FINANCIAL REVIEW
(dollars in millions, except per share amounts)
RELATIONSHIP WITH ROCHE HOLDINGS, INC.
On October 25, 1995, Genentech, Inc. (the Company) and Roche Holdings, Inc.
(Roche) entered into a new agreement (the Agreement) to extend until June 30,
1999, Roche's option to cause the Company to redeem (call) the outstanding
callable putable common stock (special common stock) of the Company at
predetermined prices. Should the call be exercised, Roche will concurrently
purchase from the Company a like number of common shares for a price equal to
the Company's cost to redeem the special common stock. If Roche does not cause
the redemption as of June 30, 1999, the Company's stockholders will have the
option to cause the Company to redeem none, some, or all of their shares of
special common stock (and Roche will concurrently provide the necessary
redemption funds to the Company by purchasing a like number of shares of common
stock) within thirty business days commencing July 1, 1999. See the
"Relationship with Roche Holdings, Inc." note in the "Notes to Consolidated
Financial Statements" for further information.
In conjunction with the Agreement, F. Hoffmann-La Roche Ltd (HLR) was granted
an option for ten years for licenses to use and sell certain of the Company's
products in non-United States (U.S.) markets. As a result of the Agreement, in
1996 the Company's total product sales decreased, while contract and royalty
revenue increased. Cost of sales as a percentage of product sales also
increased due to the Agreement. See below for further discussion.
RESULTS OF OPERATIONS
(dollars in millions)
Annual % Change
Revenues 1996 1995 1994 96/95 95/94
- -------------------------------------------------------------------------------
Revenues $ 968.6 $ 917.8 $ 795.4 6 % 15%
The increase in revenues in 1996 resulted primarily from higher contract and
royalty revenue partly offset by lower product sales. The 1995 increase
resulted primarily from higher royalty income and product sales. Product sales
to HLR in conjunction with the Agreement were $13.2 million in 1996 and $1.8
million in 1995.
Annual % Change
Product Sales 1996 1995 1994 96/95 95/94
- ------------------------------------------------------------------------------
Activase $ 284.1 $ 301.0 $ 280.9 (6)% 7%
Protropin and
Nutropin 218.2 219.4 225.4 (1) (3)
Pulmozyme 76.0 111.3 88.3 (32) 26
Actimmune 4.5 3.6 6.4 25 (44)
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Total product
sales $ 582.8 $ 635.3 $ 601.0 (8)% 6%
% of revenues 60% 69% 76%
Total product sales decreased in 1996 compared to 1995 primarily as a result of
the Agreement with Roche. On a pro forma basis that includes sales to HLR in
1996 and the fourth quarter of 1995, and excludes Canadian and European
customer sales in 1995, sales increased to $582.8 million in 1996 from $578.7
million in 1995.
Activase: Total net sales of Activase, registered trademark, in 1996 decreased
compared to 1995 primarily due to the impact of not having Canadian customer
sales in 1996 as a result of the Agreement with Roche and the increased use of
angioplasty (see below). Activase sales to Canadian customers were $12.7
million in 1995. Sales to U.S. customers decreased slightly in 1996 due to a
decline in the market size. Although Activase's market share grew to
approximately 80% in 1996 from approximately 75% in 1995, the overall size of
the thrombolytic market at year end 1996 declined from 1995 by approximately
6%. The decline in the market size was the result of the increasing use of
angioplasty rather than thrombolytic therapy, as well as from patients
receiving therapy through ongoing clinical trials. On a pro forma basis,
Activase sales were $284.1 million in 1996 versus $288.3 million in 1995, with
the slight decrease due to lower U.S. sales and lower bulk product sales to
Japan licensees. In June 1996, the Company received clearance from the U.S.
Food and Drug Administration (FDA) to market Activase for the treatment of
acute ischemic stroke or brain attack. Activase is the first therapy to be
indicated for the management of stroke. The increase in Activase sales in 1995
over 1994 was attributable to growth in market share and an increase in the
number of patients receiving thrombolytic therapy in the United States.
Protropin and Nutropin: Net sales of Protropin, registered trademark, and
Nutropin, registered trademark, (together, growth hormone) were essentially
flat in 1996 compared to 1995. On a pro forma basis, growth hormone sales in
1996 were $218.2 million compared to $216.7 million in 1995. The Company
continues to face increased competition in the growth hormone market. Three
companies in 1995, and a fourth company in 1996, received FDA approval to
market their growth hormone products for treatment of growth hormone inadequacy
in children, although one of those companies has been preliminarily enjoined
from selling its product. Two competitors have received approval to market
their existing human growth hormone products for additional indications.
Growth hormone sales decreased in 1995 compared to 1994 due to a slight volume
increase in sales being more than offset by the impact of pricing programs for
distribution channels and for the managed care sector. In December 1996, the
Company received clearance from the FDA to market Nutropin for the treatment of
growth failure associated with Turner syndrome.
Pulmozyme: Net sales of Pulmozyme, registered trademark, in 1996 decreased
compared to 1995 primarily in conjunction with the Agreement with Roche.
Pulmozyme sales to customers in Europe and Canada totaled $41.3 million in
1995. In 1996, sales in these territories were made by Roche for the full
year, and the Company received royalties on Roche's sales. On a pro forma
basis, Pulmozyme sales were $76.0 million in 1996 compared to $70.0 million in
1995. Pulmozyme sales in 1995 increased over 1994 due to market launches in
additional European countries and continued adoption of the product by
physicians to treat cystic fibrosis patients. In December 1996, Pulmozyme was
cleared for marketing by the FDA for the management of cystic fibrosis patients
with advanced disease, a condition that affects approximately 500 patients in
the United States.
Royalties, Contract and Other, Annual % Change
and Interest Income 1996 1995 1994 96/95 95/94
- ------------------------------------------------------------------------------
Royalties $ 214.7 $ 190.8 $ 126.0 13% 51%
Contract and other 107.0 31.2 25.6 243 22
Interest income 64.1 60.5 42.8 6 42
The Company receives royalty payments from HLR from its sales of the Company's
products outside of the U.S. under the Agreement, and receives royalties from
other licensees and HLR from the sales of various other health care products.
Total royalties in 1996 increased over 1995 primarily due to new royalties from
HLR in conjunction with the Agreement, as well as higher income from existing
licensees due to increased licensee sales. Royalty revenue under the Agreement
was $17.0 million in 1996 and $1.9 million in 1995. All other royalty revenue
from HLR in 1996, 1995 and 1994, totaled $9.2 million, $10.6 million and $7.9
million, respectively. The increase in 1995 compared to 1994 was attributable
to increases in product sales by various licensees and new royalty
arrangements. In 1995, the largest dollar increase was attributable to the
receipt and recognition of $30.0 million of royalty revenue relating to the
December 1994 settlement with Eli Lilly and Company (Lilly) regarding certain
of the Company's patents. Under the December 1994 settlement agreement with
Lilly, royalties of $30.0 million per year are payable, subject to possible
offsets and contingent upon Humulin, registered trademark, continuing to be
marketed in the U.S., to the Company through 1998, at which time such royalty
obligations expire. Under a prior license agreement with Lilly, the Company
receives royalties from Lilly's sales of its human insulin product. These
royalty obligations expire in August of 1998. Cash flows from royalty income
include non-dollar denominated revenues. The Company currently purchases
simple foreign currency put option contracts (options) and enters into foreign
currency forward exchange contracts (forward contracts) to hedge these cash
flows. All options expire within the next four years. The Company has forward
contracts of various durations that will expire by the end of 1997.
Contract and other revenues increased in 1996 due to contract revenue from HLR
for the exercises of their options under the Agreement with respect to the
development of three projects - IDEC-C2B8, insulin-like growth factor (IGF-1)
and nerve growth factor (NGF). The Company recorded non-recurring contract
revenues of $58.2 million relating to these option exercises in 1996. All
other contract revenue from HLR, including reimbursement for ongoing
development expenses after the option exercise date, totaled $37.1 million in
1996, $13.4 million in 1995 and $17.1 million in 1994. The increase in 1995
compared to 1994 was attributable to $6.4 million of gains recorded from sales
of biotechnology equity securities. Contract and other revenues will continue
to fluctuate due to variations in the timing of contract benchmark
achievements; the initiation of new contractual arrangements, including the
potential exercise of product options by HLR; and the conclusion of existing
arrangements.
Interest income increased in 1996 compared to 1995 due to a larger investment
portfolio. The increase in 1995 compared to 1994 was attributable to a larger
investment portfolio and a higher average portfolio yield. The Company enters
into interest rate swaps as part of its overall strategy of managing the
duration of its investment portfolio. See the "Financial Instruments" note in
the "Notes to Consolidated Financial Statements" for further information.
Annual % Change
Costs and Expenses 1996 1995 1994 96/95 95/94
- -------------------------------------------------------------------------------
Cost of sales $104.5 $ 97.9 $ 95.8 7% 2%
Research and
development 471.1 363.0 314.3 30 15
Marketing, general and
administrative 240.1 251.7 248.6 (5) 1
Special charge - 25.0 - - -
Interest expense 5.0 8.0 7.1 (38) 13
----------------------------------------------------------
Total costs
and expenses $820.7 $ 745.6 $ 665.8 10% 12%
% of revenues 85% 81% 84%
Cost of sales as % of
product sales 18% 15% 16%
R&D as % of revenues 49 40 40
MG&A as % of revenues 25 27 31
Cost of Sales: The cost of sales as a percentage of product sales increased
in 1996 compared to 1995 primarily due to the impact of lower margin sales to
HLR in 1996. The economic benefits from sales to HLR are also reflected in
royalties as discussed above. In 1996, 1995 and 1994, reserves of $3.6
million, $3.7 million and $11.9 million, respectively, were provided for
expected expirations of certain inventories.
Research and Development: Research and development (R&D) expense increased 30%
in 1996 compared to 1995 due to continued late-stage clinical testing of
products and new development projects. The increase in 1995 over 1994 resulted
from a higher level of activity and associated costs of products in the later
stages of clinical trials and the manufacture of products for clinical trials.
To gain additional access to potential new products and technologies and to
utilize other companies to help develop the Company's potential new products,
the Company has established strategic alliances with, including acquiring the
equity and convertible debt of, 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.
Marketing, General and Administrative: Marketing, general and administrative
expenses (MG&A) in 1996 decreased from 1995 primarily due to the closure of the
Company's European and Canadian operations in conjunction with the Agreement.
MG&A expenses in 1995 were comparable to the 1994 level of expenses.
Special Charge: The Company recorded a special charge of $25.0 million in
1995, which included $21.0 million related to the Agreement with Roche and $4.0
million associated with the resignation of the Company's former President and
Chief Executive Officer. The merger expenses included investment banking fees,
legal expenses, filing fees and other costs related to the Agreement, as well
as charges associated with the settlement of stockholder lawsuits filed after
the transaction was announced.
Interest Expense: Interest expense in 1996, 1995 and 1994, net of amounts
capitalized, relates primarily to interest on the Company's 5% convertible
subordinated debentures. In 1995, it also included interest on a $25.0 million
borrowing arrangement which commenced in February 1995 and was paid in December
of that year.
Income Before Taxes and Income Taxes 1996 1995 1994
- -----------------------------------------------------------------------------
Income before taxes $ 147.9 $ 172.2 $ 129.6
Income tax provision 29.6 25.8 5.2
Effective tax rate 20% 15% 4%
The increase in the effective tax rate to 20% in 1996 from 15% in 1995 is due
to the recognition of a greater amount of tax credit carryforwards in 1995 than
in 1996. The net increase in the rate from 1994 to 1995 was primarily related
to limitations on the utilization of existing carryforwards related to the U.S.
alternative minimum tax.
Annual % Change
Net Income 1996 1995 1994 96/95 95/94
- -------------------------------------------------------------------------------
Net income $ 118.3 $ 146.4 $124.4 (19)% 18%
Net income per share $ 0.96 $ 1.21 $ 1.04
Net income in 1996 decreased compared to 1995 primarily due to higher R&D
expenses and lower product sales, partly offset by increased contract and
royalty revenue. Net income in 1995 increased over 1994 due to higher revenue
from all sources, partly offset by higher expenses, primarily R&D and special
charges.
LIQUIDITY AND CAPITAL RESOURCES 1996 1995 1994
- ------------------------------------------------------------------------------
Cash, cash equivalents, short-term investments
and long-term marketable debt and equity
securities $1,159.1 $1,096.8 $ 920.9
Working capital 705.1 812.0 776.6
Cash provided by (used in):
Operating activities 139.7 133.9 200.4
Investing activities (141.7) (117.7) (322.3)
Financing activities 72.2 54.1 71.2
Capital expenditures
(included in investing activities above) (141.8) (70.2) (82.8)
Current ratio 3.8:1 4.5:1 4.5:1
Cash generated from operations, the maturity of investments and stock issuances
were used to purchase marketable securities and make capital additions in 1996.
Capital expenditures in 1996 primarily include building and land purchases and
improvements to existing manufacturing and office facilities. In 1995, the
Company entered into an arrangement with a lessor for a new manufacturing
facility which qualifies as an operating lease and is expected to become
operational in 1998.
FORWARD-LOOKING STATEMENTS
The following section contains forward-looking statements that are based on
the Company's current expectations. Because the Company's actual results may
differ materially from any forward-looking statements made by or on behalf of
the Company, this section also includes a discussion of important factors that
could affect the Company's actual future results, including its product sales,
royalties, contract revenues, expenses and net income.
Total Product Sales: The Company anticipates that total reported quarterly
product sales in 1997 will be comparable to 1996; however, product sales will
be dependent on the overall competitive environment. Other factors affecting
the Company's total product sales include, but are not limited to, the amount
and timing of the Company's sales to HLR, the amount of sales to customers in
the U.S., increased competition in the growth hormone and thrombolytic
markets, the timing and amount of bulk shipments to licensees, and the
possibility of the introduction of a new product in late 1997.
Activase Sales: The Company faces new competition in the thrombolytic market.
The Company is aware that one company received FDA approval in October 1996 to
market its product for the treatment of acute myocardial infarction (AMI) in
the U.S. The Company has brought suit against that company for patent
infringement. In addition, there is an increasing use of angioplasty in the
treatment of AMI patients in lieu of the use of thrombolytic therapy.
Depending on the extent and type of new competition, the Company's total
Activase sales could be materially affected. Other factors affecting the
Company's Activase sales include, but are not limited to, the timing of FDA
approval, if any, of additional competitive products, pricing decisions made
by the Company, the outcome of litigation against Boehringer Mannheim GmbH and
Boehringer Mannheim Corporation involving the Company's patents for tissue
plasminogen activator and processes related to its production and formulation,
the increasing use of other therapies such as angioplasty techniques for the
treatment of AMI, and the impact of the FDA's recent clearance for the Company
to market Activase for the treatment of acute ischemic stroke.
Growth Hormone Sales: The Company continues to face the possibility of
increased competition in the growth hormone market. Three companies received
FDA approval in 1995, and a fourth company received FDA approval in October
1996, to market their growth hormone products for treatment of growth hormone
inadequacy in children, although one of those companies has been preliminarily
enjoined from selling its product. Two of the Company's competitors have
received approval to market their existing human growth hormone products for
additional indications. The Company expects such competition to have an
adverse effect on its sales of Protropin and Nutropin which, depending on the
extent and type of competition, could be material. Other factors affecting
the Company's growth hormone sales include, but are not limited to, the timing
of FDA approval, if any, of other new competitive products, the outcome of
litigation involving the Company's patents for human growth hormone and
related processes, pricing decisions made by the Company, the availability of
third- party reimbursement for the cost of growth hormone therapy, and the
impact of Nutropin as a treatment for growth failure associated with Turner
syndrome.
Pulmozyme Sales: Factors that may influence the future sales of Pulmozyme
include, but are not limited to, physician perception of the number and kinds
of patients who will benefit from such therapy, the availability of third-
party reimbursement for the costs of therapy, the timing of the development of
alternative therapies for the treatment and care of cystic fibrosis, whether
and when additional indications are approved, and the cost of therapy.
Royalty and Contract Revenues: Royalty and contract revenues in future
periods could vary significantly from 1996 levels. Major factors affecting
these revenues include, but are not limited to: HLR's decisions to exercise
or not to exercise its option to develop and sell the Company's future
products in non-U.S. markets and the timing and amount of related development
cost reimbursement, if any; variations in HLR's sales of Genentech products,
and other licensees' sales of licensed products; the expiration of royalties
from Lilly in 1998; fluctuations in foreign currency exchange rates; the
timing of non-U.S. approvals, if any, for products licensed to HLR; whether
and when contract benchmarks are achieved; the initiation of other new
contractual arrangements; and the conclusion of existing arrangements with
other companies and HLR.
R&D Expenses: The Company intends to continue its commitment to aggressive
investment in R&D. As it continues late-stage clinical testing of products,
the Company anticipates that its R&D expenses will continue at a high
percentage of revenues over the short-term. Over the long-term, however, R&D
as a percent of revenues should decrease, although in dollar terms R&D
spending is generally expected to rise as revenues rise. Factors affecting the
Company's R&D expenses include, but are not limited to: the outcome of
clinical trials currently being conducted; the number of products entering
into development from late-stage research; future levels of the Company's
product sales (including the impact of competition), royalty and contract
revenues; the possibility of competition with respect to products or
technologies under development; and decisions by HLR to exercise or not to
exercise its option to develop and sell potential products of the Company in
non-U.S. markets and the timing of such decisions.
Income Tax Provision: The Company expects that its effective tax rate will
increase from the current rate of 20% to approximately 35% in 1997, and
continue at or near 35% for the next several years dependent upon several
factors. These factors include, but are not limited to, changes in tax laws
and rates, future levels of R&D spending, the outcome of clinical trials of
certain development products, the Company's success in commercializing such
products, and potential competition regarding the products.
Successful Development of Products: The Company intends to continue to
develop new products. Successful pharmaceutical product development is highly
uncertain and is dependent on numerous factors, many of which are beyond the
Company's control. Products that appear promising in the early phases of
development may fail to reach the market for numerous reasons. They may be
found to be ineffective or to have harmful side effects in preclinical or
clinical testing, may fail to receive necessary regulatory approvals, may turn
out to be uneconomical because of manufacturing costs or other factors, or may
be precluded from commercialization by the proprietary rights of others or by
competing products or technologies for the same indication. 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 which 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.
Uncertainties Surrounding Proprietary Rights: The patent positions of
pharmaceutical and biotechnology companies can be highly uncertain and involve
complex legal and factual questions. Accordingly, the breadth of claims
allowed in such companies' patents cannot be predicted. Patent disputes are
frequent and can preclude commercialization of products. The Company, as in
the past, may be involved in future material patent litigation. Such
litigation is costly in its own right and could subject the Company to
significant liabilities to third-parties and, if decided adversely, the
Company may need to obtain third party licenses or cease using the technology
or product in dispute. The presence of patents or other proprietary rights
belonging to other parties may lead to the termination of research and
development of a particular product. The Company believes it has strong patent
protection or the potential for strong patent protection for a number of its
products that generate sales and 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.
Liquidity: The Company believes that its cash, cash equivalents, and short-
term investments, together with funds provided by operations and leasing
arrangements, will be sufficient to meet its foreseeable operating cash
requirements. Factors affecting the Company's cash position include, but are
not limited to, future levels of the Company's product sales, royalty and
contract revenues, expenses and capital expenditures.
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, but not limited to, the effectiveness and safety of the products,
FDA and foreign regulatory agencies' approvals for new products and new
indications, and the degree of patent protection afforded to particular
products.
Roche Holdings, Inc.: At December 31, 1996, Roche held approximately 66.0% of
the Company's outstanding common equity. In January and February 1997, Roche
purchased additional shares of the Company's common equity increasing Roche's
holdings to 68.0%. The Company expects to continue to have material
transactions with Roche, including royalty and contract development revenues,
product sales and joint product development.
Foreign Exchange: The Company receives royalty revenues from countries
throughout the world. As a result, the Company's 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 the
Company's products are sold. The Company is exposed to changes in exchange
rates in Europe, Asia and Canada. When the U.S. dollar strengthens against
the currencies in these countries, the U.S. dollar value of non-U.S. dollar-
based revenue decreases; when the U.S. dollar weakens, the U.S. dollar value
of the non-U.S. dollar-based revenues increases. Accordingly, changes in
exchange rates, and in particular a strengthening of the U.S. dollar, may
adversely affect the Company's royalty revenues as expressed in U.S. dollars.
To mitigate this risk, the Company hedges certain of these anticipated
revenues by purchasing options with expiration dates and amounts of currency
that are based on a portion of probable revenues so that the 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. The Company also enters into forward contracts to lock in the dollar
value of a portion of these anticipated revenues.
Interest Rates: The Company's interest income is sensitive to changes in the
general level of U.S. interest rates. In this regard, changes in U.S.
interest rates affect the interest earned on the Company's cash equivalents,
short-term investments and long-term investments. To mitigate the impact of
fluctuations in U.S. interest rates, the Company enters into interest rate
swap transactions which generally involve the receipt of fixed rate interest
and the payment of floating rate interest without the exchange of the
underlying principal. These agreements have the effect of locking in rates
for longer periods of time than the duration of short-term investments.
Equity Securities: As part of its strategic alliance efforts, the Company
invests in equity instruments that are subject to fluctuations from market
value changes in stock prices. To mitigate this risk, certain equity
securities are hedged with costless collars. 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 the Company from a decline in the market value of
the security below a certain minimum level (the put "strike" level); while the
call effectively limits the Company's potential to benefit from an increase in
the market value of the security above a certain maximum level (the call
"strike" level).
Credit Risk of Counterparties: The Company could be exposed to losses related
to the above financial instruments should one of its counterparties default.
This risk is mitigated through credit monitoring procedures.
Legal Proceedings: The Company is a party to various legal proceedings
including patent infringement cases and various cases involving product
liability and other matters. See the "Leases, Commitments and Contingencies"
note in the "Notes to Consolidated Financial Statements" for further
information.
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 51 to 74, 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 75.
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 general audit
activities, the adequacy and effectiveness of the systems and controls are
reviewed and the resultant findings are communicated 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 and general auditor 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.
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr. Bradford S. Goodwin
President and Senior Vice President and Vice President - Finance
Chief Executive Officer Chief Financial Officer and Controller
CONSOLIDATED STATEMENTS OF INCOME
(thousands, except per share amounts)
YEAR ENDED DECEMBER 31 1996 1995 1994
- ---------------------------------------------------------------------------------
Revenues
Product sales (including amounts from
related parties: 1996-$13,216;
1995-$1,776; 1994-$0) $ 582,829 $ 635,263 $ 601,064
Royalties (including amounts
from related parties: 1996-$26,240;
1995-$12,492; 1994-$8,454) 214,702 190,811 126,022
Contract and other (including amounts
from related parties: 1996-$95,299;
1995-$13,448; 1994-$17,106) 107,037 31,209 25,556
Interest 64,110 60,562 42,748
-----------------------------------
Total revenues 968,678 917,845 795,390
Costs and expenses
Cost of sales (including amounts from
related parties: 1996-$10,900;
1995-$6,963; 1994-$0) 104,527 97,930 95,829
Research and development (including
contract related: 1996-$37,051;
1995-$17,124; 1994-$7,584) 471,143 363,049 314,322
Marketing, general and administrative 240,063 251,653 248,604
Special charge (primarily merger related) -- 25,000 --
Interest 5,010 7,940 7,058
------------------------------------
Total costs and expenses 820,743 745,572 665,813
Income before taxes 147,935 172,273 129,577
Income tax provision 29,587 25,841 5,183
------------------------------------
Net income $ 118,348 $ 146,432 $ 124,394
====================================
Net income per share $ 0.96 $ 1.21 $ 1.04
====================================
Weighted average number of shares used
in computing per share amounts 123,695 121,220 119,465
====================================
<FN>
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
Increase (Decrease) in Cash and
Cash Equivalents
YEAR ENDED DECEMBER 31 1996 1995 1994
- -------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 118,348 $ 146,432 $ 124,394
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 62,124 58,421 53,452
Writedown of securities available-for-sale - 6,609 12,590
Gain on sales of securities available-for-sale (347) (7,432) -
Deferred income taxes (34,021) (22,655) (34,193)
Loss on fixed asset dispositions
(including merger-related in 1995) 5,309 1,032 5,510
Other - (234) 748
Changes in assets and liabilities:
Net cash flow from trading securities (8,184) (50,014) (4,634)
Receivables and other current assets (30,416) (28,446) (11,937)
Inventories 1,705 9,552 (18,475)
Accounts payable, other current
liabilities and other long-term
liabilities 25,153 20,682 72,901
----------------------------------
Net cash provided by operating activities 139,671 133,947 200,356
Cash flows from investing activities:
Purchases of securities held-to-maturity (634,124) (682,396) (1,088,737)
Proceeds from maturities of securities
held-to-maturity 772,922 924,345 877,139
Purchases of securities available-for-sale (304,806) (353,118) (22,644)
Proceeds from sales of securities available-
for-sale 182,564 101,591 -
Purchases of non-marketable equity securities (9,323) - (4,000)
Capital expenditures (141,837) (70,166) (82,837)
Change in other assets (7,046) (37,948) (1,198)
------------------------------------
Net cash used in investing activities (141,650) (117,692) (322,277)
Cash flows from financing activities:
Stock issuances 72,558 54,946 71,955
Reduction in long-term debt,
including current portion (358) (871) (794)
------------------------------------
Net cash provided by financing activities 72,200 54,075 71,161
------------------------------------
Increase (decrease) in cash and cash equivalents 70,221 70,330 (50,760)
Cash and cash equivalents at beginning of year 137,043 66,713 117,473
------------------------------------
Cash and cash equivalents at end of year $ 207,264 $ 137,043 $ 66,713
====================================
Supplemental cash flow data:
Cash paid during the year for:
Interest, net of portion capitalized $ 5,010 $ 7,917 $ 7,058
Income taxes 52,243 44,699 4,099
<FN>
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
DECEMBER 31 1996 1995
- --------------------------------------------------------------------------------
Assets:
Current assets:
Cash and cash equivalents $ 207,264 $ 137,043
Short-term investments 415,900 603,296
Accounts receivable - trade (net of
allowances of: 1996-$4,110; 1995-$4,579) 77,785 87,694
Accounts receivable - other (net of
allowances of: 1996-$3,759; 1995-$2,093) 86,450 65,185
Accounts receivable - related party 33,377 19,281
Inventories 91,943 93,648
Prepaid expenses and other current assets 42,365 39,267
-----------------------------
Total current assets 955,084 1,045,414
Long-term marketable securities 535,916 356,475
Property, plant and equipment, net 586,167 503,654
Other assets 149,205 105,452
-----------------------------
Total assets $ 2,226,372 $ 2,010,995
=============================
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 45,501 $ 37,101
Accrued liabilities - related party 9,908 8,745
Other accrued liabilities 194,542 187,598
-----------------------------
Total current liabilities 249,951 233,444
Long-term debt 150,000 150,000
Other long-term liabilities 25,362 25,504
-----------------------------
Total liabilities 425,313 408,948
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.02 par value; authorized:
100,000,000 shares; none issued - -
Special common stock, $.02 par value;
authorized: 100,000,000 shares; outstanding:
1996-44,805,755; 1995-42,646,958 896 853
Common stock, $.02 par value;
authorized: 200,000,000 shares;
outstanding: 1996 and 1995-76,621,009 1,532 1,532
Additional paid-in capital 1,362,585 1,281,640
Retained earnings (since October 1, 1987
quasi-reorganization) 382,097 263,749
Net unrealized gain on securities
available-for-sale 53,949 54,273
-------------------------------
Total stockholders' equity 1,801,059 1,602,047
-------------------------------
Total liabilities and stockholders' equity $ 2,226,372 $ 2,010,995
===============================
<FN>
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands)
1996 1995 1994
Year ended December 31 ------------------- ------------------- -------------------
Shares Amount Shares Amount Shares Amount
-------- --------- -------- --------- -------- ---------
Special common stock
Beginning balance 42,647 $ 853 - - - -
Issuance of stock upon exercise
of options and warrants 2,159 43 298 $ 6 - -
Conversion of common stock
to special common stock - - 42,349 847 - -
---------------------------------------------------------------
Ending balance 44,806 896 42,647 853 - -
---------------------------------------------------------------
Redeemable common stock
Beginning balance - - 50,106 1,002 47,690 $ 954
Issuance of stock upon exercise
of options and warrants - - 679 14 1,905 38
Issuance of stock under
employee stock plan - - 322 6 511 10
Conversion of redeemable
common stock to common stock - - (51,107) (1,022) - -
---------------------------------------------------------------
Ending balance - - - - 50,106 1,002
---------------------------------------------------------------
Common stock
Beginning balance 76,621 1,532 67,133 1,343 67,133 1,343
Issuance of stock upon exercise
of options and warrants - - 512 10 - -
Issuance of stock under
employee stock plan - - 218 4 - -
Conversion of redeemable
common stock to common stock - - 51,107 1,022 - -
Conversion of common stock
to special common stock - - (42,349) (847) - -
---------------------------------------------------------------
Ending balance 76,621 1,532 76,621 1,532 67,133 1,343
---------------------------------------------------------------
Additional paid-in capital
Beginning balance 1,281,640 1,207,720 1,070,121
Issuance of stock upon exercise
of options and warrants 55,103 37,087 56,133
Issuance of stock under
employee stock plan 17,412 17,819 15,774
Income tax benefits
realized from employee
stock option exercises 8,430 7,204 26,038
Tax benefits arising prior
to quasi-reorganization - 11,810 39,654
---------- ---------- -----------
Ending balance 1,362,585 1,281,640 1,207,720
---------- ----------- -----------
Retained earnings
Beginning balance 263,749 129,127 44,387
Net income 118,348 146,432 124,394
Tax benefits arising prior
to quasi-reorganization - (11,810) (39,654)
---------- ---------- -----------
Ending balance 382,097 263,749 129,127
---------- ---------- -----------
Net unrealized gain on securities
Beginning balance 54,273 9,592 -
Net unrealized (loss) gain on
securities available-for-sale (324) 44,681 9,592
---------- ---------- ----------
Ending balance 53,949 54,273 9,592
---------- ---------- ----------
Total stockholders' equity $1,801,059 $1,602,047 $1,348,784
========== ========== ==========
<FN>
See Notes to Consolidated Financial Statements.
</TABLE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business: Genentech, Inc. (the Company) is a biotechnology
company that discovers, develops, manufactures and markets human
pharmaceuticals produced by recombinant DNA technology for significant unmet
medical needs. The Company manufactures and markets six products directly in
the United States (U.S.) and sells these products to F. Hoffmann-La Roche Ltd
(HLR) for HLR to sell outside of the United States. Of these six products,
HLR has the right to sell five in Canada and one in a number of countries. In
addition, the Company receives royalties from HLR's sales of these products,
and receives royalties from HLR and other licensees from sales of five other
products which originated from the Company's technology.
Principles of Consolidation: The consolidated financial statements include the
accounts of the Company and all significant subsidiaries and collaborations.
Material intercompany balances and transactions are eliminated.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
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, primarily corporate notes, certificates of deposit and treasury
notes. As part of its strategic alliance efforts, the Company also invests in
equity securities and convertible debt of other biotechnology companies.
Investment securities are 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 dates. Held-to-maturity securities are stated
at amortized cost, including adjustment 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 either
short-term investments or long-term marketable securities and are carried at
market value with unrealized gains and losses included in stockholders'
equity. 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. The cost of all
securities sold is based on the specific identification method.
Property, Plant and Equipment: The costs of buildings and equipment are
depreciated using the straight-line method over the following estimated useful
lives of the assets: buildings - 25 years; certain manufacturing equipment -
15 years; other equipment - 4 or 8 years; leasehold improvements - length of
applicable lease. The costs of repairs and maintenance are expensed as
incurred. Repairs and maintenance expenses for the years ended December 31,
1996, 1995 and 1994, were $28.8 million, $22.1 million and $19.2 million,
respectively. Interest on construction-in-progress of $2.5 million in 1996,
$1.5 million in 1995 and $0.6 million in 1994 has been capitalized and is
included in property, plant and equipment.
Property, plant and equipment balances at December 31 are summarized below
(thousands):
1996 1995
---------------------------------------------------------------------
At cost:
Land $ 67,619 $ 57,313
Buildings 297,888 258,717
Equipment 428,738 383,387
Leasehold improvements 12,314 12,508
Construction in progress 99,708 60,480
-----------------------------
906,267 772,405
Less: accumulated depreciation 320,100 268,751
-----------------------------
Net property, plant and equipment $ 586,167 $ 503,654
=============================
Patents and Other Intangible Assets: 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 U.S. 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 on a straight-line basis
over their estimated useful lives of approximately 12 years. Intangible
assets are generally amortized on a straight-line basis over their estimated
useful lives.
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.
Royalty Expenses: Royalty expenses directly related to product sales are
classified in cost of sales. Other royalty expenses, relating to royalty
revenue, totaled $36.0 million, $30.2 million and $26.5 million in 1996, 1995
and 1994, respectively, and are classified in marketing, general and
administrative expenses.
Advertising Expenses: The Company expenses the costs of advertising as
incurred. Advertising expenses for the years ended December 31, 1996, 1995
and 1994, were $28.0 million, $29.2 million and $44.2 million, respectively.
Income Taxes: The Company accounts for income taxes by the asset and
liability approach for financial accounting and reporting of income taxes.
The Company's method of accounting for operating loss and tax credit
carryforwards arising prior to the date of the Company's quasi-reorganization
in 1987 is described in the "Quasi-Reorganization" note.
Net Income Per Share: Net income per share is computed based on the weighted
average number of shares of the Company's special common stock, common stock
and common stock equivalents, if dilutive.
Financial Instruments: The Company purchases simple foreign currency put
options (options) with expiration dates and amounts of currency that are based
on a portion of probable non-dollar revenues so that the potential adverse
impact of movements in currency exchange rates on the non-dollar denominated
revenues will be at least partially offset by an associated increase in the
value of the options. See the "Financial Instruments" note for further
discussion. At the time the options are purchased they have little or no
intrinsic value. Realized and unrealized gains related to the options are
deferred until the designated hedged revenues are recorded. The associated
costs, which are deferred and classified as other current assets, are
amortized over the term of the options and recorded as a reduction of the
hedged revenues. Realized gains and losses are recorded in the income
statement with the related hedged revenues. The Company also enters into
foreign currency forward contracts (forward contracts) as hedging instruments.
Forward contracts are recorded at fair value, and any gains and losses from
these forward contracts are recorded in the income statement with the related
hedged revenues. Financial instruments, such as forward contracts, not
qualifying as hedges under generally accepted accounting principles are marked
to market with gains or losses recorded in income as they occur.
Interest rate swaps have been used and may be used in the future to adjust the
duration of the investment portfolio in order to meet duration targets.
Interest rate swaps are contracts in which two parties agree to swap future
streams of payments over a specified period. See the "Financial Instruments"
note for further discussion. 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 classified as other assets and
are amortized to interest income over the original contractual term of the
swaps by a method that approximates the level-yield method.
The Company's marketable equity portfolio consists primarily of biotechnology
companies whose risk of market fluctuations is greater than the stock market
in general. To manage this risk, the Company enters into certain costless
collar instruments to hedge certain equity securities against changes in
market value. See the "Financial Instruments" note for further discussion.
Gains and losses on these instruments are recorded as an adjustment to
unrealized gains and losses on marketable securities with a corresponding
receivable or payable recorded in long-term other assets or long-term
liabilities.
401(k) Plan: The Company's 401(k) plan (Plan) covers substantially all of its
U.S. employees. Under the 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 1996, 1995 and
1994, the Company provided $6.1 million, $5.6 million and $5.2 million,
respectively, for the Company match under the Plan.
New Accounting Standards: On January 1, 1996, the Company adopted Statement
of Financial Accounting Standards (FAS) 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which requires
the Company to review for impairment of long-lived assets, certain
identifiable intangibles, and goodwill related to those assets whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. In certain situations, an impairment loss would be
recognized. The adoption of FAS 121 did not have a material impact on the
financial position, results of operations or cash flows of the Company.
In 1996, the Company also implemented the disclosure requirements of FAS 123
"Accounting for Stock-Based Compensation" (FAS 123). Under FAS 123, the
Company will continue to account for stock-based employee compensation
arrangements under the intrinsic value method prescribed by Accounting
Principles Board Opinion 25 "Accounting for Stock Issued to Employees" (APB
25), and will provide pro forma disclosures of net income and earnings per
share as if the fair value basis method prescribed by FAS 123 had been applied
in measuring employee compensation expense. See the "Capital Stock" note for
such disclosure.
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, 1996 and 1995 are summarized
below (thousands):
1996 1995
------------------------------------------------------------------
Raw materials and supplies $ 17,971 $ 12,808
Work in process 61,368 67,239
Finished goods 12,604 13,601
----------------------
Total $ 91,943 $ 93,648
======================
Reclassifications: Certain reclassifications of prior year amounts have been
made to conform with the current year presentation.
SIGNIFICANT CUSTOMER AND GEOGRAPHIC INFORMATION
HLR contributed approximately 14% of the Company's total revenues in 1996, and
contributed less than 10% in 1995 and 1994. See the "Related Party
Transactions" note below for further information. Two major customers,
Caremark, Inc. and Bergen Brunswig, contributed 10% or more of the Company's
total revenues. Caremark, Inc., which accounted for 15%, 18% and 21% of total
revenues in 1996, 1995 and 1994, respectively, distributes Protropin,
Nutropin, Pulmozyme and Actimmune through its extensive branch network and is
then reimbursed through a variety of sources. Bergen Brunswig, a wholesale
distributor of all of the Company's products, contributed 10% of revenues in
1996 and 11% in each of the years 1995 and 1994.
Approximate foreign sources of revenues were as follows (millions):
1996 1995 1994
- -----------------------------------------------------
Europe $146.4 $112.0 $81.8
Asia 17.8 23.6 19.5
Canada 11.1 25.0 9.7
The Company currently sells primarily to distributors and hospitals throughout
the U.S., performs ongoing credit evaluations of its customers' financial
condition and generally requires no collateral. In 1996, 1995 and 1994, the
Company did not record any material additions to, or losses against, its
provision for doubtful accounts.
RESEARCH AND DEVELOPMENT ARRANGEMENTS
To gain access to potential new products and technologies and to utilize other
companies to help develop the Company's potential new products, the Company has
established strategic alliances with, including the acquisition of both
marketable and non-marketable equity investments and convertible debt in,
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 may be due to
certain collaborative partners if the partners achieve certain benchmarks as
defined in the collaborative agreements. The Company has also entered into
product-specific collaborations to acquire development and marketing rights
for products.
SPECIAL CHARGE
The $25.0 million special charge in 1995 includes $21.0 million related to the
merger agreement (the Agreement) with Roche Holdings, Inc. (Roche), discussed
in the note "Relationship with Roche Holdings, Inc.," and $4.0 million of
charges associated with the resignation of the Company's former President and
Chief Executive Officer. The merger expenses include legal expenses,
investment banking fees, filing fees and other costs related to the Agreement
with Roche, as well as charges associated with the settlement of stockholder
lawsuits filed after the transaction was announced.
INCOME TAXES
The income tax provision consists of the following amounts (thousands):
1996 1995 1994
- ----------------------------------------------------------------
Current:
Federal $ 61,502 $ 43,997 $ 38,331
State 2,104 4,467 1,016
Foreign 2 32 29
------------------------------------
Total current 63,608 48,496 39,376
------------------------------------
Deferred:
Federal (34,021) (12,319) (34,193)
State - (10,336) -
------------------------------------
Total deferred (34,021) (22,655) (34,193)
------------------------------------
Total income tax provision $ 29,587 $ 25,841 $ 5,183
====================================
Actual current tax liabilities are lower than reflected above by $8.4 million,
$7.2 million and $26.0 million in 1996, 1995 and 1994, respectively, 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:
1996 Amount Tax Rate
(thousands) 1996 1995 1994
- ------------------------------------------------------------------------------------
Tax at U.S. statutory rate $ 51,777 35.0% 35.0% 35.0%
Operating losses utilized - - - (45.6)
Research and development
credits realized (4,500) (3.0) (15.9) -
Alternative minimum tax liability - - - 24.6
Adjustment of deferred tax assets
valuation allowance (22,566) (15.3) (13.1) (26.4)
Foreign losses (benefited) not benefited (5,050) (3.4) 2.8 15.0
State taxes 3,368 2.3 2.6 0.8
Other 6,558 4.4 3.6 0.6
-------------------------------------------
Income tax provision $ 29,587 20.0% 15.0% 4.0%
===========================================
The components of deferred taxes consist of the following at December 31
(thousands):
1996 1995
- -----------------------------------------------------------------------------
Deferred tax liabilities:
Depreciation $ 58,842 $ 50,010
Unrealized gain on sale of securities
available-for-sale 21,017 21,204
Other 10,543 3,109
--------------------------
Total deferred tax liabilities 90,402 74,323
Deferred tax assets:
Capitalized research and development costs 34,280 -
Federal credit carryforwards 111,400 107,350
Expenses not currently deductible 38,368 39,433
State credit carryforwards 26,710 32,147
Other 6,340 5,058
--------------------------
Total deferred tax assets 217,098 183,988
Valuation allowance (35,827) (52,817)
--------------------------
Total net deferred tax assets 181,271 131,171
--------------------------
Total net deferred taxes $ 90,869 $ 56,848
==========================
Total tax credit carryforwards of $138.1 million expire in the years 1997
through 2012, except for $43.0 million of alternative minimum tax credits which
have no expiration date. The valuation allowance at December 31, 1996,
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 $17.0 million in 1996, $31.6 million in
1995 and $38.5 million in 1994.. Realization of net deferred taxes depends 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, as well as
the scientific success, results of clinical trials and regulatory approval of
products under development.
INVESTMENT SECURITIES
Securities classified as trading, available-for-sale and held-to-maturity at
December 31, 1996 and 1995 are summarized below. Estimated fair value is based
on quoted market prices for these or similar investments.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1996 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $ 144,460 $ 1,932 $ (2,897) $ 143,495
==============================================
SECURITIES AVAILABLE-FOR-SALE
(carried at estimated
fair value):
Equity securities $ 42,773 $ 56,347 $ (1,376) $ 97,744
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing within:
1 year 51,179 - (71) 51,108
1-5 years 103,057 1,299 (209) 104,147
5-10 years 113,176 1,001 (2,114) 112,063
Other debt securities
maturing within:
1 year 46,583 27 - 46,610
1-5 years 43,954 185 (94) 44,045
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 400,722 $ 58,859 $ (3,864) $ 455,717
==============================================
SECURITIES HELD-TO-MATURITY*
(carried at amortized cost):
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing within:
1 year $ 76,718 $ 31 - $ 76,749
5-10 years 30,155 - $ (777) 29,378
Other debt securities
maturing within:
1 year 91,664 4 (35) 91,633
1-5 years 141,553 576 (27) 142,102
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 340,090 $ 611 $ (839) $ 339,862
==============================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1995 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $135,325 $ 1,314 $ (1,328) $135,311
==============================================
SECURITIES AVAILABLE-FOR-SALE
(carried at estimated
fair value):
Equity securities $ 22,423 $ 45,894 $ (350) $ 67,967
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing within:
1 year 7,503 17 - 7,520
1-5 years 162,322 7,103 - 169,425
5-10 years 83,188 437 - 83,625
Other debt securities
maturing within
1-5 years 29,868 1,172 - 31,040
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $305,304 $ 54,623 $ (350) $359,577
==============================================
SECURITIES HELD-TO-MATURITY*
(carried at amortized cost)
maturing within 1 year:
U.S. Treasury securities
and obligations of other
U.S. government agencies $219,267 $ 318 $ (53) $219,532
Other debt securities 236,870 95 (297) 236,668
----------------------------------------------
TOTAL HELD-TO-MATURITY $456,137 $ 413 $ (350) $456,200
==============================================
* Interest rate swap arrangements are used to modify the duration of certain
held-to-maturity securities. The average effective maturity of the
portfolio was 2.5 years and 2.7 years at December 31, 1996 and 1995,
respectively. See "Financial Instruments" note for further information.
The carrying value of all investment securities held at December 31, 1996 and
1995 is summarized below (thousands):
Security 1996 1995
- ------------------------------------------------------------------------------
Trading securities $143,495 $135,311
Securities available-for-sale maturing within one year 97,718 7,520
Securities held-to-maturity maturing within one year 168,382 456,137
Accrued interest 6,305 4,328
-------- --------
Total short-term investments $415,900 $603,296
======== ========
Securities available-for-sale maturing within 1-10 years,
including equity securities $357,999 $352,057
Securities held-to-maturity maturing within 1-10 years 171,708 -
Accrued interest 6,209 4,418
-------- --------
Total long-term marketable securities $535,916 $356,475
======== ========
In 1996, proceeds from sales of available-for-sale securities totaled $182.6
million; gross realized gains totaled $1.0 million and gross realized losses
totaled $0.7 million. In 1995, proceeds from sales of available-for-sale
securities totaled $101.6 million; gross realized gains totaled $7.6 million
and gross realized losses totaled $0.2 million. During 1994, no available-for-
sale securities were sold. The Company recorded charges in 1995 and 1994 of
$6.6 million and $12.6 million, respectively, to write down certain available-
for-sale biotechnology equity securities for which the decline in fair value
below cost was other than temporary.
During the year ended December 31, 1996, net unrealized holding losses on
trading securities included in net income totaled $1.0 million. In 1995 and
1994, such losses were not material.
Marketable debt securities held by the Company are issued by a diversified
selection of corporate and financial 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 1996, 1995 and
1994.
FINANCIAL INSTRUMENTS
Foreign Currency Instruments: Certain of the Company's revenues are earned
outside of the United States. Moreover, the Company's foreign currency
denominated revenues exceed its foreign currency denominated expenses;
therefore, risk exists that net income may be impacted by changes in the
exchange rates between the U.S. dollar and foreign currencies. To hedge
anticipated non-dollar denominated net revenues, the Company currently
purchases options and enters into forward contracts. At December 31, 1996,
the Company had hedged approximately 90% of probable net foreign revenues
anticipated within 12 months and between 20% and 45% of its probable net
foreign revenues through 2000. At December 31, 1996 and 1995, the notional
amount of the options totaled $100.3 million and $72.8 million, respectively,
and consisted of the following currencies: Australian dollars, Canadian
dollars, German marks, Spanish pesetas, French francs, British pounds, Italian
lire, Japanese yen, and Swedish krona. All option contracts mature within the
next four years. The fair value of the options, which is based on exchange
rates and market conditions at December 31, 1996 and 1995, totaled $7.3
million and $6.3 million, respectively. At December 31, 1996 and 1995, the
U.S. dollar equivalent of the notional amount of the forward sell contracts
was $34.3 million and $6.0 million, respectively, and the forward buy
contracts totaled $0.4 million and $6.2 million, respectively.
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 losses due to credit impairment of its
foreign currency instruments.
Interest Rate Swaps: 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. 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 London Inter-Bank
Offered Rate (LIBOR)) on a notional principal amount. By designating 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. 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 establish
the Company's interest income. LIBOR payments received on swaps are highly
correlated to interest collections on short-term investments. The use of
swaps in this manner generates net interest income on the swap and the
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. The Company's swap counterparties 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's credit exposure on swaps as of December 31, 1996 and 1995, was
$6.8 million and $24.1 million, respectively. The net carrying amount of the
swaps, which reflects the net interest accrued for such swaps, totaled $2.1
million and $7.2 million at December 31, 1996 and 1995, respectively, and is
included in accounts receivable.
The Company targets the average maturity of its investment portfolio
(including cash, cash equivalents, short-term and long-term investments,
swaps, and excluding equity securities) based on 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 to investments maturing within the next one
to ten years for future working capital, capital expenditures, strategic
investments and debt repayment.
The notional amount of each swap is equal to the amount of designated high-
quality short-term investments which are expected to be invested in during the
life of the swap. The anticipated 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.
For the years ended December 31, 1996 and 1995, the weighted average rate
received on swaps was 6.71% and 7.29%, respectively, and the weighted average
rate paid on swaps was 5.68% and 6.56%, respectively. Net interest income
(loss) from swaps, including amortization of net losses on terminated swaps,
totaled $2.5 million in 1996 and ($0.7) million in 1995.
During 1995, 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 to interest income. At December 31, 1996, net losses of $0.7
million remained unamortized; $0.5 million will be recognized in 1997 and $0.2
million will be recognized in 1998.
Equity Collar Instruments: To hedge against fluctuations in the market value
of a portion of the marketable equity portfolio, the Company has entered into
costless collar instruments, a form of equity collar instrument, that expire
in 1998 and 1999 and will require settlement in equity securities or cash. A
costless collar instrument is a purchased put option and a written call option
on a specific equity security such that 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. The fair value of the purchased
puts and the written calls were determined based on quoted market prices at
year end. At December 31, 1996, the notional amount of the put and call
options were $17.2 million and $27.5 million, respectively.
The tables below outline specific information for the swaps outstanding at
December 31, 1996 and 1995. 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
December 31, 1996: 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 7.71% LIBOR $150 13 days 5.66%
Swaps matched to
other investments
to meet specific
maturity targets 3- or 6-
[Ending dates: 4.97%- month
10/27/97-9/20/99] 60 7.20% LIBOR 60 32 days 5.47%
Other short-term
investments - 206
-------- --------
Total $210 $416
======== ========
December 31, 1995:
- ------------------
Swaps matched
to investments
to meet maturity
target comparable
to outstanding debt 3- or 6-
[Maturing on: 7.68%- month
1/2/02] $150 7.71% LIBOR $150 118 days 5.52%
Swaps matched to
other investments
to meet specific
maturity targets 3- or 6-
[Ending dates: 6.09%- month
8/12/97 - 9/20/99] 80 7.20% LIBOR 80 93 days 5.85%
Other short-term
investments - 373
-------- --------
Total $230 $603
======== ========
<FN>
* 3- and 6-month LIBOR rates are reset every 3 or 6 months. At December 31,
1996, the 3-month LIBOR rate and the 6-month LIBOR rate were 5.6%. At December
31, 1995, the 3-month LIBOR rate was 5.6% and the 6-month LIBOR rate was 5.5%.
** Average maturity reflects either the maturity date or, for a floating
investment, the next reset date.
Financial Instruments Held for Trading Purposes: As part of its overall
investment strategy, the Company has contracted with two external money
managers to manage part of its investment portfolio. One portfolio, which had
a carrying value of $37.2 million at December 31, 1996, and $34.9 million at
December 31, 1995, consisted of primarily non-dollar denominated investments.
To hedge the non-dollar denominated investments, the money manager enters into
forward contracts. The fair value at December 31, 1996 and 1995, of the
forward contracts totaled $0.8 million and $0.1 million, respectively. The
average fair value during 1996 and 1995 totaled $0.3 million and $0.1 million,
respectively. Net realized and unrealized trading gains on the portfolio
totaled approximately $2.4 million in 1996 and $3.8 million in 1995, and are
included in interest income. Counterparties have strong credit ratings which
minimize 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, 1996 and 1995, 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.
1996 1995
------------------ ---------------------
Carrying Fair Carrying Fair
Financial Instrument Value Value Value Value
- ------------------------------------------------------------------------------
(thousands)
Assets:
Investment securities
(including accrued interest
and traded forward contracts) $ 951,816 $ 951,588 $959,771 $959,834
Purchased foreign exchange put
options 4,616 7,273 2,345 6,300
Outstanding interest rate swaps (net) 2,122 11,555 7,194 23,940
Liabilities:
Short-term and long-term debt 150,000 139,500 150,358 147,750
Equity collars 1,222 4,892 - -
Foreign exchange forward contracts 138 138 237 237
OTHER ACCRUED LIABILITIES
Other accrued liabilities at December 31 are as follows (thousands):
1996 1995
- ------------------------------------------------------------------------------
Accrued compensation $ 42,716 $ 36,945
Accrued clinical and other studies 39,981 27,290
Accrued royalties 25,098 23,159
Accrued marketing and promotion costs 11,889 18,863
Income taxes payable 18,530 14,329
Other 56,328 67,012
-----------------------------
Total other accrued liabilities $194,542 $187,598
=============================
LONG-TERM DEBT
The Company's long-term debt as of December 31, 1996 and 1995 consisted of
$150.0 million of convertible subordinated debentures, with interest payable
at 5%, due in 2002. The debentures are convertible at the option of the
holder into shares of the Company's special common stock. Upon conversion,
the holder receives, for each $74 in principal amount of debenture converted,
one-half share of the Company's special common stock and $18 in cash. The $18
in cash is reimbursed by Roche to the Company. Generally, the Company may
redeem the debentures until maturity.
LEASES, COMMITMENTS AND CONTINGENCIES
Future minimum lease payments under operating leases at December 31, 1996 are
as follows (thousands):
1997 1998 1999 2000 2001 Thereafter Total
- ------------------------------------------------------------------------------
$7,563 3,942 5,400 5,121 4,791 9,155 $35,972
The Company leases various real property under operating leases that generally
require the Company to pay taxes, insurance and maintenance. Rent expense was
approximately $11.7 million, $9.5 million and $6.5 million for the years 1996,
1995 and 1994, respectively. Sublease income was not material in any of the
three years presented.
Under three of the lease agreements, the Company has an option to purchase the
properties at an amount that does not constitute a bargain. Alternatively,
the Company can cause the property to be sold to a third party. The Company
is contingently liable, under residual value guarantees, for approximately
$166.0 million. The Company also is required to maintain certain financial
ratios and is limited to the amount of additional debt it can assume.
Pursuant to its research and development collaboration agreement entered into
with Scios Inc. (Scios) in 1995, the Company established a line of credit for
$30 million that Scios may draw down at Scios' discretion through 2002. This
commitment is supported through December 31, 1997, by a bank letter of credit
under which Scios 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 under the bank letter of credit or directly from the Company are
repayable in the form of cash or Scios common stock (at the average market
price over the thirty day period before the date of repayment) at Scios'
option any time through December 30, 2002. Interest on amounts borrowed by
Scios accrue to the Company at the prime rate of interest. At December 31,
1996 and 1995, no amounts were drawn.
In addition, the Company has entered into research collaborations with
companies whereby potential future payments may be due to selective
collaborative partners if the partners achieve certain benchmarks as defined
in the collaborative agreements. The Company may also, from time to time,
lend additional funds to these companies, subject to approval.
The Company is a party to various legal proceedings including patent
infringement cases involving human growth hormone products and Activase;
product liability cases involving Activase and growth hormone products; and
class action lawsuits regarding Protropin. In addition, in 1995 the Company
received and responded to grand jury document subpoenas from the United States
District Court for the Northern District of California for documents relating
to the Company's clinical, sales and marketing activities associated with
human growth hormone. In February 1997, the Company received another grand
jury document subpoena from the same court related to the same subject matter.
Based upon the nature of the claims made and the investigations completed to
date by the Company and its counsel, the Company believes the outcome of these
actions will not have a material adverse effect on the financial position,
results of operations or cash flows of the Company. However, were an
unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the net income of that period.
RELATIONSHIP WITH ROCHE HOLDINGS, INC.
On October 25, 1995, the Company and Roche entered into a new agreement (the
Agreement). Each share of the Company's common stock not held by Roche or its
affiliates on that date automatically converted to one share of callable
putable common stock (special common stock). The Agreement extends until June
30, 1999, Roche's option to cause the Company to redeem (call) the outstanding
special common stock of the Company at predetermined prices. Should the call
be exercised, Roche will concurrently purchase from the Company a like number
of common shares for a price equal to the Company's cost to redeem the special
common stock. During the quarter beginning January 1, 1997, the call price is
$69.25 per share; it increases by $1.25 in the following quarter, then
increases by $1.50 per share each quarter through the end of the option period
on June 30, 1999, on which date the price is $82.50 per share. If Roche does
not cause the redemption as of June 30, 1999, the Company's stockholders will
have the option (the put) to cause the Company to redeem none, some, or all of
their shares of special common stock at $60.00 per share (and Roche will
concurrently provide the necessary redemption funds to the Company by
purchasing a like number of shares of common stock at $60.00 per share) within
thirty business days commencing July 1, 1999. Roche Holding Ltd, a Swiss
corporation, has guaranteed Roche's obligation under the put.
In conjunction with the Agreement, HLR was granted an option for ten years for
licenses to use and sell certain of the Company's products in non-U.S.
markets. As a general matter, such option for a Genentech product must be
exercised at, or prior to if the Company mutually agrees, the conclusion of
phase II clinical trials for each product. In general, for each product for
which HLR exercises its option, the Company and HLR will share equally all
development expenses incurred by the Company through the option exercise date
and prospectively with respect to the development of the product in the United
States. HLR will pay all non-U.S. development expenses. At the Company's
election, and with HLR's consent, HLR may reimburse the Company for HLR's
share of development costs incurred prior to HLR's option exercise date,
either by payment of such costs at the time of the option exercise or by
making payments prospectively until HLR's share has been fully reimbursed to
the Company.
In general, HLR pays a royalty of 12.5% until a product reaches $100 million
in aggregate sales outside of the U.S., at which time the royalty rate
increases to 15%. In addition, HLR has exclusive rights to, and pays the
Company 20% royalties on, Canadian sales of the Company's existing products
and European sales of Pulmozyme. Consequently, in the fourth quarter of 1995,
the Company transferred to HLR the rights to its Canadian product sales and
European sales of Pulmozyme, and commenced recording royalty revenue from HLR
on such sales. The Company supplies its products to HLR, and has agreed to
supply products for which HLR has exercised its option, for sales outside of
the U.S. at cost plus 20%.
Under the Agreement, independent of its right to cause the Company to redeem
the special common stock, Roche may increase its ownership of the Company up
to 79.9% by making purchases on the open market. Roche holds approximately
66.0% of the outstanding common equity of the Company as of December 31, 1996.
In January and February 1997, Roche purchased additional shares of the
Company's common equity increasing Roche's holdings to 68.0%.
RELATED PARTY TRANSACTIONS
The Company has transactions with Roche, HLR (a wholly owned subsidiary of
Roche, with two officers on the Company's Board of Directors), and its
affiliates in the ordinary course of business. In 1996, HLR exercised its
option under the Agreement with respect to the development of three projects -
IDEC-C2B8, insulin-like growth factor (IGF-1) and nerve growth factor (NGF).
The Company recorded non-recurring contract revenues of $58.2 million relating
to the option exercises. Other contract revenue from HLR, including
reimbursement for ongoing development expenses after the option exercise date
for the three projects, totaled $37.1 million in 1996, $13.4 million in 1995
and $17.1 million in 1994. All other revenue from Roche, HLR and their
affiliates, principally royalties under previous product licensing agreements,
and royalties and product sales under the Agreement, totaled $39.5 million in
1996, $14.3 million in 1995 and $8.5 million in 1994. During the three years,
the Company has collaborated with HLR on other projects.
CAPITAL STOCK
Common Stock, Special Common Stock and Redeemable Common Stock
After the close of business on June 30, 1995, each share of the Company's
redeemable common stock automatically converted to one share of Genentech
common stock, in accordance with the terms of the redeemable common stock put
in place at the time of its issuance in 1990 and as described in Genentech's
Certificate of Incorporation. On October 25, 1995, pursuant to the Agreement
with Roche, each share of the Company's common stock not held by Roche or its
affiliates automatically converted to one share of callable putable common
stock (special common stock). See the "Relationship with Roche Holdings,
Inc." note above for a discussion of these transactions.
Stock Award Plans
The Company has stock option plans adopted in 1996, 1994, 1990 and 1984, which
variously allow for the granting of non-qualified stock options, incentive
stock options and stock appreciation rights to employees, and the granting of
non-qualified stock options to directors and consultants of the Company.
Generally, non-qualified options have a maximum term of 20 years and incentive
options have a maximum term of 10 years. In general, options vest in
increments over four years from the date of grant, although the Company may
grant options with different vesting terms from time to time. No stock
appreciation rights have been granted to date.
The Company adopted the 1991 Employee Stock Plan (1991 Plan) on December 4,
1990, and amended it during 1993 and 1995. All full-time employees of the
Company are eligible to participate in the 1991 Plan. Of the 3,800,000 shares
of special common stock reserved for issuance under the 1991 Plan, 2,865,196
shares have been issued as of December 31, 1996. During 1996, 2,487 of the
eligible employees participated in the 1991 Plan.
The Company has elected to continue to follow APB 25 for accounting for its
employee stock options because the alternative fair value method of accounting
prescribed by FAS 123 requires the use of option valuation models that were
not developed for use in valuing employee stock options. Under APB 25, no
compensation expense is recognized because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant.
Pro forma information regarding net income and earnings per share in 1996 and
1995 has been determined as if the Company had accounted for its employee
stock options and employee stock plan under the fair value method prescribed
by FAS 123. The resulting effect on pro forma net income and earnings per
share disclosed for 1996 and 1995 is not likely to be representative of the
effects on net income and earnings per share on a pro forma basis in future
years, because 1995 and 1996 pro forma results include the impact of only one
and two years, respectively, of grants and related vesting, while subsequent
years will include additional years of grants and vesting. The fair value of
options was estimated at the date of grant using a Black-Scholes option
valuation model with the following weighted average assumptions: risk-free
interest rates of 5.8% for 1996 and 6.0% for 1995; dividend yields of 0%;
volatility factors of the expected market price of the Company's common stock
of 6.2%; and a weighted-average expected life of the option of 5.0 years.
Grants under the employee stock plan terminate with each quarterly stock
purchase.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of pro forma disclosures, the estimated fair value of options is
amortized to pro forma expense over the options' vesting period. Pro forma
information for the years ending December 31 follows (in thousands, except per
share amounts):
1996 1995
---- ----
Net income - as reported $ 118,348 $ 146,432
Net income - pro forma 104,358 142,370
Earnings per share - as reported 0.96 1.21
Earnings per share - pro forma 0.84 1.18
A summary of the Company's stock option activity and related information were
as follows:
Shares Weighted Average
Price
----------- ----------------
Options outstanding at December 31, 1993 12,439,727 $ 27.38
Grants 5,137,055 50.19
Exercises (1,400,223) 23.53
Cancellations (195,752) 36.89
Options outstanding at December 31, 1994 15,980,807 34.93
Grants 1,303,800 48.52
Exercises (1,472,759) 24.60
Cancellations (602,774) 42.59
------------
Options outstanding at December 31, 1995 15,209,074 36.80
Grants 6,761,545 53.99
Exercises (1,624,541) 29.39
Cancellations (743,569) 48.93
------------
Options outstanding at December 31, 1996 19,602,509 42.89
============
The following table summarizes information concerning currently outstanding and
exercisable options:
Options Outstanding Options Exercisable
----------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- ----------------- ----------- ----------- -------- ----------- ---------
$14.080 - $20.625 1,278,761 2.83 $17.01 1,278,361 $17.01
$21.375 - $31.000 4,181,212 12.77 26.37 4,114,332 26.37
$32.125 - $48.125 2,964,663 16.74 41.68 2,126,573 39.33
$48.250 - $54.250 11,177,873 13.42 52.45 952,284 50.45
----------- -----------
19,602,509 13.09 42.93 8,471,550 30.91
=========== ===========
Using the Black-Scholes option valuation model, the weighted average fair value
of options granted in 1996 and 1995 was $13.36 and $12.27, respectively.
Shares of special common stock available for future grants under all stock
option plans were 4,469,574 at December 31, 1996.
Warrants
All previously outstanding warrants to purchase the Company's special common
stock were exercised or expired as of July 31, 1996. As of December 31, 1995,
121,445 shares subject to exercisable warrants were outstanding, with a price
range of $27.57 to $28.26. 113,093 shares were exercised through July 31,
1996, at a price range of $27.57 to $28.26, and 8,352 shares expired
unexercised.
QUASI-REORGANIZATION
On October 1, 1987, the Company eliminated its accumulated deficit through an
accounting reorganization of its stockholders' equity accounts (a quasi-
reorganization) that did not involve any revaluation of assets or liabilities.
An accumulated deficit of $329.5 million was eliminated by a transfer from
additional paid-in capital in an amount equal to the accumulated deficit.
The Company has been recording, 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
the accounting and quasi-reorganization literature existing at the date the
quasi-reorganization was effected. If the provisions of the subsequently
issued Staff Accounting Bulletin 86 (SAB 86) had been applied, net income in
1995 would have been reduced by $11.8 million or $.10 per share, and 1994 net
income would have been reduced by $39.7 million or $.33 per share, because SAB
86 would require that the tax benefits of prior operating loss and tax credit
carryforwards be reported as a direct addition to additional paid-in capital
rather than being recorded in the income statement. The Securities and
Exchange Commission staff has indicated that it would not object to the
Company's accounting for such tax benefits. As of June 30, 1995, the
operating loss and tax credit carryforwards arising prior to the quasi-
reorganization had been fully utilized, therefore there was no impact on
earnings in 1996.
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, 1996 and 1995, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1996. 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, 1996 and 1995, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1996, in conformity with generally accepted accounting principles.
Ernst & Young LLP
San Jose, California
January 17, 1997
QUARTERLY FINANCIAL DATA (UNAUDITED)
(thousands, except per share amounts)
1996 Quarter Ended
-----------------------------------------------
December 31 September 30 June 30 March 31
- ------------------------------------------------------------------------------
Total revenues $230,325 $251,707 $243,762 $242,884
Product sales 139,724 142,463 148,305 152,337
Gross margin from product sales 113,065 117,627 121,152 126,458
Net income 7,470 50,942 21,719 38,217
Net income per share .06 .41 .18 .31
1995 Quarter Ended
-----------------------------------------------
December 31 September 30 June 30 March 31
- ------------------------------------------------------------------------------
Total revenues $221,914 $223,911 $233,053 $238,967
Product sales 153,482 158,478 161,236 162,067
Gross margin from product sales 130,983 134,109 136,924 135,317
Net income 25,636 40,229 37,163 43,404
Net income per share .21 .33 .31 .36
Total revenues were higher in the first three quarters of 1996 compared to the
fourth quarter due primarily to contract revenue from HLR for the exercises of
its options under the Agreement (see the "Related Party Transactions" note in
the "Notes to Consolidated Financial Statements" for more information) in each
of the first three quarters. Net income was lower in the fourth quarter due
to lower revenues and higher expenses, primarily research and development.
11-YEAR FINANCIAL SUMMARY (UNAUDITED)
(millions, except per share and employee data)
1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------
Total revenues $ 968.6 $ 917.8 $ 795.4 $ 649.7 $ 544.3
Product sales 582.8 635.3 601.0 457.4 391.0
Royalties 214.7 190.8 126.0 112.9 91.7
Contract & other 107.0 31.2 25.6 37.9 16.7
Interest 64.1 60.5 42.8 41.5 44.9
----------------------------------------------
Total costs and expenses $ 820.7 $ 745.6 $ 665.8 $ 590.8 $ 522.3
Cost of sales 104.5 97.9 95.8 70.5 66.8
Research & development 471.1 363.0 314.3 299.4 278.6
Marketing, general & administrative 240.1 251.7 248.6 214.4 172.5
Special charge - 25.0(1) - - -
Interest 5.0 8.0 7.1 6.5 4.4
----------------------------------------------
Income data
Income (loss) before taxes $ 147.9 $ 172.2 $ 129.6 $ 58.9 $ 21.9
Income tax provision 29.6 25.8 5.2 - 1.1
Net income (loss) 118.3 146.4 124.4 58.9 20.8
Net income (loss) per share 0.96 1.21 1.04 0.50 0.18
----------------------------------------------
Selected balance sheet data
Cash, short-term investments
& marketable securities $1,159.1 $1,096.8 $ 920.9 $ 719.8 $ 646.9
Accounts receivable 197.6 172.2 146.3 130.5 93.9
Inventories 91.9 93.6 103.2 84.7 65.3
Property, plant & equipment, net 586.2 503.7 485.3 456.7 432.5
Other long-term assets 149.2 105.5 61.0 64.1 37.1
Total assets 2,226.4 2,011.0 1,745.1 1,468.8 1,305.1
Total current liabilities 250.0 233.4 220.5 190.7 133.5
Long-term debt 150.0 150.0 150.4 151.2 152.0
Total liabilities 425.3 408.9 396.3 352.0 297.8
Total stockholders' equity 1,801.1 1,602.0 1,348.8 1,116.8 1,007.3
----------------------------------------------
Other data
Depreciation and amortization expense $ 62.1 $ 58.4 $ 53.5 $ 44.0 $ 52.2
Capital expenditures 141.8 70.2 82.8 87.5 126.0
----------------------------------------------
Share information
Shares used to compute EPS 123.7 121.2 119.5 117.1 114.0
Actual year-end 121.4 119.3 117.2 114.8 112.9
----------------------------------------------
Per share data
Market price: High $ 55.38 $ 53.00* $ 53.50 $ 50.50 $ 39.50
Low $ 51.38 $ 44.50* $ 41.75 $ 31.25 $ 25.88
Book value $ 14.84 $ 13.43 $ 11.50 $ 9.73 $ 8.92
----------------------------------------------
Number of employees 3,071 2,842 2,738 2,510 2,331
----------------------------------------------
<FN>
The Company has paid no dividends.
The Financial Summary above reflects adoption of FAS 121 in 1996, FAS 115 in 1994, FAS
109 in 1992 and FAS 96 in 1988.
All share and per share amounts reflect a two-for-one split in 1986 and a two-for-one
split in 1987.
*Special common stock began trading October 26, 1995. On October 25, 1995, pursuant to
the new Agreement with Roche, each share of the Company's common stock not held by
Roche or its affiliates automatically converted to one share of special common stock.
**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 related to 1995 merger and new Agreement with Roche ($21 million) and
resignation of the Company's former CEO ($4 million).
(2) Charges primarily related to 1990 Roche merger.
(3) Primarily inventory-related charge.
(4) Charge for purchase of in-process R&D.
1991 1990 1989 1988 1987 1986
- --------------------------------------------------------------------
$ 515.9 $ 476.1 $ 400.5 $ 334.8 $ 230.5 $ 134.0
383.3 367.2 319.1 262.5 141.4 43.6
63.4 47.6 36.7 26.7 20.1 12.9
20.4 31.9 27.5 33.5 57.1 70.9
48.8 29.4 17.2 12.1 11.9 6.6
- --------------------------------------------------------------------
$ 469.8 $ 572.7 $ 352.9 $ 311.7 $ 186.6 $ 484.6
68.4 68.3 60.6 46.9 23.8 10.8
221.3 173.1 156.9 132.7 96.5 79.8
175.3 158.1 127.9 101.9 59.5 27.3
- 167.7(2) - 23.3(3) - 366.7(4)
4.8 5.5 7.5 6.9 6.8 -
- --------------------------------------------------------------------
$ 46.1 $ (96.6) $ 47.6 $ 23.1 $ 43.9 $ (350.6)
1.8 1.5 3.6 2.5 1.7 2.4
44.3 (98.0) 44.0 20.6 42.2 (353.0)
0.39 (1.05) 0.51 0.24 0.50 (5.10)
- --------------------------------------------------------------------
$ 711.4 $ 691.3 $ 205.0 $ 152.5 $ 158.3 $ 84.3
69.0 58.8 66.8 63.9 92.2 24.5
56.2 39.6 49.3 63.4 58.0 14.7
342.5 300.2 299.1 289.4 195.7 133.1
42.7 61.7 85.0 89.7 108.7 114.9
1,231.4 1,157.7 711.2 662.9 619.0 376.0
118.6 101.4 75.9 95.4 82.8 37.8
152.9 153.5 154.4 155.3 168.1 31.6
281.7 264.5 242.2 263.6 263.6 83.3
949.7 893.2 469.0 399.3 355.4 292.6
- --------------------------------------------------------------------
$ 46.9 $ 47.6 $ 44.6 $ 38.3 $ 23.5 $ 8.1
71.3 36.0 37.2 110.9 65.3 46.3
- --------------------------------------------------------------------
112.5 93.0 86.0 84.5 84.4 69.3
111.3 110.6 84.3 82.9 78.7 67.0
- --------------------------------------------------------------------
$ 36.25 $ 30.88 $ 23.38 $ 47.50 $ 64.75 $ 49.38
$ 27.50**
$ 20.75 $ 20.13 $ 16.00 $ 14.38 $ 28.00 $ 16.44
$ 21.75**
$ 8.53 $ 8.08 $ 5.56 $ 4.82 $ 4.52 $ 4.37
- --------------------------------------------------------------------
2,202 1,923 1,790 1,744 1,465 1,168
- --------------------------------------------------------------------
COMMON STOCK, SPECIAL COMMON STOCK AND REDEEMABLE COMMON STOCK INFORMATION
Stock Trading Symbol GNE
Stock Exchange Listings
The Company's callable putable common stock (special common stock) has traded
on the New York Stock Exchange and the Pacific Stock Exchange under the symbol
GNE since October 26, 1995. On October 25, 1995, the Company's non-Roche
stockholders approved a new agreement (the Agreement) with Roche Holdings,
Inc. (Roche). Pursuant to the Agreement, each share of the Company's common
stock not held by Roche or its affiliates automatically converted to one share
of special common stock. From July 3, 1995 through October 25, 1995, the
Company's common stock was traded under the symbol GNE. After the close of
business on June 30, 1995, each share of the Company's redeemable common stock
automatically converted to one share of the Company's common stock. The
conversion was in accordance with the terms of the redeemable common stock put
in place at the time of its issuance on September 7, 1990, when the Company's
merger with a wholly owned subsidiary of Roche was consummated. The
redeemable common stock of the Company traded under the symbol GNE from
September 10, 1990 to June 30, 1995. 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, special common stock or
redeemable common stock. The Company currently intends to retain all future
income for use in the operation of its business and, therefore, does not
anticipate paying any cash dividends in the foreseeable future. See the
"Relationship with Roche Holdings, Inc." note in the "Notes to Consolidated
Financial Statements" for a further description of the Agreement with Roche.
Special Common Stockholders
As of December 31, 1996, there were approximately 16,748 stockholders of
record of the Company's special common stock.
Stock Prices Special Common/Redeemable Common/Common Stock
1996 1995
- --------------------------------------------------------------------------
High Low High Low
-------------------------------------------------
4th Quarter $ 54 3/8 $ 52 3/4 $ 53 $ 47 7/8
3rd Quarter 53 1/4 51 3/8 49 1/4 46 5/8
2nd Quarter 53 3/8 51 7/8 52 46 3/8
1st Quarter 55 3/8 52 1/2 51 44 1/2