MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
OVERVIEW
Genentech, Inc. (the Company) is an international biotechnology company that
discovers, develops, manufactures and markets human pharmaceuticals for
significant medical needs. The science of biotechnological product discovery
and development is at the core of the Company's business and has led to ten of
the approved human pharmaceutical products of biotechnology. The Company
manufactures and markets five of these products directly and receives
royalties from the sales of five products which have originated from the
Company's technology.
RESULTS OF OPERATIONS
Annual % Change
Revenues 1994 1993 1992 94/93 93/92
______________________________________________________________________________
Revenues $ 795.4 $ 649.7 $ 544.3 22% 19%
Revenues have increased in each year since the Company's inception. The
increase in 1994 revenues resulted primarily from higher product sales. The
increase in 1993 revenues resulted primarily from higher product sales,
royalty income and contract revenues.
Annual % Change
Product Sales 1994 1993 1992 94/93 93/92
______________________________________________________________________________
Activase $ 280.9 $ 236.3 $ 182.2 19% 30%
Protropin and
Nutropin 225.4 216.8 205.9 4 5
Pulmozyme 88.3 - - - -
Actimmune 6.4 4.3 2.9 49 48
__________________________________________________________
Total product
sales $ 601.0 $ 457.4 $ 391.0 31% 17%
% of revenues 76% 70% 72%
Activase: The increase in Activase, registered trademark, sales in 1994 and
1993 is attributable to an increase in the number of patients being treated
with Activase as a result of the completion of the worldwide Global Utilization
of Streptokinase and Activase for occluded coronary arteries (GUSTO) clinical
trial and the reporting of its results in 1993. During 1994, Activase market
share increased to over 70% from approximately 66% and 50% in 1993 and 1992,
respectively, in the United States.
Protropin and Nutropin: Net sales of Protropin, registered trademark, and
Nutropin, registered trademark, continued to increase in 1994 due primarily to
the introduction of Nutropin for the treatment of chronic renal insufficiency
and to more growth hormone inadequate patients starting treatment. The Company
has not faced new competition in the growth hormone market, although this
possibility exists for 1995. If additional competitors enter the growth hormone
market, the Company expects that such competition will have an adverse effect
on its sales of Protropin and Nutropin which, depending on the extent and type
of competition, could be material to the Company's total growth hormone sales.
Factors that may influence future Protropin and Nutropin sales include: the
number and market entry dates of new competitive products and their effect on
the Company's market share and pricing; the availability of third party
reimbursement for the costs of such therapies; and the outcome of litigation
involving the Company's patents for growth hormone and related processes.
Pulmozyme: Pulmozyme, registered trademark, was launched during 1994 in the
United States, Canada and certain European countries. In 1994, sales totaled
$88.3 million. In 1995, as approvals for marketing the product in other
European countries are received, and a full year of sales is achieved in
countries in which Pulmozyme sales began in 1994, the Company expects sales to
grow. Other factors that may influence future sales of Pulmozyme for the
management of cystic fibrosis include: the number and kinds of patients
benefiting from such therapy; the availability of third party reimbursement for
the costs of such therapies, physicians' personal experiences in the use and
results of the therapy; the development of alternate therapies for the
treatment and cure of cystic fibrosis; the development of additional
indications for using Pulmozyme; and the cost of Pulmozyme therapy. To protect
the Company from adverse changes in foreign currency exchange rates, the
Company has purchased simple put options to hedge anticipated non-dollar
denominated revenue. All options mature within one year. See Note 6 in the
"Notes to Consolidated Financial Statements" for further information.
Actimmune: Actimmune, registered trademark, sales increased in 1994 and 1993
primarily due to the sales of interferon gamma to licensee Boehringer Ingelheim
International GmbH, which has approval to market interferon gamma in several
countries in its licensed territory.
Royalties, Contract and Other, and Interest Income Annual % Change
1994 1993 1992 94/93 93/92
_______________________________________________________________________________
Royalties $ 126.0 $ 112.9 $ 91.7 12% 23%
Contract and other 25.6 37.9 16.7 (32) 127
Interest income 42.7 41.5 44.9 3 (8)
The Company receives royalty payments from the sales of various human health
care products. These payments have increased in each of the past three years
primarily due to increases in product sales by the Company's licensees. In
1994, the largest dollar increase was attributable to royalties earned from the
sales of recombinant human insulin. In 1993, the largest dollar increase was
attributable to hepatitis B vaccine royalties. Cash flows from royalty income
include non-dollar denominated revenues. The Company currently purchases simple
foreign currency put options to hedge these cash flows, all of which expire
within the next two years. Royalty expense obligations associated with these
revenues are included in marketing, general and administrative expenses. In
December 1994, the Company and Eli Lilly and Company (Lilly) reached an
agreement regarding all patent infringement and contract actions between the
two parties, which included the Company granting to Lilly licenses, options to
license, or immunities from suit for certain of the Company's patents. Future
payments are required from Lilly on sales of these products. See Note 12 in the
"Notes to Consolidated Financial Statements" for further information.
Contract revenues in 1993 included $18.2 million related to fixed license fees
receivable through 1996 from Schering Corporation and its affiliates for a
world-wide license to certain patented technology and processes used to produce
recombinant interferon alpha. Contract and other revenues will continue to
fluctuate due to variations in the timing of contract benchmark achievements,
the initiation of new contractual arrangements, and the conclusion of existing
arrangements.
Interest income was slightly higher in 1994 due to a larger investment
portfolio in 1994 more than offsetting the decline in the average portfolio
yield. Similarly, interest income was lower in 1993 compared to 1992 primarily
due to the lower average portfolio yield in 1993. The Company enters into
interest rate swaps as part of its overall strategy of managing the duration of
its investment portfolio. See Note 6 in the "Notes to Consolidated Financial
Statements" for further information. Due to the approximately two-year
effective average duration of the portfolio, which includes the impact of the
swaps, the average yield on the portfolio in any one year is primarily a
function of financial instruments purchased in prior years. The average
portfolio yield decline in 1993 and 1994 reflected the generally continuous
decline in interest rates between 1990 and the first quarter of 1994. As
discussed in Note 6, during 1994, the Company terminated certain swaps which
resulted in an unamortized loss of $6.2 million being recorded at December 31,
1994. The amortization of these losses over the next four years will reduce
yields during those years.
Annual % Change
Costs and Expenses 1994 1993 1992 94/93 93/92
________________________________________________________________________________
Cost of sales $ 95.8 $ 70.5 $ 66.8 36% 6%
Research and
development 314.3 299.4 278.6 5 7
Marketing, general and
administrative 248.6 214.4 172.5 16 24
Interest expense 7.1 6.5 4.4 9 48
__________________________________________________________
Total costs
and expenses $665.8 $ 590.8 $ 522.3 13% 13%
% of revenues 84% 91% 96%
Cost of sales as % of
product sales 16% 15% 17%
R&D as % of revenues 40 46 51
MG&A as % of revenues 31 33 32
Cost of Sales: Cost of sales increased in 1994 and 1993 primarily due to
increased product sales and provisions for inventory obsolescence.
Research and Development: The increase in R&D expenses in 1994 and 1993
reflects the Company's continued commitment to developing new products and new
indications for existing products. Overall increases resulted from the higher
level of activity and associated costs of products in the later stages of
clinical trials and the manufacture of products for clinical trials. As a
percentage of revenues, research and development has declined over the last
three years due to increasing revenues combined with the Company's disciplined
approach to its research and development investment. The Company now has 12
products in the clinic and two products in preclinical development. At the end
of 1993 the Company had nine products in the clinic and four products in
preclinical development.
To gain additional access to potential new products and technologies, the
Company has established research collaborations, including equity investments,
with companies developing technologies that fall outside the Company's research
focus and with companies having the potential to generate new products through
technology exchanges and investments. The Company has also entered into
product-specific collaborations to acquire development and marketing rights for
products. In December 1994, the Company entered into a collaboration with Scios
Nova Inc. (Scios Nova) for the U.S. and Canadian development of Scios Nova's
Auriculin, registered trademark, (anaritide) for the treatment of acute renal
failure, which is currently in Phase III clinical trials. See Note 2 in the
"Notes to Consolidated Financial Statements" for a further description of this
collaboration.
Marketing, General and Administrative: Marketing, general and administrative
expenses increased in 1994 primarily due to the launch of Pulmozyme in Europe
and higher corporate expenses, including litigation related expenses, and $12.6
million in charges due to the write-down of marketable equity securities of
several of the biotechnology companies that are strategic alliance partners of
the Company. The declines in the fair value of such securities were considered
other than temporary. The increase in 1993 compared to 1992 was primarily due
to additional Activase marketing expenses, Pulmozyme marketing costs in
preparation for the anticipated U.S. and European product launches in 1994, and
increased growth hormone marketing expenses in anticipation of future
competition.
Interest expense in 1994, 1993 and 1992, net of amounts capitalized, relates
primarily to interest on the Company's 5% convertible subordinated debentures.
Income Before Taxes and Income Taxes 1994 1993 1992
_____________________________________________________________________________
Income before taxes $ 129.6 $ 58.9 $ 21.9
Income tax provision 5.2 - 1.1
Effective tax rate 4% - 5%
Deferred tax assets less
deferred tax liabilities $ 118.6 $ 123.0 $ 132.8
Valuation allowance 84.4 123.0 132.8
________________________________
Total net deferred taxes $ 34.2 $ - $ -
================================
Approximately $26 million of the valuation allowance at December 31, 1994,
reflected above relates to the tax benefits of stock option deductions which
will be credited to additional paid-in capital when realized.
Realization of the net deferred taxes, future effective tax rates, and future
reversals of the valuation allowance (that is, recognition of deferred tax
assets) depend on future earnings from existing and new products and new
indications for existing products. The timing and amount of future earnings
will depend on continued success in marketing and sales of the Company's
current products, scientific success, results of clinical trials and regulatory
approval of products under development.
The net increase in the effective tax rate from 1993 to 1994 was primarily
related to limitations on the utilization of existing carryforwards related to
the U.S. alternative minimum tax. Expected increases in future effective tax
rates are also attributable to these limitations. Additionally, possible
changes in tax legislation could affect the Company's effective tax rate. Based
on current projections, the Company estimates its 1995 effective tax rate to be
around 15%.
Annual % Change
Net Income 1994 1993 1992 94/93 93/92
_______________________________________________________________________________
Net income $124.4 $ 58.9 $ 20.8 111% 183%
Net income per share 1.04 0.50 0.18
Net income as a
% of revenue 16% 9% 4%
Net income as a percent of revenue has increased each year as careful expense
management, particularly R&D expense management, has allowed an increasing
proportion of revenues to flow to net income. Earnings in 1995 will depend on a
continuation of the positive impact of the GUSTO trial results on Activase
sales, sales of Pulmozyme, Protropin and Nutropin competition, and the level of
costs and expenses.
LIQUIDITY AND CAPITAL RESOURCES 1994 1993 1992
_______________________________________________________________________________
Cash, cash equivalents, short-term investments
and long-term marketable debt and equity
securities $ 920.9 $ 719.8 $ 646.9
Working capital 776.6 694.6 447.0
Cash provided by (used in):
Operating activities 200.4 114.5 36.0
Investing activities (322.3) (121.3) (126.4)
Financing activities 71.2 49.9 35.6
Capital expenditures
(included in investing activities above) $ (82.8) $ (87.5) $(126.0)
Current ratio 4.5:1 4.6:1 4.3:1
Cash generated from operating activities was used to purchase short-term
investments, long-term marketable securities, and property, plant and
equipment, increasing the amount of cash used in investing activities. Cash
provided by financing activities increased from the issuance of redeemable
common stock under employee stock plans and the exercise of warrants.
Capital expenditures in 1994 include costs incurred for additional
manufacturing facilities and the addition of a central process utility plant.
Capital expenditures decreased in 1993 as compared to 1992 primarily due to
completing construction in 1992 of the Founders Research Center, a state-of-
the-art facility housing many of the Company's research activities, and
substantially completing in 1992 new manufacturing facilities for Pulmozyme.
PROSPECTIVE INFORMATION
Market Potential/Risk: Over the longer term, the Company's (and its partners')
ability to successfully market current products, expand their usage, and bring
new products to the marketplace will depend on many factors, including the
effectiveness and safety of the products, FDA and foreign regulatory agencies'
approvals for new indications, the degree of patent protection afforded to
particular products, Orphan Drug Act legislation, the possible future
enactments of biotechnology product protection in the United States as well as
in Europe and Japan, and the outcome in the United States of potential health
care reform legislation. The Company believes it has strong patent protection
or the potential for strong patent protection for a number of its products that
generate royalty revenue or that the Company is developing; however, the courts
will determine the ultimate strength of patent protection of the Company's
products and those on which the Company earns royalties. A product that has
received an Orphan Drug designation for a specific indication, when approved,
will be protected from FDA approval of similar products for similar indications
during the first seven years of product sales in the United States. Loss of
Orphan Drug Act protection for the Company's products that are currently
marketed or in development, resulting from expiration of Orphan Drug status or
amendment of the Orphan Drug Act, could lead to increased competition for those
products and potentially lower future product revenues.
Roche Holdings, Inc.: At December 31, 1994, the Company was 65% owned by Roche
Holdings, Inc. (Roche). See Note 9 in the "Notes to Consolidated Financial
Statements" for further information.
Foreign Exchange: The Company receives revenues from countries throughout the
world. As a result, risk exists that revenues may be impacted by changes in the
exchange rates between the U.S. dollar and foreign currencies. To mitigate this
risk, the Company hedges certain of these revenues as discussed in Note 6 in
the "Notes to Consolidated Financial Statements."
Legal Proceedings: The Company is a party to various legal proceedings. See
Note 12 in the "Notes to Consolidated Financial Statements" for further
information.
General: The Company believes that its cash, cash equivalents, and short-term
and long-term investments, together with funds provided by operations and
leasing arrangements, will be sufficient to meet its operating cash
requirements, including capital expenditures and the development of existing
and new products through internal research and development activities, product
in-licensing, research collaborations, equity investments and geographic
expansion.
REPORT OF MANAGEMENT
Genentech, Inc. is responsible for the preparation, integrity and fair
presentation of its published financial statements. The Company has prepared
the financial statements, presented on pages 33 to 60, in accordance with
generally accepted accounting principles. As such, the statements include
amounts based on judgments and estimates made by management. The Company also
prepared the other information included in the annual report and is responsible
for its accuracy and consistency with the financial statements.
The financial statements have been audited by the independent auditing firm,
Ernst & Young LLP, which was given unrestricted access to all financial records
and related data, including minutes of all meetings of stockholders, the Board
of Directors and committees of the Board. The Company believes that all
representations made to the independent auditors during their audit were valid
and appropriate. Ernst & Young LLP's audit report appears on page 61.
Systems of internal accounting controls, applied by operating and financial
management, are designed to provide reasonable assurance as to the integrity
and reliability of the financial statements and reasonable, but not absolute,
assurance that assets are safeguarded from unauthorized use or disposition, and
that transactions are recorded according to management's policies and
procedures. The Company continually reviews and modifies these systems, where
appropriate, to maintain such assurance. Through the Company's audit
activities, the adequacy and effectiveness of the systems and controls are
reviewed and the resultant findings to management and the Audit Committee of
the Board of Directors.
The selection of Ernst & Young LLP as the Company's independent auditors has
been approved by the Company's Board of Directors and ratified by the
stockholders. An Audit Committee of the Board of Directors, composed of four
non-management directors, meets regularly with, and reviews the activities of,
corporate financial management, the general audit function and the independent
auditors to ascertain that each is properly discharging its responsibilities.
The independent auditors separately meet with the Audit Committee, with and
without management present, to discuss the results of their work, the adequacy
of internal accounting controls and the quality of financial reporting.
G. Kirk Raab Louis J. Lavigne, Jr. Bradford S. Goodwin
President and Chief Senior Vice President and Vice President and
Executive Officer Chief Financial Officer Controller
CONSOLIDATED STATEMENTS OF INCOME
(thousands, except per share amounts)
YEAR ENDED DECEMBER 31 1994 1993 1992
________________________________________________________________________________
Revenues
Product sales $ 601,064 $ 457,360 $ 390,975
Royalties (including amounts
from related parties: 1994-$8,454;
1993-$5,488; 1992-$5,378) 126,022 112,872 91,682
Contract and other (including amounts
from related parties: 1994-$17,106;
1993-$8,869; 1992-$7,234) 25,556 37,957 16,727
Interest 42,748 41,560 44,881
___________________________________
Total revenues 795,390 649,749 544,265
Costs and expenses
Cost of sales 95,829 70,514 66,824
Research and development (including
contract related: 1994-$7,584;
1993-$4,235; 1992-$8,468) 314,322 299,396 278,615
Marketing, general and administrative 248,604 214,410 172,486
Interest 7,058 6,527 4,406
____________________________________
Total costs and expenses 665,813 590,847 522,331
Income before taxes 129,577 58,902 21,934
Income tax provision 5,183 -- 1,097
____________________________________
Net income $124,394 $ 58,902 $ 20,837
====================================
Net income per share $ 1.04 $ .50 $ .18
====================================
Weighted average number of shares used
in computing per share amounts 119,465 117,106 113,992
====================================
<FN>
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
Increase (Decrease) in Cash and
Cash Equivalents
YEAR ENDED DECEMBER 31 1994 1993 1992
________________________________________________________________________________
Cash flows from operating activities:
Net income $ 124,394 $ 58,902 $ 20,837
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 53,452 44,003 52,170
Gain on sale of equity investments - - (3,946)
Reserve for long-term assets 748 600 2,275
Net loss on fixed asset dispositions 5,510 1,652 410
Write-down of available-for-sale
securities 12,590 - -
Deferred income taxes (34,193) - -
Changes in assets and liabilities:
Receivables and other current assets (16,571) (20,212) (43,843)
Inventories (18,475) (19,410) (9,141)
Accounts payable, other current
liabilities and other long-term
liabilities 72,901 48,995 17,251
_________________________________
Net cash provided by operating activities 200,356 114,530 36,013
Cash flows from investing activities:
Purchases of securities held-to-maturity (1,088,737) (564,855) (533,808)
Proceeds from maturities of securities
held-to-maturity 877,139 535,089 547,250
Purchases of securities available-for-sale (22,644) (8,222) -
Purchases of non-marketable equity securities (4,000) - (6,009)
Capital expenditures (82,837) (87,461) (126,049)
Proceeds from sale of fixed assets - 26,316 2,004
Change in other assets (1,198) (22,181) (9,768)
_________________________________
Net cash used in investing activities (322,277) (121,314) (126,380)
Cash flows from financing activities:
Stock issuances 71,955 50,582 36,782
Reduction in long-term debt,
including current portion (794) (721) (1,171)
_________________________________
Net cash provided by financing activities 71,161 49,861 35,611
_________________________________
Increase (decrease) in cash and cash equivalents (50,760) 43,077 (54,756)
Cash and cash equivalents at beginning of year 117,473 74,396 129,152
_________________________________
Cash and cash equivalents at end of year $ 66,713 $ 117,473 $ 74,396
=================================
Supplemental cash flow data:
Cash paid during the year for:
Interest, net of portion capitalized $ 7,058 $ 6,527 $ 4,406
Income taxes 4,099 2,194 1,002
<FN>
Non-cash activity: In 1994 income tax benefits realized from employee stock option
exercises of $26,038 were recorded as an increase in stockholders' equity.
See notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
DECEMBER 31 1994 1993
______________________________________________________________________________
Assets:
Current assets:
Cash and cash equivalents $ 66,713 $ 117,473
Short-term investments 652,461 539,638
Accounts receivable (including amounts from a
related party: 1994-$13,184;1993-$10,259;
less allowances of: 1994-$4,422;1993-$3,572) 146,267 130,469
Inventories 103,200 84,725
Prepaid expenses and other current assets 28,475 13,032
____________________________
Total current assets 997,116 885,337
Long-term marketable securities 201,726 62,657
Property, plant and equipment, at cost:
Land 55,998 49,939
Buildings 245,871 245,923
Equipment 331,392 300,396
Leasehold improvements 11,988 12,535
Construction in progress 55,299 14,893
______________________________
700,548 623,686
Less: accumulated depreciation 215,255 166,954
______________________________
Net property, plant and equipment 485,293 456,732
Other assets 60,989 64,074
______________________________
Total assets $ 1,745,124 $ 1,468,800
==============================
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 30,963 $ 30,265
Accrued compensation 36,939 32,639
Accrued interest 5,685 5,708
Accrued royalties 25,864 18,889
Accrued marketing and promotion costs 27,463 19,942
Accrued clinical and other studies 36,277 23,324
Income taxes payable 17,839 1,921
Other accrued liabilities 38,598 57,267
Current portion of long-term debt 871 793
_____________________________
Total current liabilities 220,499 190,748
Long-term debt 150,358 151,230
Other long-term liabilities 25,483 10,017
_____________________________
Total liabilities 396,340 351,995
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.02 par value; authorized
100,000,000 shares, none issued - -
Redeemable common stock, $.02 par value;
authorized 100,000,000 shares, outstanding:
1994-50,105,925;1993-47,690,108 1,002 954
Common stock, $.02 par value; authorized
200,000,000 shares, outstanding:
1994 and 1993-67,133,409 1,343 1,343
Additional paid-in capital 1,207,720 1,070,121
Retained earnings (since October 1, 1987
quasi-reorganization in which a deficit
of $329,457 was eliminated) 129,127 44,387
Net unrealized gain on securities
available-for-sale 9,592 -
_______________________________
Total stockholders' equity 1,348,784 1,116,805
_______________________________
Total liabilities and stockholders' equity $ 1,745,124 $ 1,468,800
===============================
<FN>
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands)
Redeemable Retained Net Total
Common Stock Common Stock Additional Earnings Unrealized Stock-
Par Par Paid-In (Accumulated Gain On holders'
Shares Value Shares Value Capital Deficit) Securities Equity
____________________________________________________________________________________________________
Balance January 1, 1992 44,165 $ 883 67,133 $1,343 $954,755 $(7,279) - $949,702
Issuance of stock upon
exercise of options
and warrants 989 20 - - 25,094 - - 25,114
Issuance of stock under
employee stock plans 590 12 - - 11,656 - - 11,668
Net income - - - - - 20,837 - 20,837
Tax benefits arising prior
to quasi-reorganization - - - - 7,457 (7,457) - -
________________________________________________________________________
Balance December 31,1992 45,744 915 67,133 1,343 998,962 6,101 - 1,007,321
Issuance of stock upon
exercise of options
and warrants 1,385 28 - - 37,125 - - 37,153
Issuance of stock under
employee stock plan 561 11 - - 13,418 - - 13,429
Net income - - - - - 58,902 - 58,902
Tax benefits arising prior
to quasi-reorganization - - - - 20,616 (20,616) - -
________________________________________________________________________
Balance December 31,1993 47,690 954 67,133 1,343 1,070,121 44,387 - 1,116,805
Issuance of stock upon
exercise of options
and warrants 1,905 38 - - 56,133 - - 56,171
Issuance of stock under
employee stock plan 511 10 - - 15,774 - - 15,784
Income tax benefits
realized from employee
stock option exercises - - - - 26,038 - - 26,038
Net unrealized gain
on securities
available-for-sale - - - - - - $9,592 9,592
Net income - - - - - 124,394 - 124,394
Tax benefits arising prior
to quasi-reorganization - - - - 39,654 (39,654) - -
_________________________________________________________________________
Balance December 31, 1994 50,106 $1,002 67,133 $1,343 $1,207,720 $129,127 $9,592 $1,348,784
=========================================================================
<FN>
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summary of Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include the
accounts of the Company and its wholly owned and majority owned subsidiaries
and collaborations. All significant intercompany balances and transactions have
been eliminated.
Cash and Cash Equivalents: The Company considers all highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents.
Short-term Investments and Long-term Marketable Securities: The Company
invests its excess cash balances in short-term and long-term marketable
securities. These investments primarily include corporate notes, certificates
of deposit and treasury notes.
On January 1, 1994, the Company adopted Statement of Financial Accounting
Standard (FAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The effect of adopting this new standard was not material to net
income. FAS 115 requires that all investment securities be classified into one
of three categories: held-to-maturity, available-for-sale, or trading.
Securities are considered held-to-maturity when the Company has the positive
intent and ability to hold the securities to maturity. These securities are
recorded as either short-term investments or long-term marketable securities on
the balance sheet depending upon their contractual maturity date. Held-to-
maturity securities are stated at amortized cost, adjusted for amortization of
premiums and accretion of discounts. Securities are considered trading when
bought principally for the purpose of selling in the near term. These
securities are recorded as short-term investments and are carried at market
value. Unrealized holding gains and losses on trading securities are included
in interest income. Securities not classified as held-to-maturity or as trading
are considered available-for-sale. These securities are recorded as long-term
marketable securities and are carried at market value with unrealized gains and
losses included in stockholders' equity net of related tax effects. If a
decline in fair value below cost is considered other than temporary, such
securities are written down to estimated fair value with a charge to marketing,
general and administrative expenses. Prior to adopting FAS 115, marketable debt
securities were carried at amortized cost that approximated fair value.
Marketable equity securities were carried at the lower of cost or market. The
cost of all securities sold is based on the specific identification method.
Non-marketable Equity Investments: The carrying value, which approximates the
fair value, is included in other assets in the consolidated balance sheets. The
fair value of non-marketable equity investments is estimated based on the lower
of amortized cost or the offering price in the most recent round of financing.
Property, Plant and Equipment: The costs of buildings and equipment are
depreciated using the straight-line method over the estimated useful lives of
the assets. Leasehold improvements are generally amortized over the length of
the applicable lease. Expenditures for maintenance and repairs are expensed as
incurred. Interest on construction-in-progress of $0.6 million in 1994, $1.3
million in 1993 and $3.4 million in 1992 has been capitalized and is included
in property, plant and equipment.
Patents: As a result of its research and development (R&D) programs, the
Company owns or is in the process of applying for patents in the United States
and other countries which relate to products and processes of significant
importance to the Company. Costs of patents and patent applications are
capitalized and amortized for financial reporting purposes on a straight-line
basis over their estimated useful lives of approximately 12 years.
Contract Revenue: Contract revenue for R&D is recorded as earned based on the
performance requirements of the contract. In return for contract payments,
contract partners may receive certain marketing and manufacturing rights,
products for clinical use and testing or R&D services.
Income Taxes: The Company accounts for income taxes in conformance with FAS
109, "Accounting for Income Taxes," which requires the asset and liability
approach for the financial accounting and reporting for income taxes.
Net Income Per Share: Net income per share is computed based on the weighted
average number of shares of the Company's redeemable common stock, common stock
and redeemable common stock equivalents, if dilutive. The Company's convertible
subordinated debentures are redeemable common stock equivalents but have been
antidilutive to date; therefore, they have not been included in net income per
share calculations.
Financial Instruments: Certain of the Company's revenues are earned outside of
the United States. Since the Company has nominal expenses denominated in
foreign currencies, risk exists that income may be impacted by changes in the
exchange rates between the U.S. dollar and foreign currencies. To mitigate this
risk, the Company purchases simple foreign currency put options (options) with
expiration dates and amounts of currency that match a portion of expected
revenues so that the adverse impact of movements in currency exchange rates on
the non-dollar denominated revenues will be largely offset by an associated
increase in the value of the options. Realized and unrealized gains related to
the options are deferred until the designated hedged revenues are recorded. The
associated costs, which are amortized over the term of the options, are
recorded as a reduction of the hedged revenues. In prior years, the Company
also purchased foreign currency forward contracts as hedging instruments. These
contracts are currently recorded at fair value and the associated losses are
reflected in the income statement.
Interest income is subject to fluctuations as U.S. interest rates change. To
manage this risk, the Company periodically establishes duration targets for its
investment portfolio that reflect its anticipated use of cash and fluctuations
in market rates of interest. Swaps are used to adjust the duration of the
investment portfolio in order to meet these duration targets. By combining a
swap with a pool of short-term securities equal in size to the notional amount
of the swap, an instrument with an effective interest rate and maturity equal
to the term of the swap is created. The characteristics of the instrument
(including interest rate, maturity, and fair value) are similar to the
characteristics of a high grade corporate security which could be purchased at
the same time the instrument is created. Increases (decreases) in swap variable
payments caused by rising (falling) interest rates will be essentially offset
by increased (reduced) interest income on the related short-term investments,
while the fixed rate payments received from the swap counterparty establishes
the Company's interest income. Net payments made or received on swaps are
included in interest income as adjustments to the interest received on invested
cash. Amounts deferred on terminated swaps are amortized to interest income
over the original contractual term of the swaps by a method that approximates
the level yield method.
401(k) Plan: The Company's 401(k) Plan covers substantially all its U.S.
employees. Under the 401(k) Plan, eligible employees may contribute up to 15%
of their eligible compensation, subject to certain Internal Revenue Service
restrictions. The Company matches a portion of employee contributions, up to a
maximum of 4% of each employee's eligible compensation. The match is effective
December 31 of each year and is fully vested when made. During 1994, 1993 and
1992, the Company provided $5.2 million, $4.4 million, and $4.1 million,
respectively, for the Company match under the 401(k) Plan.
Note 1: Significant Customer and Geographic Information
One major customer in 1994, 1993 and 1992 contributed 10% or more of the
Company's total revenues. The portions of revenues attributable to this
customer
were 21% in 1994, 26% in 1993 and 31% in 1992. This customer distributes
Protropin, Nutropin, Pulmozyme and Actimmune through its extensive branch
network, and is then reimbursed through a variety of sources. A second
customer, a wholesale distributor of all of the Company's products, contributed
11% of revenues in 1994.
Approximate foreign sources of revenues were as follows (millions):
1994 1993 1992
_____________________________________________________
Europe $81.8 $41.0 $46.4
Asia 19.5 22.2 16.3
Canada 9.7 12.2 10.1
The Company sells primarily to distributors and hospitals throughout the United
States, Canada and Europe, performs ongoing credit evaluations of its
customers' financial condition and generally requires no collateral. In 1994,
1993 and 1992 the Company did not record any material additions to, or losses
against, its provision for doubtful accounts.
Note 2: Research and Development Arrangements
To gain access to potential new products and technologies, the Company has
established research collaborations, including both marketable and non-
marketable equity investments, with companies developing technologies that fall
outside the Company's research focus and with companies having the potential to
generate new products through technology exchanges and investments. Potential
future payments maybe due to selective collaborative partners if the partners
achieve certain benchmarks as defined in the collabortive agreements.
In addition to the collaborations with F. Hoffmann-La Roche, Ltd. discussed in
Note 10, in December 1994, the Company entered into a collaboration with Scios
Nova Inc. (Scios Nova) for the U.S. and Canadian development of Scios Nova's
Auriculin or the treatment of acute renal failure, which is currently in Phase
III clinical trials. Under the terms of the collaboration, both companies will
copromote Auriculin in the United States and Canada, sharing profits from its
commercialization. The Company received exclusive rights to all markets outside
the United States and Canada subject to a royalty obligation to Scios Nova. In
connection with the collaboration, the Company purchased Scios Nova non-voting
preferred stock, which is convertible into shares of Scios Nova common stock,
for $20 million and charged approximately $5 million to research and
development expense. The Company established a line of credit for Scios Nova
which is described in Note 8. In addition, the Company agreed to pay up to $50
million in benchmark payments, conditional on achieving certain predetermined
commercialization goals.
Note 3: Income Taxes
The income tax provision consists of the following amounts (thousands):
1994 1993 1992
_________________________________________________________________
Current:
Federal $ 38,331 $ - $ 200
State 1,016 - 711
Foreign 29 - 186
_____________________________________
Total current 39,376 - 1,097
Deferred:
Federal (34,193) - -
_____________________________________
Total $ 5,183 $ - $ 1,097
=====================================
Actual 1994 current tax liabilities are lower than reflected above by $26
million due to employee stock option related tax benefits which were credited
to stockholders' equity.
A reconciliation between the Company's effective tax rate and the U.S.
statutory
rate follows:
1994 Amount Tax Rate
(thousands) 1994 1993 1992
______________________________________________________________________________
Tax at U.S. statutory rate $ 45,352 35.0% 35.0% 34.0%
Operating losses utilized (39,654) (30.6) (35.0) (33.1)
Alternative minimum tax liability 31,900 24.6 - -
Adjustment of deferred tax assets
valuation allowance (34,193) (26.4) - -
Other, including state taxes 1,778 1.4 - 4.1
________________________________________________
Income tax provision $ 5,183 4.0% - 5.0%
================================================
The components of deferred taxes consist of the following at December 31
(thousands):
1994 1993
________________________________________________________________________________
Deferred tax liabilities:
Depreciation $ 42,109 $ 34,297
Inventory valuation differences (545) 7,024
Other 20,473 21,443
__________________________
Total deferred tax liabilities 62,037 62,764
Deferred tax assets:
Federal net operating loss (NOL) carryforward 43,027 75,612
Federal credit carryforward 86,804 56,097
Reserves not currently deductible 31,688 21,929
State credit carryforward 11,324 14,895
State NOL carryforward 1,893 5,531
Amortization of purchased technology 1,330 2,660
Other 4,616 8,992
__________________________
Total deferred tax assets 180,682 185,716
Valuation allowance (84,452) (122,952)
__________________________
Total net deferred tax assets 96,230 62,764
__________________________
Total net deferred taxes $ 34,193 $ -
==========================
The NOL and credit carryforwards, which totaled $123 million and $87 million,
respectively, listed above expire in the years 1995 through 2009, except for
$20 million of alternative minimum tax credits which never expire.
Approximately $26 million of the valuation allowance at December 31, 1994
reflected above relates to the tax benefits of stock option deductions which
will be credited to additional paid-in capital when realized.
The valuation allowance decreased by $38.5 million in 1994 and $10 million in
1993. Realization of net deferred taxes, as well as future reversals of the
valuation allowance (that is, recognition of deferred tax assets), depend on
future earnings from existing and new products and new indications for existing
products. The timing and amount of future earnings will depend on continued
success in marketing and sales of the Company's current products, scientific
success, results of clinical trials and regulatory approval of products under
development.
Note 4: Inventories
Inventories are stated at the lower of cost or market. Cost is determined using
a weighted-average approach which approximates the first-in, first-out method.
Inventories at December 31, 1994 and 1993 are summarized below (thousands):
1994 1993
__________________________________________________________________
Raw materials and supplies $ 13,145 $ 10,995
Work in process 76,974 60,256
Finished goods 13,081 13,474
______________________
Total $103,200 $ 84,725
======================
The increase in total inventories in 1994 compared to 1993 is primarily
attributable to an increase in the inventories of Activase.
Note 5: Investment Securities
Securities classified as trading, available-for-sale and held-to-maturity at
December 31, 1994 are summarized below. Estimated fair value is based on quoted
market prices for these or similar investments.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
___________________________________________________________________________
(thousands)
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $ 85,295 $ 1,107 $ 1,105 $ 85,297
==============================================
TOTAL AVAILABLE-FOR-SALE(a)
(carried at estimated
fair value) $ 25,669 $ 10,058 $ 67 $ 35,660
==============================================
SECURITIES HELD-TO-MATURITY:
(carried at amortized cost)
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing within:
1 year $ 77,453 $ 15 $ 37 $ 77,431
1-3 years 119,714 - 218 119,496
Other debt securities
maturing within:
1 year 482,463 1,770 452 483,781
1-3 years 44,715 285 490 44,510
______________________________________________
TOTAL HELD-TO-MATURITY $ 724,345 $ 2,070 $ 1,197 $ 725,218
==============================================
<FN>
(a) Securities available-for-sale include only equity securities. Net
unrealized gains, reduced by related tax effects, of $9.6 million are
included in stockholders' equity. At January 1, 1994, the excess of
market value over the cost of these securities was $3.9 million.
The carrying value of all investment securities (excluding non-marketable
securities) held at December 31, 1994 is summarized below (thousands):
Security Carrying Value
__________________________________________________________________________
Held-to-maturity securities maturing within one year
(at amortized cost) $ 559,916
Accrued interest 7,248
Trading securities (at fair value) 85,297
----------
Total short-term investments $ 652,461
==========
Held-to-maturity securities maturing within 1-3 years
(at amortized cost) $ 164,429
Accrued interest 1,637
Securities available-for-sale (at fair value) 35,660
----------
Total long-term marketable securities $ 201,726
==========
During 1994, no available-for-sale securities were sold and the Company
recorded a $12.6 million charge to write down certain available-for-sale
biotechnology securities for which the decline in fair value below cost was
other than temporary.
At December 31, 1993, the fair value of the short-term investments approximated
carrying value. The fair value of the long-term marketable debt securities
totaled $63.4 million. The carrying value of marketable equity securities at
December 31, 1993 totaled $12.1 million and was included in other assets.
The carrying value, which approximated the fair value, of non-marketable equity
securities totaled $6.8 million and $10.5 million at December 31, 1994 and
1993, respectively.
The Company invests its excess cash principally in marketable debt securities
with terms ranging from overnight to three years. Marketable debt securities
held by the Company are issued by a diversified selection of institutions with
strong credit ratings. The Company's investment policy limits the amount of
credit exposure with any one institution. These debt securities are generally
not collateralized. The Company has not experienced any material losses due to
credit impairment on its investments in marketable debt securities in the years
1994, 1993 and 1992.
Note 6: Financial Instruments
Foreign Currency Instruments: As discussed above, the Company currently
purchases simple foreign currency put options (options) solely to hedge
anticipated non-dollar denominated net revenues. At December 31, 1994, the
Company had hedged approximately 85% of net foreign revenues anticipated within
12 month and 35% of net foreign revenues anticipated in the following 12
months. At December 31, 1994, the notional amount of the options totaled $78.3
million and consisted of the following currencies: Australian dollars, Canadian
dollars, German marks, Spanish pesetas, French francs, British pounds, Italian
lira, Japanese yen, and Swedish krona. All contracts mature within the next
two years. The fair value of the options, which is based on exchange rates and
market conditions at December 31, 1994, totaled $1.6 million.
Previously, the Company had entered into foreign currency forward exchange
contracts (forward contracts) as hedging instruments. Unrealized gains and
losses were deferred until the revenue was recognized. In 1994, the Company
closed out its positions by entering into offsetting contracts so that the net
notional amount denominated in foreign currencies was zero. At December 31,
1994, the U.S. dollar equivalent of the notional amount of the forward sell
contracts totaled $28.3 million; the forward buy contracts totaled $29.8
million. The difference, an unrealized loss of $1.5 million, was recorded as a
reduction of net income in 1994 as a charge to marketing, general and
administrative expenses and at December 31, 1994, is included in other accrued
liabilities. All contracts mature within two years.
At December 31, 1993, the Company had simple put option contracts with a
notional amount of $6.8 million and forward contracts with a notional amount
of $47.0 million to sell various foreign currencies within the next two years.
At December 31, 1993, the fair value of the option contracts was $0.4 million
and the fair value of the forward contracts was ($1.2) million.
Credit exposure is limited to the unrealized gains on these contracts. All
agreements are with a diversified selection of institutions with strong credit
ratings which minimizes risk of loss due to nonpayment from the counterparty.
The Company has not experienced any material losses due to credit impairment of
its foreign currency instruments.
Interest Rate Swaps: The Company enters into interest rate swaps (swaps) as
part of its overall strategy of managing the duration of its cash portfolio.
For each swap, the Company receives interest based on fixed rates and pays
interest to counterparties based on floating rates (three or six month LIBOR)
on a notional principal amount. By combining a swap with a pool of short-term
securities equal in size to the notional amount of the swap, an instrument with
an effective interest rate and maturity equal to the term of the swap is
created. The use of swaps in this manner generates net interest income on the
swap and associated pool of short-term securities equivalent to interest income
that would be earned from a high grade corporate security of the same maturity
as the swap, while reducing credit risk (there is no principal invested in a
swap). The Company's credit exposure on swaps is limited to the value of the
interest rate swaps that have become favorable to the Company and any net
interest earned but not yet received. Swap counterparties typically have strong
credit ratings which minimize the risk of non-performance on the swaps. The
Company has not experienced any material losses due to credit impairment.
The Company targets the average maturity of its investment portfolio (including
swaps) based on to its anticipated use of cash and fluctuations in the market
rates of interest. The maturity of the investment portfolio (including swaps)
ranges from overnight funds used for near-term working capital purposes,
investments maturing within the next one to five years for future working
capital, capital expenditures and strategic investments, to maturities of up to
seven years which is comparable to the remaining term of the Company's
outstanding convertible debt. Due to the increase in market interest rates
during 1994 and concern about a continuing rise in rates, the Company gradually
reduced the average effective maturity of its investment portfolio (including
swaps) from 2.8 years at December 31, 1993 to 1.9 years at December 31, 1994,
which approximates the lower end of the range of the Company's average
anticipated cash needs.
The notional amount of each swap is equal to the amount of designated high
quality short-term investments which either mature or reprice within the next
six months. The investments include U.S. Treasury securities, U.S. government
agency securities, commercial paper and corporate debt obligations. Swaps are
used to extend the maturity of the investment portfolio; no speculative
activity occurs.
The table below outlines specific information for the swaps outstanding at
December 31, 1994. The fair value is based on market prices of similar
agreements. Dollars are in millions.
Interest Rate Swaps Short-term Investments
___________________________ _______________________________
Fixed Average
Rates Variable Effective
Notional To Be Rates To Carrying Average Interest
Amounts Received Be Paid* Value Maturity** Rate
_____________________________________________________________________________________
Swaps matched
to investments
to meet maturity
target comparable
to outstanding debt 3 or 6
[Maturing on: 7.68%- month
1/2/02] $150 7.92% LIBOR $150 84 days 5.45%
Swaps matched to
other investments
to meet specific
maturity targets 3 or 6
[Ending dates: 4.08%- month
12/29/95 - 9/20/99] 180 7.20% LIBOR 180 35 days 5.34%
Other short-term
investments - - - 322 - -
________________________________________________________________
Total $330 - - $652 - -
================================================================
<FN>
* 3 and 6-month LIBOR rates are reset every 3 or 6 months. At December 31, 1994,
the 3-month LIBOR rate was 6.5% and the 6-month LIBOR rate was 7.0%.
** Average maturity reflects either the maturity date or, for a floating
investment, the next reset date.
For the year ended December 31, 1994, the weighted average rate received
on swaps was 6.30% and the weighted average rate paid on swaps was 5.12%. Net
interest income received from swaps totaled $4.3 million in 1994.
The carrying amount of the swaps, which reflects the net interest accrued for
such swaps, totaled $6.2 million and $7.5 million at December 31, 1994 and
1993, respectively, and is included in accounts receivable. At December 31,
1993, the notional amount totaled $350 million and the fair value totaled $13.0
million.
During 1994, to reduce the average effective maturity of its portfolio, the
Company terminated certain swap agreements prior to maturity and is amortizing
the realized gains and losses over the original contractual term of the swaps
as a reduction of interest income. At December 31, 1994, net losses of $6.2
million remained unamortized; $3.1 million will be recognized in 1995 and $3.1
million will be recognized during the following three years.
Financial Instruments Held for Trading Purposes: As part of its overall
investment strategy, in 1994 the Company contracted with two external money
managers to manage part of its investment portfolio. One portfolio, which had a
carrying value of $31 million at December 31, 1994, consisted of both U.S.
dollar and non-dollar denominated investments. To hedge the non-dollar
denominated investments, the money manager purchases forward contracts. The
fair value at December 31, 1994, of the forward contracts totaled $2.7
million; the average fair value during the year totaled $15.3 million. Net
realized and unrealized trading gains totaled approximately $389,000 in 1994
and are included in interest income. Counterparties have strong credit ratings
which minimizes the risk of non-performance from the counterparties.
Summary of Fair Values: The table below summarizes the carrying value and fair
value at December 31, 1994, of the Company's financial instruments. The fair
value of the long-term debt was estimated based on the quoted market price at
year end.
Financial Instrument Carrying Value Fair Value
_______________________________________________________________________
(thousands)
Assets:
Investment securities
(including accrued interest
and traded forward contracts)
(Note 5) $ 854,187 $ 855,060
Non-marketable equity
investments (Note 5) 6,820 6,820
Options 1,646 1,600
Outstanding swaps 6,165 (2,044)
Liabilities:
Short-term and long-term
debt (Note 7) 151,229 125,250
Forward contracts 1,500 1,500
Note 7: Long-term Debt
Long-term debt consists of the following (thousands):
1994 1993
_______________________________________________________________________________
Convertible subordinated debentures, interest at 5%,
due in 2002 $ 150,000 $ 150,000
Mortgage note payable on buildings and land,
interest at 9.5%, due through 1996 1,229 2,023
______________________
151,229 152,023
Less current maturities 871 793
______________________
Total long-term debt $ 150,358 $ 151,230
======================
Maturities of long-term debt in 1995 and 1996 are $0.9 million and $0.3
million, respectively. Exclusive of the convertible subordinated debentures, no
long-term debt maturities are due in 1997 and thereafter. The fair value of the
Company debt was $146 million at December 31, 1993.
Convertible subordinated debentures are convertible at the option of the holder
into shares of the Company's redeemable common stock at a conversion price of
$74 in principal amount of the debenture. Upon conversion, the holder receives,
for each $74 in principal amount of the debenture converted, one-half share of
redeemable common stock and $18 in cash. Under the terms of the Merger (see
Note 9), the $18 in cash is reimbursed by Roche Holdings, Inc. (Roche)to the
Company. Generally, the Company may redeem the debentures until maturity.
Note 8: Leases, Commitments and Contingencies
Future minimum lease payments under noncancelable operating leases at December
31, 1994 are as follows (thousands):
_______________________________________________________________________
1995 $ 6,501
1996 2,375
1997 2,041
1998 704
__________
Total minimum lease payments $ 11,621
==========
The Company has leased certain real property. Under many of its lease
arrangements, the Company is responsible for taxes, insurance and maintenance
related to the leased properties. Rent expense under operating leases was
approximately $6.5 million, $5.1 million and $9.4 million for 1994, 1993 and
1992, respectively. Income from subleases was immaterial.
Under two of its lease agreements, the Company is contingently liable to
purchase three buildings at the end of their lease terms. These leases expire
in 1995, but the Company has the option to extend one lease until 1997 and the
other until 1998. If at the end of the final lease renewal term the Company
does not purchase the property or arrange a third party purchase, then the
Company would be obligated to the lessor for a guaranteed payment equal to a
specified percentage of the lessor's purchase price for the properties. The
Company would also be obligated to the lessor for all or some portion of this
amount if the price paid by a third party for the property is below a specified
percentage of the lessor's purchase price. Under these leases, the Company is
also required to maintain certain financial ratios and is subject to limits on
certain types and amounts of debt. The properties under these leases include a
process science laboratory, which is scheduled for completion in 1995, and two
office buildings. As of December 31, 1994, the total amount related to these
leased facilities, for which the Company would be contingently liable, is $65.0
million. In connection with one of the leases, the Company has pledged
securities worth $42.4 million as of December 31, 1994.
The Company expects to develop a new manufacturing facility over the next three
years with a total expected cost of $150 million. In connection therewith, the
Company expects to enter into an operating lease arrangement similar to the
arrangements described above.
Pursuant to its collaboration agreement with Scios Nova (see Note 2), the
Company established a line of credit for $30 million that Scios Nova may draw
down at Scios Nova's discretion through 2002. This commitment is supported
through December 31, 1997, by a bank letter of credit under which Scios Nova
may draw up to $30 million directly from the bank, with immediate repayment of
the funds due to the bank by the Company. Amounts drawn by Scios Nova under the
bank letter of credit or directly from the Company are repayable in the form of
cash or Scios Nova common stock (at the market price prevailing on the date of
repayment) at Scios Nova's option any time through December 30, 2002. Interest
on amounts borrowed by Scios Nova accrue to the Company at the prime rate of
interest. At December 31, 1994, no amounts were drawn.
Note 9: Merger With Roche Holdings, Inc.
The Company's merger (Merger) with a wholly owned subsidiary of Roche Holdings,
Inc. (Roche) was consummated on September 7, 1990 (Effective Date). Pursuant to
the merger agreement with Roche, the Company's stockholders of record on the
Effective Date received, for each share of common stock that they owned, $18 in
cash from Roche and one half share of newly issued redeemable common stock from
the Company. In the Merger, Roche acquired one-half of the Company's
outstanding common stock for $1,537.2 million. The redeemable common stock is
substantially identical to the common stock previously held by stockholders,
except that it is redeemable by the Company at the election of Roche, provided
that Roche first deposits in trust sufficient funds to pay the aggregate
redemption price of all outstanding shares of redeemable common stock. Roche
has the right to require the Company to exercise its redemption right,
providing it does so for all shares of outstanding redeemable common stock at
$58.75 per share in the first calendar quarter of 1995 and increasing to $60.00
per share on April 1, 1995. The redemption right expires on June 30, 1995. For
the period of July 1, 1995 until June 30, 1996, Roche may submit a bid to
purchase the remaining shares of the Company. The bid must not be for less than
$60.00 per share and is subject to the approval of the Board of Directors and
subsequently, of non-Roche stockholders.
Independent of its right to have the Company redeem the redeemable common
stock, Roche is permitted to acquire additional shares of the Company's stock
through open market or privately negotiated purchases, provided that Roche's
aggregate holdings do not exceed 75% of the Company's stock outstanding
on a fully diluted basis.
In connection with the Merger, the Company issued 24,433,951 shares of common
stock to Roche for $487.3 million in cash. The common stock Roche acquired in
the Merger and redeemable common stock purchased in the open market represents
approximately 65% of the outstanding equity of the Company as of December 31,
1994.
Note 10: Related Party Transactions
The Company has transactions with related parties in the ordinary course of
business. Pursuant to contracts, principally regarding R&D projects
and product licensing agreements as described below, the Company recorded
revenue of approximately $25.6 million in 1994, $14.4 million in 1993 and $12.6
million in 1992 from the following related parties: F. Hoffmann-LaRoche, Ltd.
(HLR) (a wholly owned subsidiary of Roche; two officers of HLR serve on the
Company's Board of Directors - Note 9) and Genencor, Inc. (in which the Company
formerly owned a 25% equity interest). The Company is also developing a
mammalian cell line for HLR. In 1994, the Company and HLR began developing an
anti-IgE antibody and Pulmozyme in Japan. During 1994 and 1993, the Company
collaborated with HLR on four projects, including oral antagonists to platelet
gpIIb/IIIa, IL-8, LFA/ICAM and ras farnesyltransferase. In 1992, the Company
entered into a collaboration with HLR to codevelop and copromote Pulmozyme in
Europe. In connection with this collaboration and the Company's efforts to
expand its markets, Genentech Europe Limited (GEL) was established. GEL and
affiliates are currently promoting Pulmozyme in the United Kingdom, Ireland,
Germany and the Netherlands. HLR is responsible for promoting the drug for
cystic fibrosis in the remaining thirteen European countries in the
collaboration. In addition to sharing profits related to Pulmozyme sales from
all collaborative countries with HLR, the Company has received and will
continue to receive milestone payments and technical support from HLR. Also, as
part of the agreement with HLR, and in return for royalties on product sales,
the Company has granted HLR an exclusive license to sell Pulmozyme in countries
outside of Western Europe, the United States and Canada. The Company has three
other R&D collaborations with HLR which were entered into in 1992.
Note 11: Capital Stock
Stock Option Plans
1984 PLANS: The 1984 Plans are the 1984 Incentive Stock Option Plan and the
1984 Non-Qualified Stock Option Plan. The Company may grant options under the
1984 Incentive Stock Option Plan only to employees (including officers) of the
Company. The Company may grant options under the 1984 Non-Qualified Stock
Option Plan to employees (including officers) and consultants of the Company.
Options granted under the 1984 Incentive Stock Option Plan and the 1984 Non-
Qualified Stock Option Plan have a maximum term of ten and 20 years,
respectively, from the date of grant. The options generally become exercisable
in increments over a period of four years from the date of grant, with the
first increment vesting after one year. The Company may grant options with
different vesting terms from time to time.
Transactions for the 1984 plans for the year ended December 31, 1994, were as
follows:
Price
Shares Per Share
________________________________________________________________________________
Options outstanding - beginning of year 4,033,276 $ 14.08-49.75
Grants - -
Exercises (695,348) 14.08-41.75
Cancellations (28,273) 19.38-49.75
_______________________________
Options outstanding - end of year 3,309,655 14.08-49.75
Options available for future grant -
at December 31 ___________
Total shares reserved under the 1984 Plans
at December 31 3,309,655
===========
Shares reserved under options exercisable
at December 31 2,956,972 $ 14.08-49.75
===============================
1990 PLAN: The 1990 Stock Option/Stock Incentive Plan (1990 Plan) permits the
granting of options intended to qualify as incentive stock options and the
granting of options that do not so qualify. The Company may only grant
incentive options to employees (including officers and employee-directors). The
Company may only grant the non-qualified options and other non-option stock
incentives under the 1990 Plan to employees (including officers and employee-
directors) and consultants of the Company. All non-qualified options have a
maximum term of 20 years and all incentive options have a maximum term of ten
years. The options generally become exercisable in increments over a period of
four years from the date of grant, with the first increment vesting after one
year. The Company may grant options with different vesting terms from time to
time. The 1990 Plan includes an Automatic Grant Program whereby each individual
who was a non-employee member of the Board on July 18, 1990, and/or on April
30, 1992, was automatically granted, on each of those dates, a non-statutory
option to purchase 15,000 shares of redeemable common stock. These options have
a term of ten years from the date of grant and vest in equal increments over a
three-year period from the date of grant. Each non-employee member of the Board
who is elected to that position after April 30, 1992, will be automatically
granted such an option as will any employee member of the Board who becomes a
non-employee member of the Board immediately upon the change in status from
employee to non-employee. The 1990 Plan contains a special provision whereby
the Company's former Chairman of the Board was granted in 1990 a special non-
statutory option for 170,000 shares of redeemable common stock with a per share
exercise price of $25.70 in cancellation of outstanding options for the same
number of shares with an exercise price of $44.25.
Transactions for the 1990 Plan for the year ended December 31, 1994 were as
follows:
Price
Shares Per Share
_______________________________________________________________________________
Options outstanding - beginning of year 8,406,451 $ 25.50-46.50
Grants 957,055 48.00-50.75
Exercises (704,875) 25.50-46.50
Cancellations (152,479) 25.50-50.75
______________________________
Options outstanding - end of year 8,506,152 25.50-50.75
Options available for future grants
at December 31 1,893,133
____________
Total shares reserved under the 1990 Plan
at December 31 10,399,285
============
Shares reserved under options exercisable
at December 31 3,770,903 $ 25.50-50.75
==============================
In addition, the 1990 Plan permits the Company to grant stock appreciation
rights in connection with non-qualified options or incentive options and issue
shares of redeemable common stock, either fully vested at the time of issuance
or vesting according to a pre-determined schedule. The Company may grant three
types of stock appreciation rights under the 1990 Plan: tandem stock
appreciation rights, concurrent stock appreciation rights and limited stock
appreciation rights. At December 31, 1994, no stock appreciation rights for
redeemable common stock have been granted under the 1990 Plan.
1994 PLAN: The 1994 Stock Option Plan (1994 Plan) permits the granting of
options intended to qualify as incentive stock options and the granting of
options that do not so qualify. Incentive options may only be granted to
employees (including officers and employee-directors). The non-qualified
options may only be granted under the 1994 Plan to employees (including
officers and employee-directors) and consultants of the Company. All non-
qualified options have a maximum term of 20 years and all incentive options
have a maximum term of ten years. The options generally become exercisable in
increments over a period of five years from the date of grant, with the first
increment vesting after two years. Options may be granted with different
vesting terms from time to time. The 1994 Plan includes an Automatic Grant
Program whereby each individual who is a non-employee member of the Board on
April 30, 1995, will be automatically granted a non-statutory option to
purchase 15,000 shares of redeemable common stock. These options have a term of
ten years from the date of grant and vest in equal increments over a three-year
period from the date of grant. Each non-employee member of the Board who is
elected to that position after April 30, 1995 will be automatically granted
such an option as will any employee member of the Board who becomes a non-
employee member of the Board immediately upon the change in status from
employee to non-employee. Beginning on April 30, 1995, non-employee members of
the Board will no longer receive automatic option grants under the 1990 Plan.
Transactions for the 1994 Plan for the year ended December 31, 1994, were as
follows:
Price
Shares Per Share
________________________________________________________________________________
Grants 4,180,000 $ 50.13-50.75
Cancellations (15,000) 50.13
______________________________
Options outstanding - end of year 4,165,000 $ 50.13-50.75
Options available for future grants
at December 31 335,000
____________
Total shares reserved under the 1994 Plan
at December 31 4,500,000
============
Shares reserved under options exercisable 0
at December 31 ============
Employee Stock Plans
The Company adopted the 1991 Employee Stock Plan (1991 Plan) on December 4,
1990, and amended it during 1993. All full-time employees of the Company are
eligible to participate in the 1991 Plan. Of the 2,900,000 shares of redeemable
common stock reserved for issuance under the 1991 Plan, 1,905,018 shares have
been issued as of December 31, 1994. During 1994, 2,364 of the eligible
employees participated in the 1991 Plan.
Warrants
In consideration of the grant to the Company by certain limited partners of
Genentech Clinical Partners IV (GCP IV) of an option to purchase all of such
limited partners' interests in GCP IV, the Company issued warrants with each
partnership interest to purchase an aggregate of 2,639,250 shares of common
stock (subsequently converted to 1,319,625 shares of redeemable common stock
under the terms of the Merger). All previously unexercisable warrants held by
nondefaulted limited partners became exercisable upon termination of GCP IV's
research program in September 1992. The warrants are exercisable through July
31, 1996. Redeemable common stock activity during 1994 related to the warrants
is reflected in the following table:
Shares Price
Per Share
_______________________________________________________________________________
Shares subject to exercisable
warrants - beginning of year 648,357 $ 22.57-28.26
Shares issued upon exercise
of warrants (509,442) 22.57-28.26
__________
Shares subject to exercisable
warrants - end of year 138,915 $ 27.57-28.26
Shares reserved for issuance ==========
under warrant agreements 138,915
==========
Note 12: Legal Proceedings
The Company is a party to various legal proceedings including patent
infringement cases involving growth hormone; Activase; and antibodies to IgE, a
protein central to allergic reactions; and product liability cases involving
Activase. In addition, the FDA is investigating the Company's promotional
practices in connection with Activase, Protropin and Pulmozyme. The Company and
its directors are defendants in two suits filed in California challenging their
actions in connection with the Merger.
In December 1994, the Company and Eli Lilly and Company (Lilly) reached a
settlement regarding all patent infringement and contract actions between the
two parties. Under the terms of the settlement Lilly agreed to pay the Company
up to $145 million ($25 million initially and 16 quarterly payments of $7.5
million), subject to certain restrictions, and the Company granted Lilly
licenses, options to license, or immunities from suit for certain of the
Company's patents. Future payments are required from Lilly on sales of these
products. The Company will continue to pursue patent invalidity and
noninfringement claims against the Regents of the University of California
(UC), which has sued Genentech for infringing a patent owned by UC relating to
recombinant human growth hormone (hGH). In a related matter, the Company also
settled a patent infringement action against Centocor, Inc. whereby the Company
granted Centocor a royalty bearing license to its Cabilly patent for Centocor's
monoclonal anti-IIb/IIIa antibody.
On November 29, 1994, an administrative law judge of the International Trade
Commission (ITC) found, on an incomplete record, that Bio-Technology General
Corp. and its affiliate (BTG) infringed two of the Company's process patents
and Novo Nordisk A/S and certain of its affiliates (Novo) (BTG and Novo are
collectively referred to as the Competitors) infringed one process patent
covering hGH; however, the judge refused to recommend a ban on importation of
hGH products for treatment of growth hormone inadequacy by the Competitors in
the United States because the Company delayed in providing documents to the
Competitors. The judge's recommendation was subject to review by the
commissioners of the ITC. The Company filed a petition for review by the full
Commission of the judge's recommendations dismissing the complaint, but the
Commission declined such review. On December 1, 1994 the Company filed suit
against the Competitors in the U.S. District Court in Delaware seeking damages
from the Competitors, and asking for an injunction blocking the Competitors
from marketing hGH in the United States Novo has brought suit against the
Company in the U.S. District Court from Southern District New York, alleging
that the patents in the ITC action are invalid and not infringed by Novo. BTG
has brought suit against the Company in the U.S. District Court from the
Southern District of New York seeking to prevent the Company from further
patent infringement action against BTG and alleging unfair competition,
antitrust and malicious prosecution claims.
Based upon the nature of the claims made and the investigation completed to
date by the Company and its counsel, the Company believes the outcome of the
above actions will not have a material adverse effect on the financial
position, results of operations or cash flows of the Company.
Note 13: Quasi-reorganization
On February 18, 1988, the Company's Board of Directors approved the elimination
of the Company's accumulated deficit through an accounting reorganization of
its stockholders' equity accounts (a quasi-reorganization) effective October 1,
1987, that did not involve any revaluation of assets or liabilities. The
Company eliminated the accumulated deficit of $329.5 million by a transfer from
additional paid-in capital in an amount equal to the accumulated deficit.
Simultaneous with the quasi-reorganization, the Company FAS 96, providing for
recognition of the tax benefits of operating loss and tax credit carryforward
items that arose prior to a quasi-reorganization involving only the elimination
of a deficit in retained earnings being reported in the income statement and
then reclassified from retained earnings to additional paid-in capital.
Subsequently, in September 1989, the staff of the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin No. 86 (SAB 86) which states
that a quasi-reorganization cannot involve only an elimination of a deficit in
retained earnings and, therefore, the tax benefits of prior operating loss and
tax credit carryforwards must be reported as a direct addition to additional
paid-in capital rather than being recorded in the income statement.
In February 1992, the Financial Accounting Standards Board issued FAS 109 which
supersedes FAS 96. FAS 109 requires companies that have previously both adopted
FAS 96 and effected a quasi-reorganization that involves only a deficit
elimination, as did the Company, to continue to report the tax benefits of
prior operating losses and tax credit carryforwards in a manner consistent with
FAS 96. FAS 109 also provides that companies effecting a quasi-reorganization
after February 1992 that involves only a deficit elimination shall report the
tax benefits of prior operating losses and tax credit carryforwards in a manner
consistent with SAB 86.
The Company will continue to report in income the recognition of operating loss
and tax credit carryforward items arising prior to the quasi-reorganization due
to the Company's adoption of its quasi-reorganization in the context of its
interpretation of FAS 96 and the quasi-reorganization literature existing at
the date the quasi-reorganization was effected. The SEC staff has indicated
that it would not object to the Company's accounting for such tax benefits. If
the provisions of SAB 86 had been applied, net income for the year ended
December 31, 1994, would have been reduced by $39.7 million or $.33 per share
(1993-net income reduced by $20.6 million or $.18 per share; 1992-net income
reduced by $7.5 million or $.07 per share).
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Genentech, Inc.
We have audited the accompanying consolidated balance sheets of Genentech, Inc.
as of December 31, 1994 and 1993, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1994. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Genentech, Inc.
At December 31, 1994 and 1993, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
1994, in conformity with generally accepted accounting principles.
Ernst & Young LLP
San Jose, California
January 17, 1995
QUARTERLY FINANCIAL DATA (UNAUDITED)
(thousands, except per share amounts)
1994 Quarter Ended
December 31 September 30 June 30 March 31
________________________________________________________________________________
Total revenues $ 207,760 $ 193,838 $ 194,922 $ 198,870
Product sales 158,137 142,555 152,574 147,798
Gross margin from product sales 133,464 118,095 128,009 125,667
Net income 18,566 33,586 33,387 38,855
Net income per share .15 .28 .28 .33
1993 Quarter Ended
December 31 September 30 June 30 March 31
________________________________________________________________________________
Total revenues $ 161,529 $ 165,386 $ 169,837 $ 152,997
Product sales 124,201 119,733 110,768 102,658
Gross margin from product sales 106,517 101,182 93,088 86,059
Net income 18,651 15,516 10,401 14,334
Net income per share .16 .13 .09 .12
11-YEAR FINANCIAL SUMMARY (UNAUDITED)
(millions, except per share and employee data)
1994 1993 1992 1991
_______________________________________________________________________________
Total revenues $ 795.4 $ 649.7 $ 544.3 $ 515.9
Product sales 601.1 457.4 391.0 383.3
Royalties 126.0 112.9 91.7 63.4
Contract & other 25.6 37.9 16.7 20.4
Interest 42.7 41.5 44.9 48.8
______________________________________
Total costs and expenses $ 665.8 $ 590.8 $ 522.3 $ 469.8
Cost of sales 95.8 70.5 66.8 68.4
Research & development 314.3 299.4 278.6 221.3
Marketing, general & administrative 248.6 214.4 172.5 175.3
Special charge - - - -
Interest 7.1 6.5 4.4 4.8
______________________________________
Income data
Income(loss) before taxes $ 129.6 $ 58.9 $ 21.9 $ 46.2
Income tax provision 5.2 - 1.1 1.8
Net income (loss) 124.4 58.9 20.8 44.3
Net income (loss) per share 1.04 0.50 0.18 0.39
______________________________________
Selected balance sheet data
Cash & marketable securities $ 920.9 $ 719.8 $ 646.9 $ 711.4
Accounts receivable 146.3 130.5 93.9 69.0
Inventories 103.2 84.7 65.3 56.2
Property, plant & equipment, net 485.3 456.7 432.5 342.5
Other long-term assets 61.0 64.1 37.1 42.7
Total assets 1,745.1 1,468.8 1,305.1 1,231.4
Total current liabilities 220.5 190.7 133.5 118.6
Long-term debt 150.4 151.2 152.0 152.9
Total liabilities 396.3 352.0 297.8 281.7
Total stockholders' equity 1,348.8 1,116.8 1,007.3 949.7
______________________________________
Other data
Depreciation and amortization expense $ 53.5 $ 44.0 $ 52.2 $ 46.9
Capital expenditures 82.8 87.5 126.0 71.3
______________________________________
Share information
Shares used to compute EPS 119.5 117.1 114.0 112.5
Actual year-end 117.2 114.8 112.9 111.3
______________________________________
Per share data
Market price: High $ 53.50 $ 50.50 $ 39.50 $ 36.25
Low $ 41.75 $ 31.25 $ 25.88 $ 20.75
Book value $ 11.50 $ 9.73 $ 8.92 $ 8.53
______________________________________
Number of employees 2,738 2,510 2,331 2,202
______________________________________
<FN
The Company has paid no dividends.
The Financial Summary above reflects adoption of FAS 115 in 1994, FAS 109 in
1992 and FAS 96 in 1988.
All share and per share amounts reflect two-for-one split in 1986, two-for-one
split in 1987.
*Redeemable common stock began trading September 10, 1990; prior to that date
all shares were common stock. Pursuant to the merger agreement with Roche, all
shareholders as of effective date September 7, 1990, received for each common
share owned, $18 in cash from Roche and one-half share of newly issued
redeemable common stock from the Company.
(1) Charges primarily related to Roche merger.
(2) Primarily inventory-related charge.
(3) Charge for purchase of in-process R&D.
11-YEAR FINANCIAL SUMMARY (UNAUDITED)
(In millions, except per share and employee data)
1990 1989 1988 1987 1986 1985 1984
______________________________________________________________________________
$ 476.1 $ 400.5 $ 334.8 $ 230.5 $ 134.0 $ 89.6 $ 69.8
367.2 319.1 262.5 141.4 43.6 5.2 -
47.6 36.7 26.7 20.1 12.9 5.3 2.1
31.9 27.5 33.5 57.1 70.9 71.1 63.5
29.4 17.2 12.1 11.9 6.6 8.0 4.2
______________________________________________________________________________
$ 572.7 $ 352.9 $ 311.7 $ 186.6 $ 484.6 $ 83.0 $ 66.8
68.3 60.6 46.9 23.8 10.8 1.7 -
173.1 156.9 132.7 96.5 79.8 64.9 55.0
158.1 127.9 101.9 59.5 27.3 16.4 11.8
167.7(1) - 23.3(2) - 366.7(3) - -
5.5 7.5 6.9 6.8 - - -
______________________________________________________________________________
$ (96.6) $ 47.5 $ 23.1 $ 43.9 $ (350.6) $ 6.6 $ 3.0
1.5 3.6 2.5 1.7 2.4 0.5 0.6
(98.0) 44.0 20.6 42.2 (353.0) 6.1 2.4
(1.05) 0.51 0.24 0.50 (5.10) 0.10 0.04
______________________________________________________________________________
$ 691.3 $ 205.0 $ 152.5 $ 158.3 $ 84.3 $ 99.8 $ 32.5
58.8 66.8 63.9 92.2 24.5 26.2 12.7
39.6 49.3 63.4 58.0 14.7 4.6 -
300.2 299.1 289.4 195.7 133.1 87.9 72.9
61.7 85.0 89.7 108.7 114.9 16.6 12.6
1,157.7 711.2 662.9 619.0 376.0 238.6 133.6
101.4 75.9 95.4 82.8 37.8 27.2 18.5
153.5 154.4 155.3 168.1 31.6 6.0 11.5
264.5 242.2 263.6 263.6 83.3 35.7 32.2
893.2 469.0 399.3 355.4 292.6 202.9 101.4
______________________________________________________________________________
$ 47.6 $ 44.6 $ 38.3 $ 23.5 $ 8.1 $ 5.7 $ 4.3
36.0 37.2 110.9 65.3 46.3 20.2 16.1
______________________________________________________________________________
93.0 86.0 84.5 84.4 69.3 64.0 57.5
110.6 84.3 82.9 78.7 67.0 65.6 57.6
______________________________________________________________________________
$ 30.88 $ 23.38 $ 47.50 $ 64.75 $ 49.38 $ 18.81 $ 10.56
$ 27.50*
$ 20.13 $ 16.00 $ 14.38 $ 28.00 $ 16.44 $ 8.56 $ 7.19
$ 21.75*
$ 8.08 $ 5.56 $ 4.82 $ 4.52 $ 4.37 $ 3.09 $ 1.76
______________________________________________________________________________
1,923 1,790 1,744 1,465 1,168 893 674
______________________________________________________________________________
COMMON STOCK AND REDEEMABLE COMMON STOCK INFORMATION
Stock Trading Symbol GNE
Stock Exchange Listings
The redeemable common stock of the Company has been traded on the New York
Stock Exchange and the Pacific Stock Exchange since September 10, 1990. The
Company's common stock was traded on the New York Stock Exchange under the
symbol GNE from March 2, 1988, until September 7, 1990, and on the Pacific
Stock Exchange under the symbol GNE from April 12, 1988, until September 7,
1990. The Company's common stock was previously traded in the NASDAQ National
Market System under the symbol GENE. No dividends have been paid on the common
stock or redeemable common stock. The Company's merger with a wholly owned
subsidiary of Roche Holdings, Inc. (Roche) was consummated on September 7,
1990. The Company's stockholders of record on September 7, 1990, received, for
each share of common stock owned, $18 in cash from Roche and one-half share of
newly issued redeemable common stock from the Company. See Note 9 to the
consolidated financial statements for a further description of the merger
transaction.
Redeemable Common Stockholders
As of December 31, 1994, there were approximately 20,512 stockholders of
record of the Company's redeemable common stock.
Stock Prices Redeemable Common Stock
1994 1993
__________________________________________________________________________
High Low High Low
_________________________________________________
4th Quarter $ 53 1/2 $ 42 1/8 $ 50 1/2 $ 42 5/8
3rd Quarter 52 1/2 48 1/8 44 7/8 40 1/2
2nd Quarter 51 5/8 43 1/4 44 31 1/4
1st Quarter 51 3/8 41 3/4 39 3/4 31 7/8
31