UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
Amendment No. 1 to 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, 2001.
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 527,478,953
Outstanding at June 30, 2001
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENENTECH, INC.
FINANCIAL REVIEW
Overview
Genentech, Inc. is a leading biotechnology company using human genetic
information to discover, develop, manufacture and market human pharmaceuticals
that address significant unmet medical needs. Fourteen of the approved
products of biotechnology stem from or are based on our science. We
manufacture and market nine protein-based pharmaceuticals listed below, and
license several additional products to other companies.
- - 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 which we market together with IDEC
Pharmaceuticals Corporation, commonly known as IDEC, for the treatment of
patients with relapsed or refractory low-grade or follicular, CD20-
positive, B-cell non-Hodgkin's lymphoma;
- - TNKase (tenecteplase) single-bolus thrombolytic agent for the treatment of
acute myocardial infarction;
- - Activase (alteplase, recombinant) 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;
- - Nutropin Depot [somatropin (rDNA origin) for injectable suspension] long-
acting growth hormone for the treatment of growth failure associated with
pediatric growth hormone deficiency;
- - Nutropin AQ [somatropin (rDNA origin) injection] liquid formulation growth
hormone for the same indications as Nutropin;
- - 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;
- - Protropin (somatrem for injection) growth hormone for the treatment of
inadequate endogenous growth hormone secretion, or growth hormone
deficiency, in children; and
- - Pulmozyme (dornase alfa, recombinant) inhalation solution for the treatment
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-
Page 2
La Roche. We receive royalties on sales of growth hormone products and t-PA
outside of the United States and Canada, and on sales of tenecteplase outside
of the United States (excluding Japan and Canada). 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.
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.
This event, referred to as the "Redemption," caused Roche to own 100% of our
common stock on that date. 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 $1,685.7 million
of goodwill and $1,499.0 million of other intangible assets onto our balance
sheet on June 30, 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.
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
provides, among other things, that we will establish a stock repurchase
program designed to maintain Roche's percentage ownership interest in our
common stock. The affiliation agreement provides that we will repurchase a
sufficient number of shares pursuant to this program such 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 as well as for stock splits or stock combinations)
divided by 509,194,352 (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, as adjusted for the two-
for-one splits of Genentech common stock in November 1999 and October 2000.
As long as Roche's percentage ownership is greater than 50%, prior to issuing
any shares, the affiliation agreement provides that we will repurchase a
sufficient number of shares of our common stock such that, immediately after
our issuance of shares, Roche's percentage ownership will be greater than 50%.
The affiliation agreement also provides that, upon Roche's request, we will
repurchase shares of our common stock to increase Roche's ownership to the
Minimum Percentage. In addition, Roche will have a continuing option to buy
stock from us at prevailing market prices to maintain its percentage ownership
interest. On June 30, 2001, Roche's percentage ownership of our common stock
was 58.12%, which was 2.09% below the Minimum Percentage. Genentech and Roche
are in discussion concerning the matter.
Page 3
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Three Months Six Months
Ended June 30, Ended June 30,
--------------- -----------------
REVENUES 2001 2000 % Change 2001 2000 %
Change
- ------------------- ------ ------ -------- -------- ------
- --------
(Restated) (Restated)
Revenues $515.9 $415.8 24% $1,055.9 $803.7
31%
====== ====== ======== ======== ======
========
Revenues increased 24% in the second quarter and 31% in the first six months
of 2001 from the comparable periods in 2000 primarily as a result of higher
product sales, royalty income and interest income. These increases were
partially offset by lower contract and other revenues. These revenue changes
are further discussed below.
Three Months Six Months
Ended June 30, Ended June 30,
--------------- ---------------
PRODUCT SALES 2001 2000 % Change 2001 2000 % Change
- ------------------- ------ ------ -------- ------ ------ --------
Herceptin $ 78.8 $ 66.7 18% $160.1 $135.4 18%
Rituxan 187.7 102.8 83 359.8 187.9 91
Activase/TNKase 51.6 56.8 (9) 103.7 104.3 (1)
Growth Hormone 62.5 49.9 25 118.0 105.0 12
Pulmozyme 28.1 32.3 (13) 58.0 59.1 (2)
Actimmune 1.6 0.9 78 2.5 0.9 178
------ ------ -------- ------ ------ --------
Total product sales $410.3 $309.4 33% $802.1 $592.6 35%
====== ====== ======== ====== ====== ========
Total product sales increased 33% in the second quarter and 35% in the first
six months of 2001 from the comparable periods in 2000 primarily as a result
of higher sales from our bio-oncology products, Rituxan and Herceptin, and
higher sales from our Growth Hormone products.
Herceptin: Net sales of Herceptin increased 18% in the second quarter and in
the first six months of 2001 from the comparable periods in 2000. An increase
in penetration into the metastatic breast cancer market has contributed to a
positive sales trend.
Rituxan: Net sales of Rituxan increased 83% in the second quarter and 91% in
the first six months of 2001 from the comparable periods in 2000. This
increase was primarily due to increased use of the product in the treatment of
B-cell non-Hodgkin's lymphoma.
Activase/TNKase: Combined net sales of our two cardiovascular products,
Activase and TNKase, decreased 9% in the second quarter of 2001 and were
slightly lower in the first six months of 2001 compared to the same periods
last year. These decreases reflect the continued decline in the overall size
of the thrombolytic therapy market due to increasing use of mechanical
reperfusion and competition from Centocor, Inc.'s Retavase, registered
trademark (reteplase). TNKase received U.S. Food and Drug Administration, or
FDA, approval in early June 2000 and was launched in mid-June 2000.
Page 4
Growth Hormone: Net sales of our four growth hormone products, Nutropin
Depot, Nutropin AQ, Nutropin and Protropin, increased 25% in the second
quarter and 12% in the first six months of 2001 from the comparable periods in
2000. This net sales growth primarily reflects an increase in market
penetration and the effects of a price increase for these products.
Pulmozyme: Net sales of Pulmozyme decreased 13% in the second quarter of 2001
compared to last year and were slightly lower in the first six months of 2001
compared to the same periods last year. These decreases were primarily due to
lower sales of the product to Hoffmann-La Roche.
Three Months Six Months
Ended June 30, Ended June 30,
ROYALTIES, CONTRACT AND --------------- ---------------
OTHER, AND INTEREST INCOME 2001 2000 % Change 2001 2000 %
Change
- -------------------------- ------ ------ -------- ------ ------
- --------
(Restated) (Restated)
Royalties $ 52.5 $ 49.6 6% $127.1 $ 97.0
31%
Contract and other 20.9 34.5 (39) 59.4 70.4
(16)
Interest income 32.2 22.3 44 67.3 43.7
54
Royalties: Royalty income increased 6% in the second quarter and 31% in the
first six months of 2001 from the comparable periods in 2000. These increases
were primarily due to higher third-party sales from various licensees offset in
part by lower sales from two licensees that are addressing manufacturing issues
which has temporarily impacted their ability to produce product for sales.
Contract and Other Revenues: Contract and other revenues in the second quarter
and first six months of 2001 decreased 39% and 16%, respectively, from the
comparable periods in 2000. The decrease in the second quarter was primarily
due to lower gains from the sale of biotechnology equity securities partially
offset by higher contract revenues. The decrease in the first six months of
2001 was attributable to lower gains from the sale of biotechnology equity
securities partially offset by higher contract revenues and the recognition of
$10.0 million in gains related to the change in the time value of certain
hedging instruments in the first quarter of 2001. (See Note 1, "Statement of
Accounting Presentation and Significant Accounting Policies," of the Notes to
Condensed Consolidated Financial Statements for more information on our
derivative and hedging activities.) The increase in contract revenues in the
second quarter and first six months of 2001 was primarily due to the
recognition of revenues from third-party collaborators that were previously
deferred under the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101. (See the "Changes in Accounting Principles" section of Note
1, "Statement of Accounting Presentation and Significant Accounting Policies,"
of the Notes to Condensed Consolidated Financial Statements.)
Interest Income: Interest income in the second quarter and in the first six
months of 2001 increased 44% and 54%, respectively, from the comparable periods
in 2000. The increase in the second quarter of 2001 was due to higher cash
balances. The increase in the first six months of 2001 was primarily due to
higher cash balances and slightly higher portfolio yields.
Page 5
Three Months Six
Months
Ended June 30, Ended
June 30,
--------------
- --------------
COSTS AND EXPENSES 2001 2000 % Change 2001
2000 % Change
- --------------------------------------- ------ ------ -------- ------
- ------ --------
Cost of sales $ 76.2 $ 97.6 (22)% $160.0
$203.8 (21)%
Research and development 123.5 115.6 7 259.8
227.0 14
Marketing, general and administrative 107.8 86.3 25 235.7
169.9 39
Collaboration profit sharing 57.9 30.9 87 104.3
49.2 112
Recurring charges related to redemption 81.5 98.1 (17) 163.0
196.6 (17)
Interest expense 1.3 1.2 8 2.8
2.5 12
------ ------ -------- ------
- ------ --------
Total costs and expenses $448.2 $429.7 4% $925.6
$849.0 9%
====== ====== ======== ======
====== ========
Cost of Sales: Cost of sales in the second quarter of 2001 decreased to $76.2
million compared to $97.6 million in the second quarter of 2000 and $160.0
million in the first six months of 2001 compared to $203.8 million in the
first six months of 2000. Cost of sales as a percent of product sales
decreased to 19% in the second quarter of 2001 from 32% in the prior year.
Cost of sales as a percent of product sales decreased to 20% in the first six
months of 2001 from 34% in the prior year. The decrease in the ratios
primarily reflects a decline in the costs recognized on the sale of inventory
that was written up at the Redemption due to push-down accounting. This
inventory had been sold at December 31, 2000.
Research and Development: Research and development, or R&D, expenses
increased 7% in the second quarter and 14% in the first six months of 2001
from the comparable periods in 2000. The increase in the second quarter of
2001 was largely due to higher expenses related to late-stage clinical trials
and higher development production partially offset by lower in-licensing
expense. The increase in the first six months of 2001 was primarily due to
higher expenses related to late-stage clinical trials, higher development
production, costs related to the termination of a collaboration agreement
partially offset by lower in-licensing expense and reimbursements from
collaborators for clinical materials. R&D expenses included $15.0 million in
both the first six months of 2001 and 2000 of upfront payments for the
purchase of in-process research and development, or IPR&D, under in-licensing
agreements with collaborators. We determined that the acquired IPR&D was not
yet technologically feasible and that it had no future alternative uses.
Marketing, General and Administrative: Overall marketing, general and
administrative, or MG&A, expenses increased 25% in the second quarter and 39%
in the first six months of 2001 from the comparable periods in 2000. The
increase in the second quarter and first six months of 2001 was due to higher
marketing and selling expenses primarily in support of the continued growth of
our bio-oncology products and commercial development of pipeline products, the
write-down of certain biotechnology investments due to unfavorable market
conditions, increased royalty expenses associated with higher sales by us as a
licensee and higher legal and other corporate expenses.
Collaboration Profit Sharing: Collaboration profit sharing includes the net
operating profit sharing with IDEC on Rituxan sales, and the sharing of costs
with collaborators related to the commercialization and development of future
products. Collaboration profit sharing expenses increased to $57.9 million in
the second quarter of 2001 from $30.9 million in the second quarter of 2000.
Collaboration profit sharing expenses increased to $104.3 million in the first
six months of 2001 from $49.2 million in the first six months of 2000. These
Page 6
increases were primarily due to increased Rituxan profit sharing due to higher
Rituxan sales.
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 $81.5 million in the quarter ended
June 30, 2001, and were comprised of $79.4 million for the amortization of
intangibles and goodwill and $2.1 million of compensation expense. These
charges were approximately $163.0 million in the first six months of 2001 and
were comprised of $158.8 million for the amortization of intangibles and
goodwill and $4.2 million of compensation expense. The compensation expense
was 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.
INCOME (LOSS) BEFORE TAXES AND Three Months Six
Months
CUMULATIVE EFFECT OF ACCOUNTING Ended June 30, Ended
June 30,
CHANGE, INCOME TAXES AND CUMULATIVE ---------------
- ---------------
EFFECT OF ACCOUNTING CHANGE 2001 2000 % Change 2001
2000 % Change
- --------------------------------------- ------ ------ --------
- ------ ------ --------
(Restated)
(Restated)
Income (loss) before taxes and
cumulative effect of accounting
change $ 67.7 $(13.9) 587%
$130.3 $(45.3) 388%
Income tax provision (benefit) 29.1 (1.0) 3,010
59.3 (7.8) 860
Income (loss) before cumulative
effect of accounting change 38.6 (12.9) 399
71.0 (37.5) 289
Cumulative effect of accounting change,
net of tax - - -
(5.6) (57.8) 90
Changes in Accounting Principles: We adopted the Statement of Financial
Accounting Standards No. 133, or FAS 133, "Accounting for Derivatives and
Hedging Activities," on January 1, 2001. Upon adoption, we recorded a $5.6
million charge, net of tax, as a cumulative effect of a change in accounting
principle and an increase of $5.0 million, net of tax, in other comprehensive
income related to recording derivative instruments at fair value. See Note 1,
"Statement of Accounting Presentation and Significant Accounting Policies" in
the Notes to Condensed Consolidated Financial Statements for further
information on our adoption of FAS 133.
We adopted the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101, or SAB 101, on revenue recognition effective January 1, 2000
and recorded a $57.8 million charge, net of tax, as a cumulative effect of a
change in accounting principle related to contract revenues recognized in
prior periods. The related deferred revenue is being recognized over the term
of the agreements. For the quarter ended March 31, 2000, the impact of the
change in accounting principle was to increase net loss by $56.5 million, or
$0.11 per share, comprised of the $57.8 million cumulative effect of the
change (net of tax impact) as described above ($0.11 per share), net of $1.3
million of the related deferred revenue (net of tax) that was recognized as
revenue during the quarter ended March 31, 2000 ($0.0 per share). For the
quarter ended June 30, 2000, the impact of the change in accounting principle
was to reduce net loss by $1.3 million (net of tax) of the related deferred
Page 7
revenue recognized as revenue during the quarter ended June 30, 2000 ($0.0 per
share). For the three- and six-month periods ended June 30, 2001, we
recognized $5.9 (net of tax) and $8.2 million (net of tax) respectively, of
the related deferred revenue. See Note 1, "Statement of Accounting
Presentation and Significant Accounting Policies," in the Notes to Condensed
Consolidated Financial Statements for further information on our adoption of
SAB 101.
Income Tax: The tax provision of $29.1 million for the second quarter of 2001
increased over the tax benefit of $1.0 million for the second quarter of 2000
and the tax provision of $59.3 million for the first six months of 2001
increased over the tax benefit of $7.8 million for the first six months of
2000 primarily due to increased pretax income and decreased charges related to
the Redemption.
Our effective tax rates were approximately 43% for the second quarter and
46% for the first six months of 2001 and 7% for the second quarter and 17% for
the first six months of 2000, which reflect the non-deductibility of goodwill
amortization.
The effective tax rate of 32% in the second quarter and first six months
of 2001 on pretax income, excluding charges related to the Redemption and
cumulative effect of accounting change, is higher than the comparative tax
rate of 31% in the second quarter and first six months of 2000 primarily due
to decreased R&D tax credits.
Three Months
Six Months
Ended June 30,
Ended June 30,
---------------
- ---------------
NET INCOME (LOSS) 2001 2000 % Change
2001 2000 % Change
- -------------------------------------------- ------ ------ --------
- ------ ------ --------
(Restated)
(Restated)
Net income (loss) $ 38.6 $(12.9) 399% $
65.4 $(95.3) 169%
Earnings (loss) per share:
Basic: Earnings (loss) before cumulative
effect of accounting change $ 0.07 $(0.02) 450% $
0.13 $(0.07) 286%
Cumulative effect of accounting
change, net of tax - - -
(0.01) (0.11) 91
------ ------ --------
- ------ ------ --------
Net earnings (loss) per share $ 0.07 $(0.02) 450% $
0.12 $(0.18) 167%
====== ====== ========
====== ====== ========
Diluted: Earnings (loss) before cumulative
effect of accounting change $ 0.07 $(0.02) 450% $
0.13 $(0.07) 286%
Cumulative effect of accounting
change, net of tax - - -
(0.01) (0.11) 91
------ ------ --------
- ------ ------ --------
Net earnings (loss) per share $ 0.07 $(0.02) 450% $
0.12 $(0.18) 167%
====== ====== ========
====== ====== ========
Net Income (Loss): Net income of $38.6 million, or $0.07 per share in the
second quarter of 2001 and net income of $65.4 million, or $0.12 per share in
the first six months of 2001, primarily reflect an increase in product sales,
royalties and interest income and a decrease in cost of sales and recurring
charges related to redemption. These favorable variances were offset in part
by increased MG&A, collaboration profit sharing and R&D expenses and a
decrease in contract and other revenues.
In-Process Research and Development: At June 30, 1999, the Redemption date,
we determined that the acquired in-process technology was not technologically
Page 8
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.
Except as otherwise noted below, there have been no significant changes
to the projects since December 31, 2000. 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 $600.0 million, as
compared to $700.0 million as of the Redemption date. This estimate reflects
costs incurred since the Redemption date, 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 and changes
in expected completion dates.
The following are significant changes that occurred during the first six
months of 2001 to the projects included in the IPR&D charge at the Redemption:
- - Dornase alfa AERx - project has been discontinued.
- - Herceptin antibody for non-small cell lung cancer (NSCLC) - project has
been discontinued in this indication.
LIQUIDITY AND CAPITAL RESOURCES June 30, 2001 December 31, 2000
- --------------------------------- ------------- -----------------
Cash and cash equivalents,
short-term investments and
long-term marketable securities $ 2,601.1 $ 2,459.4
Working capital 1,516.6 1,340.1
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, 2001 increased from December 31, 2000 by $141.7
million. Working capital increased by $176.5 million in the second quarter of
2001 from December 31, 2000.
Capital expenditures totaled $85.7 million in the first six months of 2001
compared to $53.6 million in the comparable period of 2000. The increase in
2001 compared to 2000 was primarily due to an increase in machinery and
equipment and leasehold improvements.
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 "Forward-Looking Information and
Cautionary Factors that May Affect Future Results - Affiliation Agreement with
Roche Could Adversely Affect Our Cash Position" below for factors that could
negatively affect our cash position.
Page 9
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
any forward-looking statements made by or on behalf of Genentech, this section
includes a discussion of important factors that could affect our actual future
results, including, but not limited to, our product sales, royalties, contract
revenues, expenses and net income.
Fluctuations in Our Operating Results Could Affect the Price of Our Common
Stock
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 the first six
months of 2001, and in 2000, 1999 and 1998 primarily due to competition
from Centocor's Retavase and more recently to a decreasing size of the
thrombolytic marketplace as other forms of acute myocardial infarction
treatment gain acceptance.
- - The amount and timing of sales to customers in the United States.
For example, sales of our Growth Hormone products increased in 2000 and
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.
For example, sales of Pulmozyme to Hoffmann-La Roche decreased in the
second quarter of 2001 compared to last year and were slightly lower in the
first six months of 2001 compared to the same period last year.
For example, in the third quarter of 2000, Hoffmann-La Roche's approval of
Herceptin in Europe increased our sales of Herceptin product.
- - 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 by the FDA for sale.
- - The rate of adoption and use of our products for approved indications and
additional indications.
For example, sales of Rituxan increased in the last quarter of 2000 and the
first six months of 2001 due to the announcement at the American Society of
Clinical Oncology of the results of a study conducted by the Groupe d'Etude
des Lymphomes de l'Adulte, or GELA, reporting on the benefits of using
Rituxan, combined with standard chemotherapy, for treating aggressive non-
Hodgkin's lymphoma.
Page 10
- - The potential introduction of new products and additional indications for
existing products in 2001 and beyond.
- - The ability to successfully manufacture sufficient quantities of any
particular marketed product.
- - The number and size of any product price increases we may issue.
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 trial results that may show the product to be less
effective than desired or to have harmful problematic side effects. 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.
For example, in April 2001, we announced that a Phase III clinical trial of
Veletri, trademark, (tezosentan) - an intravenous dual endothelin receptor
antagonist for the treatment of symptoms (dyspnea, or shortness of breath)
associated with acute heart failure (AHF)- did not meet its primary
objectives.
- - Failure to receive the necessary regulatory approvals or delay in receiving
such approvals.
For example, in July 2001, we received a Complete Response letter from the
FDA for the license application for Xolair that was filed with the FDA in
2000. The letter requests additional preclinical and clinical data, as
well as pharmacokinetic information. With the requirement of additional
data, FDA approval of Xolair has been delayed beyond 2001. It is also
anticipated that the initial proposed label claim will likely be for only
adult allergic asthma. The exact timing of resubmission to the FDA will be
dependent on the scope of the discussions with the FDA but is expected to
occur in 2002 or early 2003.
- - Manufacturing costs or other factors that make the product uneconomical.
- - 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.
Page 11
Factors affecting our research and development, or R&D, 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, we have experienced an increase in R&D expenses in the second
quarter and first six months of 2001 due to the number of late-stage
clinical trials being conducted by us and/or our collaborators.
- - 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 preclinical 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 purchase of rights for the development and co-promotion in the
United States of tezosentan and paid Actelion an upfront fee of $15.0
million which was recorded as an R&D expense.
For example, in January 2001, we entered into an agreement with OSI
Pharmaceuticals, Inc. for the global co-development and commercialization
of an anti-cancer drug, OSI-774, and paid OSI an upfront fee of $15.0
million for the purchase of IPR&D which was recorded as an R&D expense.
- - As part of our strategy, we invest in R&D. R&D as a percent of revenues
can fluctuate with the changes in future levels of revenue. Lower revenues
can lead to more disciplined spending of R&D efforts.
- - Future levels of revenue.
Roche, Our Controlling Stockholder, May Have Interests That Are Adverse to
Other Stockholders
Roche, as our majority stockholder, 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 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 minority shareholder interests.
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Our Affiliation Agreement With Roche Could Limit Our Ability to Make
Acquisitions and Could Have a Material Negative Impact on Our Liquidity
The affiliation agreement between us and Roche contains provisions that:
- - Require 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.
- - Require us to establish a stock repurchase program designed to maintain
Roche's percentage ownership interest in our common stock based on an
established Minimum Percentage. For information regarding Minimum
Percentage, see Note 3, "Relationship with Roche -- Roche's Right to
Maintain Its Percentage Ownership Interest in Our Stock" in the Notes to
Condensed Consolidated Financial Statements.
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, these stock repurchases could have a
material adverse impact on our liquidity, credit rating and ability to access
capital in the financial markets.
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.
- - 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 your 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, Dr.
Franz B. Humer and Dr. Jonathan K.C. Knowles, currently serve as directors,
officers and employees of Roche Holding Ltd and its affiliates.
Page 13
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 provides that, among other
things, we will 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 you 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's
Retavase, either alone or in combination with the use of another Centocor
product, ReoPro, registered trademark, (abciximab) and to the use of
mechanical reperfusion therapies to treat acute myocardial infarction; the
resulting adverse effect on sales has been and could continue to be material.
Retavase received approval from the FDA in October 1996 for the treatment of
acute myocardial infarction. We expect that the use of mechanical reperfusion
in lieu of thrombolytic therapy for the treatment of acute myocardial
infarction will continue to grow.
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 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,
sales of our Growth Hormone products may decline, perhaps significantly.
Third, in the non-Hodgkin's lymphoma market, Corixa Corporation, formerly
Coulter Pharmaceutical, Inc., has filed a revised Biologics License
Application, or BLA, for Bexxar, trademark, (tositumomab and iodine I 131
tositumomab), which may potentially compete with our product Rituxan, and IDEC
has filed a BLA for Zevalin, trademark, (ibritumomab tiuxetan), a product
which could also potentially compete with Rituxan. Both Bexxar and Zevalin
are radiolabeled molecules while Rituxan is not. 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 14
For example, in June 2000 one of our competitors, Novo, received FDA
approval for a liquid formulation of its growth hormone product that will
directly compete with our liquid formulation, Nutropin AQ. Also in June
2000, another of our competitors, Serono S.A., 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%.
For example, we raised the prices of Herceptin by 3% and on Growth Hormone
Product by 5% in January 2001.
- - The degree of patent protection afforded our products by patents granted to
us and by the outcome of litigation involving our patents.
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, or BTG. Although an appeal of the judge's decision is
pending, BTG is now permitted to sell its competitive growth hormone
product in the United States.
- - The outcome of litigation involving patents of other companies concerning
our products or processes related to production and formulation of those
products or uses of those products.
For example, as described in Note 6, "Legal Proceedings," in the Notes to
Condensed Consolidated Financial Statements of Part I, several companies
have filed patent infringement lawsuits against us alleging that the
manufacture, use and sale of certain of our products infringe their
patents.
- - 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 May
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 $1,685.7 million
and $1,499.0 million, respectively, on June 30, 1999.
Page 15
Effective for fiscal years beginning after December 15, 2001, the
adoption of the Financial Accounting Standards Board, or FASB, Statement of
Financial Accounting Standards No. 142, or FAS 142, will require that goodwill
not be amortized, but rather be subject to an impairment test at least
annually. Separately identified and recognized intangible assets resulting
from business combinations completed before July 1, 2001, that do not meet the
new criteria for separate recognition of intangible assets will be subsumed
into goodwill upon adoption. In addition, the useful lives of recognized
intangible assets acquired in transactions completed before July 1, 2001, will
be reassessed and the remaining amortization periods adjusted accordingly. We
will continuously evaluate whether events and circumstances have occurred that
indicate the remaining balance of goodwill and other intangible assets may not
be recoverable. If our evaluation of the assets results in a possible
impairment, we may have to reduce the carrying value of our intangible assets.
This could have a material adverse effect on our 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 Note 2, "Redemption of Our
Special Common Stock," in the Notes to Condensed Consolidated Financial
Statements of Part I. For more information regarding FAS 142, see "New
Accounting Pronouncement Could Impact Our Financial Position and Results of
Operations" below.
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.
- - The conclusion of existing arrangements with other companies and Hoffmann-
La Roche.
For example, in the second quarter of 2001, we reacquired from Schwarz
Pharma AG the exclusive development and marketing rights for Nutropin AQ
and Nutropin Depot in Europe and other countries outside the United States,
Canada, China and Japan.
- - The timing of non-U.S. approvals, if any, for products licensed to
Hoffmann-La Roche and to other licensees.
For example, we expect the approval of Herceptin outside the United States,
which occurred in third quarter of 2000, to have a continuing positive
impact on royalties.
- - Fluctuations in foreign currency exchange rates.
- - The initiation of new contractual arrangements with other companies.
- - Whether and when contract benchmarks are achieved.
- - The failure of or refusal of a licensee to pay royalties.
Page 16
- - The expiration or invalidation of patents or licensed intellectual
property.
- - Decreases in licensees' sales of product due to competition, manufacturing
difficulties or other factors that affect sales of product.
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
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. Our current
patent litigation matters are discussed in Note 6, " Legal Proceedings," in
the Notes to Condensed Consolidated Financial Statements of Part I. 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.
The presence of patents or other proprietary rights belonging to other
parties may lead to our termination of the R&D 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.
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 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 authorities.
Of particular significance are the FDA's requirements covering R&D, 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
Page 17
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, they remain subject to ongoing FDA
regulation, including, for example, changes to their label, written
advisements to physicians 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, see "The Successful Development of Pharmaceutical Products is
Highly Uncertain" above for a description of the delay in receipt of FDA
approval for Xolair.
- - Loss of or changes to previously obtained approvals.
For example, in May 2000, we issued letters to physicians advising them of
some serious adverse events associated with the administration of
Herceptin. In October 2000, we issued a new package insert for Herceptin
including this information.
- - Failure to comply with existing or future regulatory requirements.
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 contractors' manufacturing processes could result in product defects,
which could require us to delay shipment of products, recall products
previously shipped or be unable to supply products at all.
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 April 2001, we issued another important drug notification regarding a
separate defect in the manufacture of a Pulmozyme product lot which was
causing a small puncture in a small number of ampules of the product. We
suspended shipping the product upon discovery of this defect and recalled the
few cases of the product lot that had been distributed.
On December 27, 2000, we received a Warning Letter from the FDA regarding
our quality control at our South San Francisco manufacturing plant. The
products cited were for Pulmozyme, Herceptin and Activase. On February 7,
2001, we received a letter from the FDA accepting our responses and corrective
actions with respect to the Warning Letter. If we were to experience
Page 18
additional quality control or other related manufacturing problems in the
future, the FDA could take more significant action, including causing us to
cease manufacturing of one or more products for a period of time.
In addition, any prolonged interruption in the operations of our or our
contractors' manufacturing facilities could result in cancellations of
shipments or loss of product in the process of being manufactured. A number
of factors could cause interruptions, including equipment malfunctions or
failures, or damage to a facility due to natural disasters, rolling blackouts
imposed by a utility such as Pacific Gas & Electric Company or otherwise.
Because our manufacturing processes and those of our contractors are highly
complex and are subject to a lengthy FDA approval process, alternative
qualified production capacity may not be available on a timely basis or at
all. Difficulties or delays in our and our contractors' 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, 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.
For example, our common stock reached a high of $122.50 per share in March
2000 and decreased, as the biotech sector and stock market in general
decreased, to $38.50 per share in March 2001.
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.
- - Developments concerning proprietary rights, including patents.
- - Publicity regarding actual or potential medical results relating to
products under development or being commercialized by us or our
competitors.
- - Regulatory developments concerning our products in the United States and
foreign countries.
- - Issues concerning the safety of our products or of biotechnology products
generally.
- - Economic and other external factors or a disaster or crisis.
- - Period-to-period fluctuations in financial results.
Our Affiliation Agreement With Roche Could Adversely Affect Our Cash Position
Our affiliation agreement with Roche provides that we will establish a stock
repurchase program designed to maintain Roche's percentage ownership interest
in our common stock based on an established Minimum Percentage. For
information regarding Minimum Percentage, see Note 3, "Relationship with Roche
- -- Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock"
Page 19
in the Notes to Condensed Consolidated Financial Statements. 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.
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, these stock repurchases could have a
material adverse impact on our liquidity, credit rating and ability to access
capital in the financial markets.
Future Sales by Roche Could Cause the Price of Our Common Stock to Decline
As of June 30, 2001, Roche owned 306,594,352 shares of our common stock or
approximately 58.12% 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 by Roche in the public market 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.
Our Interest Income is Subject to Fluctuations in Interest Rates
Our material interest bearing assets, or interest bearing portfolio, consisted
of cash equivalents, restricted cash, short-term investments, convertible
preferred stock investments, convertible loans and long-term investments. The
balance of our interest bearing portfolio was $1,879.6 million or 28% of total
assets at December 31, 2000. Interest income related to this portfolio was
$90.4 million or 5% of total revenues at December 31, 2000. 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 bearing portfolio. To mitigate the impact of fluctuations
in U.S. interest rates, for a portion of our portfolio, we have entered into
swap transactions, which involve the receipt of fixed rate interest and the
Page 20
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 dollar strengthens against the
currencies in these countries, the dollar value of non-dollar-based revenue
decreases; when the dollar weakens, the dollar value of the non-dollar-based
revenues increases. Accordingly, changes in exchange rates, and in particular
a strengthening of the dollar, may adversely affect our royalty revenues as
expressed in dollars. Increasingly however, these royalties are being offset
by expenses arising from our foreign facility as well as non-dollar expenses
incurred in our collaborations. Currently, our foreign royalty revenues
exceed our expenses. 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 our net foreign exchange exposure, our policy allows us to
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 term of these options is generally one to two years. To hedge
the non-dollar expenses arising from our foreign facility, we may enter into
forward contracts to lock in the dollar value of a portion of these
anticipated expenses.
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. Our biotechnology equity investment portfolio
totaled $652.7 million or 10% of total assets at December 31, 2000. These
investments are subject to fluctuations from market value changes in stock
prices. For example, in the first quarter of 2001, we took a significant
charge on an equity security investment that had an other than temporary
impairment.
To mitigate the risk of market value fluctuation, certain equity
securities are hedged with costless collars and forward contracts. 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). A forward contract is a derivative instrument
where we pay the counterparty the total return of the security above the
Page 21
current spot price and receive interest income on the notional amount for the
contract term. The forward contract 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.
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.
New Accounting Pronouncement Could Impact Our Financial Position and Results
of Operations
On June 29, 2001, the Financial Accounting Standards Board, or FASB, approved
the final standards resulting from its deliberations on the business
combinations project. The FASB is expected to issue two statements in late
July 2001, Statement of Financial Accounting Standards No. 141, or FAS 141, on
Business Combinations and FAS 142 on Goodwill and Other Intangible Assets.
FAS 141 will be effective for any business combinations initiated after June
30, 2001 and also includes the criteria for the recognition of intangible
assets separately from goodwill. FAS 142 will be effective for fiscal years
beginning after December 15, 2001 and will require that goodwill not be
amortized, but rather be subject to an impairment test at least annually.
Separately identified and recognized intangible assets resulting from business
combinations completed before July 1, 2001 that do not meet the new criteria
for separate recognition of intangible assets will be subsumed into goodwill
upon adoption. In addition, the useful lives of recognized intangible assets
acquired in transactions completed before July 1, 2001 will be reassessed and
the remaining amortization periods adjusted accordingly.
The adoption of FAS 141 and 142 is not expected to have a significant
impact on our financial position at transition. We expect that the
elimination of goodwill amortization related to push-down accounting would
have a positive impact on reported net income in 2002 of approximately $153.0
million.
Page 22
GENENTECH, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Amendment No. 1 to the Quarterly Report on
Form 10-Q to be signed on its behalf by the undersigned thereunto duly
authorized.
GENENTECH, INC.
Date: July 31, 2001 /s/ARTHUR D. LEVINSON
------------------ ------------------------------------
Arthur D. Levinson, Ph.D.
Chairman and Chief Executive Officer
Date: July 31, 2001 /s/LOUIS J. LAVIGNE, JR.
------------------ ------------------------------------
Louis J. Lavigne, Jr.
Executive Vice President and Chief
Financial Officer
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