as part of our strategic alliance efforts, we hold dividend-
bearing convertible preferred stock and have made interest-bearing loans that
are convertible into the equity securities of the debtor.
Recent Pronouncement Could Impact Our Financial Position and Results of
Operations
In July 1999, the Financial Accounting Standards Board, or FASB, announced
the delay of the effective date of Statement of Financial Accounting
Standards 133, or FAS 133, "Accounting for Derivative Instruments and Hedging
Activities," for one year, to the first quarter of 2001. FAS 133 establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities. It requires companies to recognize all derivatives as either
assets or liabilities on the balance sheet and measure those instruments at
fair value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting under FAS 133. The impact of FAS
133 on our financial position and results of operations is not expected to be
material.
On March 31, 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation," which provides guidance
on several implementation issues related to Accounting Principles Board
Opinion No. 25. The most significant are clarification of the definition of
employee for purposes of applying Opinion 25 and the accounting for options
that have been repriced. Under the interpretation, the employer-employee
relationship would be based on case law and Internal Revenue Service
regulations. The FASB granted an exception to this definition for outside
directors. Under the interpretation, repriced options effectively changed
the terms of the plan, which would make it a variable plan subject to
compensation expense. We currently do not have any options that have been
repriced. The impact of the interpretation on our financial position and
results of operations is not material.
In June 2000, the Securities and Exchange Commission delayed the
implementation date of Staff Accounting Bulletin No. 101, or SAB 101,
"Revenue Recognition in Financial Statements," until no later than the fourth
quarter of 2000. SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition issues in financial statements.
We will adopt SAB 101 as required in the fourth quarter of 2000 and we are
currently evaluating the effect that such adoption, and the related
"Frequently Asked Questions" document, may have on our financial position and
results of operations.
We Are Exposed to Credit Risk of Counterparties
We could be exposed to losses related to the financial instruments described
above under "We are Exposed to Market Risk" should one of our counterparties
default. We attempt to mitigate this risk through credit monitoring
procedures.
Page 3
GENENTECH, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In connection with our patent infringement litigation with Bio-Technology
General Corporation, or BTG, Genentech and BTG each filed appeals with the
U.S. Court of Appeals for the Federal Circuit relating to the proceedings in
the U.S. District Court for the Southern District of New York, and those
appeals are now pending. Genentech filed its appeal brief with the Federal
Circuit on May 15, 2000. BTG filed its appeal brief on July 11, 2000. In
it, BTG included a request that its antitrust claims against Genentech (which
previously had been dismissed by the District Court) be reinstated. The
Federal Circuit has not yet scheduled a date for hearing the appeals.
On June 7, 2000, Chiron Corporation filed a patent infringement suit against
us in the U.S. District Court in the Eastern District of California
(Sacramento), alleging that the manufacture, use, sale, and/or offer for sale
of our Herceptin antibody product infringes Chiron's U.S. Patent No.
6,054,561. This patent relates to certain antibodies that bind to breast
cancer cells and/or other cells. On August 4, 2000 we filed our answer to
Chiron's complaint, and in our answer we also stated counterclaims against
Chiron. The judge has not yet scheduled the trial of this suit.
See also Item 3 of the Company's report on Form 10-K for the period ended
December 31, 1999.
See also Item 1 of our report on Form 10-Q for the period ended March 31,
2000.
See also the Legal Proceedings note in the Notes to Condensed Consolidated
Financial Statements of Part I.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At Genentech's Annual Meeting of Stockholders held on May 15, 2000, four
matters were voted upon. A description of each matter and tabulation of
votes follows:
1. To elect six directors.
Votes
-------------------------
Nominee For Withheld
---------------------------- ----------- ---------
Herbert W. Boyer, Ph.D. 246,291,373 353,361
Franz B. Humer, Ph.D. 241,847,109 4,797,625
Jonathan K.C. Knowles, Ph.D. 239,753,980 6,890,754
Arthur D. Levinson, Ph.D. 246,293,711 351,023
Charles A. Sanders, M.D. 246,430,884 213,850
Sir Mark Richmond, Ph.D. 246,429,021 215,713
There were no broker nonvotes.
Page 38
2. To approve the amendment to Genentech's Amended and Restated
Certificate of Incorporation to increase the number of authorized
shares of Common Stock from 300,000,000 to 600,000,000.
Votes
-----------------------------------
For Against Abstain
----------- --------- -------
244,448,064 2,157,940 38,730
There were no broker nonvotes.
3. To approve the amendment to Genentech's 1999 Stock Plan to permit
options to be granted to Genentech directors.
Votes
-----------------------------------
For Against Abstain
----------- --------- -------
240,518,595 6,043,467 82,672
There were no broker nonvotes.
4. To ratify the appointment of Ernst & Young LLP as Genentech's
independent auditors for the year ending December 31, 2000:
Votes
-----------------------------------
For Against Abstain
----------- --------- -------
246,577,767 34,929 32,038
There were no broker nonvotes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
15.1 Letter re: Unaudited Interim Financial Information
27.1 Financial Data Schedule
(b) Reports on Form 8-K
There were no other reports on Form 8-K filed during the
quarter ended June 30, 2000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Genentech's market risk disclosures set forth in the 1999 Annual Report to
Stockholders have not changed significantly.
Page 3
GENENTECH, INC.
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.
Date: August 11, 2000 GENENTECH, INC.
/s/ARTHUR D. LEVINSON /s/LOUIS J. LAVIGNE, JR.
------------------------------------- ----------------------------
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr.
Chairman and Chief Executive Officer Executive Vice President and
Chief Financial Officer
/s/JOHN M. WHITING
----------------------------
John M. Whiting
Controller and
Chief Accounting Officer
Page 40