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 shares of common stock 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.
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 markets (the license agreement). In
the second quarter of 1997, the Company and HLR agreed in principle to
changes to the license agreement. In general, these changes allow for the
sharing of United States (U.S.) and European development costs regardless of
location or purpose of studies. Under the license agreement, as revised,
HLR may exercise its option either when the Company determines to move a
product into development or at the end of Phase II clinical trials. In
addition, HLR has assumed development of Xubix, trademark, (the oral
IIb/IIIa antagonist) globally on its own. See the Relationship with Roche
Holdings, Inc. note in the Notes to Consolidated Financial Statements for
further information.
As a result of the license agreement which transferred the Company's
Canadian and European operations to Roche, in 1996 the Company's total
product sales decreased compared to 1995, while contract and royalty revenue
increased. Cost of sales as a percentage of product sales also increased
due to the license agreement. See below for further discussion.
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Annual % Change
1997 1996 1995 97/96 96/95
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Revenues $1,016.7 $ 968.7 $ 917.8 5% 6%
Revenues for 1997 increased in all areas, but primarily from royalties and
contract revenues. The increase in 1996 resulted primarily from higher
contract and royalty revenue partly offset by lower product sales. Product
sales to HLR in conjunction with the license agreement were $17.4 million in
1997, $13.2 million in 1996 and $1.8 million in 1995.
Annual % Change
Product Sales 1997 1996 1995* 97/96 96/95
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Activase $ 260.7 $ 284.1 $ 301.0 (8)% (6)%
Protropin, Nutropin
and Nutropin AQ 223.6 218.2 219.4 2 (1)
Pulmozyme 91.6 76.0 111.3 21 (32)
Rituxan 5.5 - - - -
Actimmune 3.5 4.5 3.6 (22) 25
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- -
Total product
sales $ 584.9 $ 582.8 $ 635.3 0% (8)%
% of revenues 58% 60% 69%
Total product sales increased slightly in 1997 over 1996 due to increases in
Pulmozyme, registered trademark, growth hormone sales and new sales from the
introduction of Rituxan, trademark. This increase was offset by a decrease in
Activase, registered trademark, sales. The decrease in total product sales in
1996 compared to 1995 primarily resulted from the license 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 in 1997 decreased primarily due to a
new competitive thrombolytic agent, Retavase, registered trademark.
Activase's market share fell to approximately 71% at the end of 1997 from
approximately 80% at the end of 1996 and from approximately 75% at the end of
1995. Activase sales decreased in 1996 compared to 1995 primarily due to the
impact of not having Canadian customer sales in 1996 as a result of the
license agreement with Roche and the decline in the overall size of the U.S.
thrombolytic market. Activase sales to Canadian customers were $12.7 million
in 1995. The market size decrease was approximately 6% in 1996. This 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
March 1997, results from the GUSTO III clinical trial, which involved a head-
to-head comparison of Activase to Retavase, failed to demonstrate that
Retavase was superior over Activase, which was the endpoint that the trial
was designed to assess. 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 (blood clots in the
brain). Activase is the first therapy to be indicated for the acute
treatment of stroke.
Protropin, Nutropin and Nutropin AQ: Net sales of the Company's three growth
hormone products - Protropin, registered trademark, (somatrem for injection),
Nutropin, registered trademark, [somatropin (rDNA origin) for injection] and
Nutropin AQ, registered trademark, [somatropin (rDNA origin) injection] liquid
formulation - increased slightly in 1997 compared to 1996 and 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 for
treatment of children with growth hormone inadequacy. 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 products. In the
first quarter of 1997, three of those companies, Serono Laboratories, Inc.,
Novo Nordisk A/S (Novo) and Pharmacia & Upjohn (P&U) began selling their
growth hormone products in the U.S. market. In addition, three of the
Company's competitors have received approval to market their existing human
growth hormone products for additional indications. In December 1997, the
Company received clearance to market Nutropin and Nutropin AQ for the
treatment of growth hormone inadequacy in adults. In December 1996 and
January 1997, the Company received clearance from the FDA to market Nutropin
and Nutropin AQ, respectively, for the treatment of growth inadequacy
associated with Turner syndrome.
Pulmozyme: Net sales of Pulmozyme were higher in 1997 primarily due to
continued penetration in the moderate and early cystic fibrosis (CF) patient
populations as well as from variations in customer ordering patterns for
U.S. sales. The decrease in 1996 compared to 1995 occurred primarily as a
result of the license 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. In November 1996,
Pulmozyme was cleared for marketing by the FDA for the management of CF
patients with advanced disease, a condition that affects approximately 500
patients in the U.S.
Rituxan: Rituxan is marketed in the U.S. for the treatment of relapsed or
refractory low-grade or follicular, CD20-positive B-cell non-Hodgkin's
lymphoma (B-cell NHL), a cancer of the immune system. In late November 1997,
Rituxan was cleared for marketing in the U.S. by the FDA. B-cell NHL affects
approximately 250,000 people in the U.S. of which one-half are follicular or
low-grade lymphoma patients. A portion of these patients will have multiple
relapses and may be eligible for Rituxan therapy. The Company launched
Rituxan on December 16, 1997, and recorded initial sales of $5.5 million.
However, not enough time has passed for these figures to be indicative of the
future trend of Rituxan sales. Rituxan was co-developed by the Company and
IDEC Pharmaceuticals Corporation (IDEC), from whom the Company licenses
Rituxan, and is the first monoclonal antibody approved to treat cancer. IDEC
and the Company are jointly promoting Rituxan in the U.S. and share
responsibility for the manufacturing of the product. HLR is responsible for
marketing Rituxan in the rest of the world, excluding Japan.
Actimmune: Actimmune, registered trademark, is approved in the U.S. for the
treatment of chronic granulomatous disease, a rare, inherited disorder of the
immune system which affects an estimated 250 to 400 Americans.
Royalties, Contract and Other, Annual %
Change
and Interest Income 1997 1996 1995 97/96 96/95
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- -
Royalties $ 241.1 $ 214.7 $ 190.8 12%
13%
Contract and other 121.6 107.0 31.2 14 243
Interest income 69.1 64.2 60.5 8 6
The Company receives royalty payments from HLR from its sales of the Company's
products outside of the U.S. under the license agreement, and receives
royalties from other licensees and HLR from the sales of various other health
care products. Total royalties in 1997 increased over 1996 primarily due to
increased licensee sales from various licensees. Royalties in 1996 increased
over 1995 primarily due to new royalties from HLR in conjunction with the
license agreement, as well as higher income from existing licensees due to
increased licensee sales. Royalty revenue under the license agreement was
$17.0 million in 1996 and $1.9 million in 1995. All other royalty revenue
from HLR in 1996 and 1995, totaled $9.2 million and $10.6 million,
respectively. Royalties in 1995 include $30.0 million of royalty revenue
related 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) to hedge
these royalty cash flows. All options expire within the next three years.
See below for discussion of market risks related to these financial
instruments.
Contract and other revenues were higher in 1997 compared to 1996 primarily due
to $30.9 million from Sumitomo Pharmaceuticals Co., Ltd. (Sumitomo) and P&U
for strategic alliances and $11.7 million of gains from the sale of
biotechnology equity securities in 1997. These increases were partly offset
by higher revenues from HLR in 1996. As part of the strategic alliance with
Sumitomo, the Company has agreed to provide Sumitomo exclusive rights to
develop, import and distribute in Japan, Nutropin AQ and ProLease, registered
trademark, sustained release growth hormone. In its alliance with P&U, in
exchange for development costs, fees and, upon regulatory approval, royalties,
the Company agreed to provide P&U exclusive worldwide rights for
thrombopoietin (TPO) which is in Phase II trials for potential use in treating
patients with complications of cancer chemotherapy. P&U and the Company will
jointly develop TPO for one indication; however, the Company has no marketing
rights for this indication. Contract and other revenues increased in 1996
from 1995 due to contract revenue from HLR for the exercises of their options
under the license agreement with respect to the development of three projects
- - Rituxan, insulin-like growth factor (IGF-I) and nerve growth factor (NGF).
Development of IGF-I was subsequently terminated. The Company recorded non-
recurring contract revenues of $44.7 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 $67.6 million in 1997, $50.6 million in 1996 and $13.4 million in
1995.
Interest income increased in 1997 from last year primarily due to an increase
in the average yield on the investment portfolio and a larger investment
portfolio. The increase in 1996 compared to 1995 was due to a larger
investment portfolio. The Company enters into interest rate swaps (swaps) as
part of its overall strategy of managing the duration of its investment
portfolio. See below for discussion of market risks related to these swaps and
also the Financial Instruments note in the Notes to Consolidated Financial
Statements.
Annual % Change
Costs and Expenses 1997 1996 1995 97/96 96/95
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Cost of sales $ 102.5 $104.5 $ 97.9 (2)% 7%
Research and
development 470.9 471.1 363.0 0 30
Marketing, general and
administrative 269.9 240.1 251.7 12 (5)
Special charge - - 25.0 - -
Interest expense 3.6 5.1 8.0 (29) (36)
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Total costs
and expenses $ 846.9 $820.8 $ 745.6 3% 10%
% of revenues 83% 85% 81%
Cost of sales as % of
product sales 18% 18% 15%
R&D as % of revenues 46 49 40
MG&A as % of revenues 27 25 27
Cost of Sales: Cost of sales as a percent of product sales was 18% in 1997
which was comparable to 1996, but 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
and 1995, reserves of $3.6 million and $3.7 million, respectively, included in
cost of sales, were provided for expected expirations of certain inventories.
In 1997, such reserves were immaterial.
Research and Development: Research and Development (R&D) expenses in 1997
were flat compared to 1996. R&D as a percentage of revenues decreased to 46%
in 1997 from 49% in 1996. This percentage decrease from 1996 reflects
increases in revenues and continuing efforts towards disciplined spending in
R&D. R&D expenses increased 30% in 1996 compared to 1995 due to continued
late-stage clinical testing of products and new development projects.
To gain additional access to potential new products and technologies,
including acquiring the equity and convertible debt of, and to utilize other
companies to help develop the Company's potential new products, the Company
has established strategic alliances with companies developing technologies
that fall outside the Company's research focus and with companies having the
potential to generate new products through technology exchanges and
investments. The Company has also entered into product-specific
collaborations to acquire development and marketing rights for products.
Marketing, General and Administrative: Marketing, general and administrative
(MG&A) expenses increased in 1997 primarily due to increased marketing and
sales (M&S) expenses in the oncology area, defending Activase against new
competition and launching a new indication, growth hormone deficiency in
adults, for Nutropin and Nutropin AQ. In addition, there was an increase in
general and administrative expenses due to higher royalty expense. MG&A
expenses in 1996 decreased from 1995 primarily due to the closure of the
Company's European and Canadian operations in conjunction with the license
agreement.
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 declined in 1997 over 1996 due to higher
capitalized interest resulting from an increase in construction projects.
Interest expense in 1997, 1996 and 1995, 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 1997 1996 1995
- -----------------------------------------------------------------------------
Income before taxes $ 169.8 $ 147.9 $ 172.2
Income tax provision 40.8 29.6 25.8
Effective tax rate 24% 20% 15%
Increases in the effective tax rate for 1997 over 1996 and 1996 over 1995 are
attributable to proportionally decreased realization of previously reserved
deferred tax assets. The valuation allowance for deferred tax assets was
fully realized in 1996, with the exception of the portion attributable to the
realization of tax benefits on stock option deductions which will be credited
to additional paid-in-capital when realized.
Annual % Change
Net Income 1997 1996 1995 97/96 96/95
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Net income $ 129.0 $ 118.3 $ 146.4 9% (19)%
Earnings per share:
Basic $ 1.05 $ 0.98 $ 1.24
Diluted $ 1.02 $ 0.95 $ 1.20
Net income in 1997 increased over 1996 primarily due to higher royalties and
contract and other revenues partly offset by higher MG&A expenses. 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.
LIQUIDITY AND CAPITAL RESOURCES 1997 1996 1995
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Cash, cash equivalents, short-term investments
and long-term marketable debt and equity
securities $1,286.5 $1,159.1 $1,096.8
Working capital 904.4 705.1 812.0
Cash provided by (used in):
Operating activities 118.3 139.7 133.9
Investing activities (168.4) (141.7)
(117.7)
Financing activities 87.3 72.2 54.1
Capital expenditures
(included in investing activities above) (154.9) (141.8)
(70.2)
Current ratio 4.1:1 3.8:1 4.5:1
Cash generated from operations, income from investments and proceeds from
stock issuances were used to purchase marketable securities and make capital
additions in 1997.
Capital expenditures in 1997 primarily included building improvements to
existing manufacturing and office facilities and production systems. In 1996,
capital expenditures primarily included building and land purchases and
improvements to existing manufacturing and office facilities. In 1995, the
Company entered into an arrangement with a lessor, which qualifies as an
operating lease, for a new manufacturing facility that 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 these and any other 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.
Product Sales: The Company's product sales may vary from period to period for
several reasons including, but not limited to: the overall competitive
environment for the Company's products, the amount of sales to customers in
the U.S., the amount and timing of the Company's sales to HLR, the timing and
volume of bulk shipments to licensees, the availability of third-party
reimbursements for the cost of therapy, the effectiveness and safety of the
products, the rate of adoption and use of the Company's products for approved
indications and additional indications, and the potential introduction of
additional new products and indications for existing products in 1998 and
beyond.
Competition: The Company faces growing competition in two of its therapeutic
markets. Activase lost market share and is expected to lose additional market
share in the thrombolytic market to Retavase and such adverse effect on sales
could be material. Boehringer Mannheim (BM) manufactures and markets Retavase.
Recently, Centocor, Inc. announced that it was purchasing the U.S. and
Canadian rights to Retavase from BM and will promote and sell the product in
the U.S. Retavase received FDA approval in October 1996 for the treatment of
acute myocardial infarction (AMI). In addition, there is an increasing use of
angioplasty in lieu of thrombolytic therapy for the treatment of AMI which is
expected to continue. In the growth hormone market, the Company continues to
face increased competition from five other companies with growth hormone
products. Three of these competitors have also 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, Nutropin and Nutropin AQ and such effect could be material.
Other competitive factors affecting the Company's product 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 degree of
patent protection afforded to particular products, the outcome of litigation
involving the Company's patents and patents of competing companies for
products and processes related to production and formulation of those
products, the increasing use and development of alternate therapies, and the
rate of market penetration by competing products.
Royalty and Contract Revenues: Royalty and contract revenues in future
periods could vary significantly from 1997 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 and other licensees'
sales of licensed products; the expiration of royalties from Lilly in 1998 for
its sales of insulin which contribute substantially to current royalty
revenues; fluctuations in foreign currency exchange rates; the initiation of
other new contractual arrangements with other companies; the timing of non-
U.S. approvals, if any, for products licensed to HLR; whether and when
contract benchmarks are achieved; and the conclusion of existing arrangements
with other companies and HLR.
R&D: The Company intends to continue to develop new products and is
committed to aggressive R&D investment. 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; they may fail to receive necessary
regulatory approvals; they may turn out to be uneconomical because of
manufacturing costs or other factors; or they 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.
The Company currently has several products in late-stage clinical testing
and anticipates that its R&D expenses will continue at a high percentage of
revenues over the short-term. Over the long-term, however, as revenues
increase, R&D as a percent of revenues should decrease to the 20 to 25%
range. 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, in-
licensing activities, including the timing and amount of related development
funding or milestone payments, and future levels of revenues.
As part of the Company and HLR's agreed upon changes to the license
agreement, HLR has assumed development of Xubix on its own. As a result,
the Company will not be incurring future Xubix related R&D costs unless it
decides to opt-in on the development of this product. Such costs, net of
amounts reimbursed by HLR, were approximately $4.6 million for 1997.
In September 1997, the Company decided to discontinue development of IGF-I
in Type I and Type II diabetes mellitus. As a result, the Company will not
be incurring future IGF-I related R&D costs, net of amounts reimbursed by
HLR, which were approximately $16.1 million for 1997.
In addition, the Company announced in early October 1997 that it opted-out
of development and returned to IDEC the Company's marketing rights for IDEC-
Y2B8, a radioimmunotherapy under investigation for the treatment of relapsed
or refractory B-cell NHL. As a result, the Company discontinued its R&D
funding to IDEC for the development of IDEC-Y2B8. Such funding for 1997 was
immaterial.
Income Tax Provision: The Company expects its effective tax rate to
increase from the current rate of 24% to approximately 28% in 1998 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.
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 has in
the past, is currently and may in the future, be involved in 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 at a material cost or
cease using the technology or product in dispute. The presence of patents or
other proprietary rights belonging to other parties may lead to the
termination of R&D 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.
Year 2000: Some of the Company's older computer software programs were
written using two digit fields rather than four digit fields to define the
applicable year (i.e., "98" in the computer code refers to the year "1998").
As a result, time-sensitive functions of those software programs may
misinterpret dates after January 1, 2000, to refer to the twentieth century
rather than the twenty-first century (i.e., "02" could be interpreted as
"1902" rather than "2002"). This could cause system failures or
miscalculations resulting in inaccuracies in computer output or disruptions of
operations, including, among other things, inaccurate processing of financial
information and/or temporary inabilities to process transactions, manufacture
products, or engage in similar normal business activities.
The Company has developed plans to address the potential exposures related to
the impact on its computer systems for the Year 2000 and beyond. An
assessment of key financial, informational and operational systems to
determine if they are Year 2000 compliant has been completed. Detailed plans
and timelines for implementation and testing of modifications and corrections
to the computer systems have been or are in process of being developed to
address computer systems problems as required by December 31, 1999. The
Company believes that with these detailed plans and completed modifications,
the Year 2000 issue will not pose significant operational problems for its
computer systems. However, if such modifications and conversions are not
made, or are not completed in a timely fashion, the Year 2000 issue could have
a material impact on the operations of the Company.
The total cost of the Year 2000 systems assessments and conversions is funded
through operating cash flows and the Company is expensing these costs. The
financial impact of making the required systems changes can not be known
precisely at this time, but is not expected to be material to the Company's
financial position, results of operations or cash flows.
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. In addition, the Company believes it could access additional
funds from the capital and debt markets. 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, in-licensing
activities, including the timing and amount of related development funding or
milestone payments, and capital expenditures.
Roche Holdings, Inc.: At December 31, 1997, Roche held approximately 66.9% of
the Company's outstanding common equity. The Company expects to continue to
have material transactions with Roche, including royalty and contract
revenues, product sales and joint product development costs.
Market Risk: The Company is exposed to market risk, including changes to
interest rates, foreign currency exchange rates and equity investment prices.
To reduce the volatility relating to these exposures, the Company enters into
various derivative transactions pursuant to the Company's investment and risk
management policies and procedures in areas such as hedging and counterparty
exposure practices. The Company does not use derivatives for speculative
purposes.
A discussion of the Company's accounting policies for financial instruments
and further disclosures relating to financial instruments is included in the
Description of Business and Significant Accounting Policies and the Financial
Instruments notes in the Notes to Consolidated Financial Statements.
The Company maintains risk management control systems to monitor the risks
associated with interest rates, foreign currency exchange rates and equity
investment price changes, and its derivative and financial instrument
positions. The risk management control systems use analytical techniques,
including sensitivity analysis, and market values. Though the Company intends
for its risk management control systems to be comprehensive, there are
inherent risks which may only be partially offset by the Company's hedging
programs should there be unfavorable movements in interest rates, foreign
currency exchange rates or equity investment prices.
The estimated exposures discussed below are intended to measure the maximum
amount the Company could lose from adverse market movements in interest rates,
foreign currency exchange rates and equity investment prices, given a
specified confidence level, over a given period of time. Loss is defined in
the value at risk estimation as fair market value loss. The exposures to
interest rate, foreign currency exchange rate and equity investment price
changes are calculated based on proprietary modeling techniques from a Monte
Carlo simulation value at risk model (value at risk model) using a 30-day
holding period and a 95% confidence level. The value at risk model assumes
non-linear financial returns and generates potential paths various market
prices could take and tracks the hypothetical performance of a portfolio under
each scenario to approximate its financial return. The value at risk model
takes into account correlations and diversification across market factors,
including interest rates, foreign currencies and equity prices. Market
volatilities and correlations are based on JP Morgan Riskmetrics, trademark,
dataset as of December 31, 1997.
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, convertible equity loans and long-term investments. To
mitigate the impact of fluctuations in U.S. interest rates, the Company may
enter into swap transactions which involve the receipt of fixed rate interest
and the payment of floating rate interest without the exchange of the
underlying principal. By investing the Company's cash in an amount equal to
the notional amount of the swap contract, with a maturity date equal to the
maturity date of the floating rate obligation, the Company hedges itself from
any potential earnings impact due to changes in interest rates.
Based on the Company's overall interest rate exposure at December 31, 1997,
including derivative and other interest rate sensitive instruments, a near-
term change in interest rates, within a 95% confidence level based on
historical interest rate movements, would not materially affect the fair value
of interest rate sensitive instruments.
Foreign Currency Exchange Rates - The Company receives royalty revenues
from licensees selling products in 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 licensed products are
sold. The Company is exposed to changes in exchange rates in Europe, Asia and
Canada. The Company's exposure to foreign exchange rates primarily exists
with the German Mark. 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. In addition, as part
of its overall investment strategy, the Company has three portfolios that are
managed by external money managers and these portfolios consist primarily of
non-dollar denominated investments. As a result, the Company is exposed to
changes in the exchanges rates of the countries in which these non-dollar
denominated investments are made.
To mitigate this risk, the Company hedges certain of its anticipated revenues
by purchasing option contracts with expiration dates and amounts of currency
that are based on 40%-90% of probable future revenues so that the potential
adverse impact of movements in currency exchange rates on the non-dollar
denominated revenues will be at least partly offset by an associated increase
in the value of the option. The duration of these options is generally one to
four years. The Company may also enter into foreign currency forward
contracts (forward contracts) to lock in the dollar value of a portion of
these anticipated revenues. The duration of these forward contracts is
generally less than one year. Also, to hedge the non-dollar denominated
investments in the externally managed portfolios, the external money managers
also enter into forward contracts.
Based on the Company's overall currency rate exposure at December 31, 1997,
including derivative and other foreign currency sensitive instruments, a near-
term change in currency rates within a 95% confidence level based on
historical currency rate movements, would not materially affect the fair value
of foreign currency sensitive instruments.
Equity Investment Securities - As part of its strategic alliance
efforts, the Company invests in equity instruments of biotechnology companies
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). In
addition, as part of its strategic alliance efforts, the Company has issued
interest bearing convertible equity loans.
Based on the Company's overall exposure to fluctuations from market value
changes in equity prices at December 31, 1997, a near-term change in equity
prices within a 95% confidence level based on historic volatilities could
result in a potential loss in fair value of the equity securities portfolio of
$11.3 million.
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 42 to 60, in accordance with
generally accepted accounting principles. As such, the statements include
amounts based on judgments and estimates made by management. The Company also
prepared the other information included in the annual report and is
responsible for its accuracy and consistency with the financial statements.
The financial statements have been audited by the independent auditing firm,
Ernst & Young LLP, which was given unrestricted access to all financial
records and related data, including minutes of all meetings of stockholders,
the Board of Directors and committees of the Board. The Company believes that
all representations made to the independent auditors during their audit were
valid and appropriate. Ernst & Young LLP's audit report appears on page 61.
Systems of internal accounting controls, applied by operating and financial
management, are designed to provide reasonable assurance as to the integrity
and reliability of the financial statements and reasonable, but not absolute,
assurance that assets are safeguarded from unauthorized use or disposition,
and that transactions are recorded according to management's policies and
procedures. The Company continually reviews and modifies these systems, where
appropriate, to maintain such assurance. Through the Company's 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. The Audit Committee of the Board of Directors is composed of
four non-management directors who meet regularly with management and the
independent auditors and the general auditor, jointly and separately, to
review the adequacy of internal accounting controls and auditing and financial
reporting matters to ascertain that each is properly discharging its
responsibilities.
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr. Bradford S. Goodwin
President and Executive Vice President Vice President - Finance
Chief Executive Officer and Chief Financial Officer
CONSOLIDATED STATEMENTS OF INCOME
(thousands, except per share amounts)
YEAR ENDED DECEMBER 31 1997 1996 1995
- ---------------------------------------------------------------------------------
Revenues
Product sales (including amounts from
related parties: 1997-$17,396;
1996-$13,216; 1995-$1,776) $ 584,889 $ 582,829 $ 635,263
Royalties (including amounts
from related parties: 1997-$25,362;
1996-$26,240; 1995-$12,492) 241,112 214,702 190,811
Contract and other (including amounts
from related parties: 1997-$67,596;
1996-$95,299; 1995-$13,448) 121,587 107,037 31,209
Interest 69,160 64,110 60,562
------------------------------------
Total revenues 1,016,748 968,678 917,845
Costs and expenses
Cost of sales (including amounts from
related parties: 1997-$14,348;
1996-$10,900; 1995-$6,963) 102,536 104,527 97,930
Research and development (including
contract related: 1997-$67,596;
1996-$50,586; 1995-$17,124) 470,923 471,143 363,049
Marketing, general and administrative 269,852 240,063 251,653
Special charge (primarily merger related) -- -- 25,000
Interest 3,642 5,010 7,940
-------------------------------------
Total costs and expenses 846,953 820,743 745,572
Income before taxes 169,795 147,935 172,273
Income tax provision 40,751 29,587 25,841
-------------------------------------
Net income $ 129,044 $ 118,348 $ 146,432
=====================================
Earnings per share:
Basic $ 1.05 $ 0.98 $ 1.24
Diluted $ 1.02 $ 0.95 $ 1.20
=====================================
Weighted average shares used to compute
diluted earnings per share: 126,397 123,969 121,748
=====================================
<FN>
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
Increase in Cash and
Cash Equivalents
YEAR ENDED DECEMBER 31 1997 1996 1995
- --------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 129,044 $ 118,348 $ 146,432
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 65,533 62,124 58,421
Deferred income taxes 19,660 (34,021) (22,655)
Gain on sales of securities available-for-sale (13,203) (1,010) (7,589)
Loss on sales of securities available-for-sale 2,096 663 157
Writedown of securities available-for-sale 4,000 - 6,609
Loss on fixed asset dispositions
(including merger-related in 1995) 318 5,309 1,032
Other - - (234)
Changes in assets and liabilities:
Net cash flow from trading securities (109,132) (8,184) (50,014)
Receivables and other current assets 11,194 (30,416) (28,446)
Inventories (24,083) 1,705 9,552
Accounts payable, other current
liabilities and other long-term
liabilities 32,897 25,153 20,682
----------------------------------
Net cash provided by operating activities 118,324 139,671 133,947
Cash flows from investing activities:
Purchases of securities held-to-maturity (304,932) (634,124) (682,396)
Proceeds from maturities of securities
held-to-maturity 455,317 772,922 924,345
Purchases of securities available-for-sale (512,727) (304,806) (353,118)
Proceeds from sales of securities available-
for-sale 410,395 182,564 101,591
Purchases of nonmarketable equity securities - (9,323) -
Capital expenditures (154,902) (141,837) (70,166)
Change in other assets (61,529) (7,046) (37,948)
-----------------------------------
Net cash used in investing activities (168,378) (141,650) (117,692)
Cash flows from financing activities:
Stock issuances 87,259 72,558 54,946
Reduction in long-term debt,
including current portion - (358) (871)
-----------------------------------
Net cash provided by financing activities 87,259 72,200 54,075
-----------------------------------
Increase in cash and cash equivalents 37,205 70,221 70,330
Cash and cash equivalents at beginning of year 207,264 137,043 66,713
-----------------------------------
Cash and cash equivalents at end of year $ 244,469 $ 207,264 $ 137,043
===================================
Supplemental cash flow data:
Cash paid during the year for:
Interest, net of portion capitalized $ 3,642 $ 5,010 $ 7,917
Income taxes 15,474 52,243 44,699
<FN>
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except par value)
DECEMBER 31 1997 1996
- --------------------------------------------------------------------------------
Assets:
Current assets:
Cash and cash equivalents $ 244,469 $ 207,264
Short-term investments 588,853 415,900
Accounts receivable - trade (net of
allowances of: 1997-$8,826; 1996-$4,110) 71,415 77,785
Accounts receivable - other (net of
allowances of: 1997-$5,709; 1996-$3,759) 73,444 86,450
Accounts receivable - related party 44,386 33,377
Inventories 116,026 91,943
Prepaid expenses and other current assets 55,325 42,365
------------------------------
Total current assets 1,193,918 955,084
Long-term marketable securities 453,188 535,916
Property, plant and equipment, net 683,304 586,167
Other assets 177,202 149,205
------------------------------
Total assets $ 2,507,612 $ 2,226,372
==============================
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 48,992 $ 45,501
Income taxes payable 40,293 18,530
Accrued liabilities - related party 15,427 9,908
Other accrued liabilities 184,845 176,012
------------------------------
Total current liabilities 289,557 249,951
Long-term debt 150,000 150,000
Other long-term liabilities 36,830 25,362
------------------------------
Total liabilities 476,387 425,313
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.02 par value; authorized:
100,000,000 shares; none issued - -
Special common stock, $0.02 par value;
authorized: 100,000,000 shares; outstanding:
1997-47,606,785; 1996-44,805,755 952 896
Common stock, $0.02 par value;
authorized: 200,000,000 shares;
outstanding: 1997-76,621,009;
1996-76,621,009 1,532 1,532
Additional paid-in capital 1,463,768 1,362,585
Retained earnings (since October 1, 1987
quasi-reorganization) 511,141 382,097
Net unrealized gain on securities
available-for-sale 53,832 53,949
-------------------------------
Total stockholders' equity 2,031,225 1,801,059
-------------------------------
Total liabilities and stockholders' equity $ 2,507,612 $ 2,226,372
===============================
<FN>
See Notes to Consolidated Financial Statements.
<CAPITON>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands)
1997 1996 1995
Year ended December 31 ------------------- ------------------- -------------------
Shares Amount Shares Amount Shares Amount
-------- -------- -------- -------- -------- --------
Special common stock
Beginning balance 44,806 $ 896 42,647 $ 853 - -
Issuance of stock upon exercise
of options and warrants 2,801 56 2,159 43 298 $ 6
Conversion of common stock
to special common stock - - - - 42,349 847
---------------------------------------------------------------
Ending balance 47,607 952 44,806 896 42,647 853
---------------------------------------------------------------
Redeemable common stock
Beginning balance - - - - 50,106 1,002
Issuance of stock upon exercise
of options and warrants - - - - 679 14
Issuance of stock under
employee stock plan - - - - 322 6
Conversion of redeemable
common stock to common stock - - - - (51,107) (1,022)
---------------------------------------------------------------
Ending balance - - - - - -
---------------------------------------------------------------
Common stock
Beginning balance 76,621 1,532 76,621 1,532 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 76,621 1,532
---------------------------------------------------------------
Additional paid-in capital
Beginning balance 1,362,585 1,281,640 1,207,720
Issuance of stock upon exercise
of options and warrants 68,346 55,103 37,087
Issuance of stock under
employee stock plan 18,857 17,412 17,819
Income tax benefits
realized from employee
stock option exercises 13,980 8,430 7,204
Tax benefits arising prior
to quasi-reorganization - - 11,810
---------- ---------- -----------
Ending balance 1,463,768 1,362,585 1,281,640
---------- ---------- -----------
Retained earnings
Beginning balance 382,097 263,749 129,127
Net income 129,044 118,348 146,432
Tax benefits arising prior
to quasi-reorganization - - (11,810)
---------- ---------- -----------
Ending balance 511,141 382,097 263,749
---------- ---------- -----------
Net unrealized gain on securities
Beginning balance 53,949 54,273 9,592
Net unrealized (loss) gain on
securities available-for-sale (117) (324) 44,681
---------- ---------- ----------
Ending balance 53,832 53,949 54,273
---------- ---------- ----------
Total stockholders' equity $2,031,225 $1,801,059 $1,602,047
========== ========== ==========
<FN>
See Notes to Consolidated Financial Statements.
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 seven 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 U.S. Of these seven products, HLR
has the right to sell six in Canada and two 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. 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 interest bearing convertible debt of other biotechnology
companies. Marketable equity securities are accounted for as available-for-
sale investment securities as described below. Nonmarketable equity
securities and convertible debt are carried at cost. At December 31, 1997 and
1996, the Company had investments of $55.2 million and $15.7 million,
respectively, in convertible debt of various 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 adjustments 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,
1997, 1996 and 1995 were $32.9 million, $28.8 million and $22.1 million,
respectively. Capitalized interest on construction-in-progress of $3.9
million in 1997, $2.5 million in 1996 and $1.5 million in 1995 is included in
property, plant and equipment.
Property, plant and equipment balances at December 31 are summarized below
(in thousands):
1997 1996
-------------------------------------------------------------------------
At cost:
Land $ 69,010 $ 67,619
Buildings 339,708 297,888
Equipment 494,874 428,738
Leasehold improvements 3,270 12,314
Construction in progress 152,533 99,708
----------------------------
1,059,395 906,267
Less: accumulated depreciation 376,091 320,100
----------------------------
Net property, plant and equipment $ 683,304 $ 586,167
=============================
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 $39.8 million, $36.0 million, and $30.2 million in 1997,
1996, and 1995, respectively, and are classified in marketing, general and
administrative expenses.
Advertising Expenses: The Company expenses the costs of advertising, which
also includes promotional expenses, as incurred. Advertising expenses for the
years ended December 31, 1997, 1996, and 1995, were $41.8 million, $28.0
million, and $29.2 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.
Earnings Per Share: Basic earnings per share is computed based on the
weighted average number of shares of the Company's special common stock and
common stock. Diluted earnings 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. See also the New Accounting
Standards section below.
Financial Instruments: The Company uses external money managers to manage
part of its investment portfolio that is held for trading purposes. This
externally managed investment portfolio consists entirely of debt securities.
When the money managers purchase securities denominated in a foreign currency,
they enter into foreign currency forward contracts which are recorded at fair
value with the related gain or loss recorded in interest income.
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.
Options are generally terminated, or offsetting contracts are entered into,
upon determination that purchased options no longer qualify as a hedge or are
determined to exceed probable anticipated net foreign revenues. The realized
gains and losses are recorded as a component of other revenues. For early
termination of options that qualify as hedges, the gain or loss on termination
will be deferred through the original term of the option and then recognized
as a component of the hedged revenues. Changes in the fair value of hedging
instruments that qualify as a hedge are not recognized and changes in the fair
value of instruments that do not qualify as a hedge would be recognized in
other revenues.
The Company may also enter 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
other revenues if they occur.
Interest rate swaps (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. The accrued net settlement amounts on
swaps are reflected on the balance sheet as other accounts receivable or other
accrued liabilities. 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. For early termination
of swaps where the underlying asset is not sold, the amount of the terminated
swap is deferred and amortized over the remaining life of the original swap.
For early termination of swaps with the corresponding termination or sale of
the underlying asset, the amounts are recognized through interest income.
Changes in the fair value of swap hedging instruments that qualify as a hedge
are not recognized and changes in the fair value of swap instruments that do
not qualify as a hedge would be recognized in other income.
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 short-term or long-term other assets or
liabilities. Equity collar instruments that do not qualify for hedge
accounting and early termination of these instruments with the sale of the
underlying security would be recognized through earnings. For early
termination of these instruments without the sale of the underlying security,
the time value would be recognized through earnings and the intrinsic value
will adjust the cost basis of the underlying security.
401(k) Plan: The Company's 401(k) Plan (Plan) covers substantially all of its
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 1997, 1996, and
1995, the Company provided $6.7 million, $6.1 million, and $5.6 million,
respectively, for the Company match under the Plan.
New Accounting Standards: On December 31, 1997, the Company adopted Statement
of Financial Accounting Standards (FAS) 128, "Earnings per Share." As a
result, the Company has changed the method used to compute earnings per share
(EPS) and has restated all prior periods as required by FAS 128. The adoption
of FAS 128 did not have a material impact on the Company's results of
operations. The following is a reconciliation of the numerator and
denominators of the basic and diluted EPS computations for the years ended
December 31, 1997, 1996 and 1995 (in thousands).
1997 1996 1995
-------------------------------------
Numerator:
Net income - numerator for
basic and diluted EPS: $ 129,044 $ 118,348 $ 146,432
--------- --------- ---------
Denominator:
Denominator for basic EPS--
weighted-average shares 123,042 120,623 118,271
Effect of dilutive securities:
Stock options 3,355 3,325 3,440
Warrants - 21 37
--------- --------- ---------
Denominator for diluted EPS
--adjusted weighted-average
shares and assumed conversions 126,397 123,969 121,748
========= ========= ==========
Options to purchase 103,700 shares of common stock at $59.00 per share,
5,251,665 shares of common stock at $54.25 per share and 17,500 shares of
common stock at $51.63 per share were outstanding during 1997, 1996 and 1995,
respectively, but were not included in the computation of diluted earnings per
share because the options' exercise price was greater than the average market
price of the common shares and therefore, the effect would be anti-dilutive.
See Capital Stock note for information on option expiration dates.
During 1997, 1996 and 1995, the Company had convertible subordinated
debentures which are convertible to 1,013,514 shares of common stock, but were
not included in the computation of diluted earnings per share because they
were anti-dilutive. See the Long-Term Debt note for additional information
on the convertible subordinated debentures.
The Financial Accounting Standards Board also issued FAS 130, Reporting
Comprehensive Income, and FAS 131, Disclosures about Segments of an Enterprise
and Related Information, in June 1997, which requires additional disclosures
to be adopted on December 31, 1998. Under FAS 130, the Company is required to
display comprehensive income and its components as part of the Company's full
set of financial statements. FAS 131 requires that the Company report
financial and descriptive information about its reportable operating segments.
The Company is evaluating the impact on its disclosures, if any.
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, 1997 and 1996 are summarized
below (in thousands):
1997 1996
------------------------------------------------------------------
Raw materials and supplies $ 17,544 $ 17,971
Work in process 84,831 61,368
Finished goods 13,651 12,604
----------------------
Total $116,026 $ 91,943
======================
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 11% of the Company's total revenues in 1997, 14%
in 1996, and less than 10% in 1995. 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 in each of
the last three years. Caremark, Inc., which accounted for 14%, 15% and 18% of
total revenues in 1997, 1996 and 1995, respectively, distributes Protropin,
registered trademark, Nutropin, registered trademark, Nutropin AQ, registered
trademark, Pulmozyme, registered trademark, and Actimmune, registered
trademark, 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% in 1997 and 1996 and 11% in 1995.
Approximate foreign sources of revenues were as follows (in millions):
1997 1996 1995
- ----------------------------------------------------
Europe $139.5 $146.4 $112.0
Asia 34.2 17.8 23.6
Canada 11.7 11.1 25.0
The Company currently sells primarily to distributors and hospitals throughout
the U.S., performs ongoing credit evaluations of its customers' financial
condition and extends credit without collateral. In 1997, 1996 and 1995, 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 achieving 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 Relationship with Roche Holdings, Inc. note, 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 (in thousands):
1997 1996 1995
- --------------------------------------------------------------
Current:
Federal $ 30,617 $ 61,502 $ 43,997
State 432 2,104 4,467
Foreign 2 2 32
----------------------------------
Total current 31,051 63,608 48,496
----------------------------------
Deferred:
Federal 23,799 (34,021) (12,319)
State (14,099) - (10,336)
----------------------------------
Total deferred 9,700 (34,021) (22,655)
----------------------------------
Total income tax provision $ 40,751 $ 29,587 $ 25,841
==================================
Actual current tax liabilities are lower than reflected above by $14.0
million, $8.4 million and $7.2 million in 1997, 1996 and 1995, respectively,
due to employee stock option related tax benefits which were credited to
stockholders' equity. The deferred provision excludes activity in the net
deferred tax assets relating to appreciation in securities available-for-sale
in the amount of $10.0 million.
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate follows:
Tax Rate
1997 Amount ---------------------------
(thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------
Tax at U.S. statutory rate $ 59,428 35.0% 35.0% 5.0%
R&D credits realized (19,298) (11.4) (3.0) (15.9)
Tax benefit of realized gains on
securities available-for-sale (6,517) (3.8) - -
Adjustment of deferred tax assets
valuation allowance - - (15.3) (13.1)
Foreign losses (benefited) not benefited - - (3.4) 2.8
State taxes 3,871 2.3 2.3 2.6
Other 3,267 1.9 4.4 3.6
-----------------------------------------
Income tax provision $ 40,751 24.0% 20.0% 15.0%
=========================================
The components of deferred taxes consist of the following at December 31
(in thousands):
1997 1996
- ------------------------------------------------------------------------------
Deferred tax liabilities:
Depreciation $ 55,137 $ 58,842
Unrealized gain on sale of securities
available-for-sale 25,086 21,017
Other 2,173 10,543
--------------------------
Total deferred tax liabilities 82,396 90,402
Deferred tax assets:
Capitalized R&D costs 33,950 34,280
Federal credit carryforwards 100,400 111,400
Expenses not currently deductible 35,000 38,368
State credit carryforwards 28,365 26,710
Other 4,398 6,340
--------------------------
Total deferred tax assets 202,113 217,098
Valuation allowance (48,508) (35,827)
--------------------------
Total net deferred tax assets 153,605 181,271
--------------------------
Total net deferred taxes $ 71,209 $ 90,869
==========================
Total tax credit carryforwards of $128.8 million expire in the years 1998
through 2012, except for $43.0 million of alternative minimum tax credits
which have no expiration date. The valuation allowance at December 31, 1997,
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 increased by $12.7 million in 1997, decreased by $17.0
million in 1996 and decreased by $31.6 million in 1995. 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, 1997 and 1996 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, 1997 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $ 256,428 $ 686 $ (4,487) $ 252,627
==============================================
SECURITIES AVAILABLE-FOR-SALE
(carried at estimated
fair value):
Equity securities $ 46,262 $ 75,796 $ (2,147) $ 119,911
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing:
between 5-10 years 38,330 577 (3) 38,904
Corporate debt securities
maturing:
within 1 year 98,073 51 (8) 98,116
between 1-5 years 98,283 770 (103) 98,950
between 5-10 years 146,921 4,053 - 150,974
Other debt securities
maturing:
within 1 year 40,314 - (578) 39,736
between 1-5 years 40,323 - (2,008) 38,315
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 508,506 $ 81,247 $ (4,847) $ 584,906
==============================================
SECURITIES HELD-TO-MATURITY
(carried at amortized cost):
Corporate debt securities
maturing:
within 1 year $ 193,295 $ 19 - $ 193,314
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 193,295 $ 19 - $ 193,314
==============================================
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
between 1-5 years 103,057 1,299 (209) 104,147
between 5-10 years 113,176 1,001 (2,114) 112,063
Other debt securities
maturing:
within 1 year 46,583 27 - 46,610
between 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
between 5-10 years 30,155 - $ (777) 29,378
Other debt securities
maturing:
within 1 year 91,664 4 (35) 91,633
between 1-5 years 141,553 576 (27) 142,102
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 340,090 $ 611 $ (839) $ 339,862
==============================================
* 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 at December 31, 1996.
The carrying value of all investment securities held at December 31, 1997 and
1996 is summarized below (in thousands):
Security 1997 1996
- ------------------------------------------------------------------------------
Trading securities $252,627 $143,495
Securities available-for-sale maturing within one year 137,852 97,718
Securities held-to-maturity maturing within one year 193,295 68,382
Accrued interest 5,079 6,305
-------- --------
Total short-term investments $588,853 $415,900
======== ========
Securities available-for-sale maturing between
1-10 years, including equity securities $447,054 $357,999
Securities held-to-maturity maturing between 1-10 years - 171,708
Accrued interest 6,134 6,209
-------- --------
Total long-term marketable securities $453,188 $535,916
======== ========
In 1997, proceeds from the sales of available-for-sale securities totaled
$410.4 million; gross realized gains totaled $13.2 million and gross realized
losses totaled $2.1 million. 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. The Company recorded charges in 1997 and 1995 of $4.0 million and
$6.6 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. In 1996, there were no such write downs.
During the year ended December 31, 1997 and 1996, net unrealized holding
losses on trading securities included in net income totaled $3.8 million and
$1.0 million, respectively. In 1995, 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 1997, 1996 and
1995.
FINANCIAL INSTRUMENTS
Foreign Currency Instruments: Certain of the Company's revenues are earned
outside of the U.S. 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, 1997, the Company had hedged
approximately 75% of probable net foreign revenues anticipated within 12
months and between 40% and 75% of its probable net foreign revenues through
the year 2000. At December 31, 1997 and 1996, the notional amount of the
options totaled $122.9 million and $100.3 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 three
years. The fair value of the options is based on exchange rates and market
conditions at December 31, 1997 and 1996. At December 31, 1996, the U.S.
dollar equivalent of the notional amount of the forward sell contracts was
$34.3 million and the forward buy contracts totaled $0.4 million,
respectively. All forward contracts were closed out at the end of December
31, 1997.
Credit exposure is limited to the unrealized gains on these contracts. All
agreements are with a diversified selection of institutions with strong credit
ratings which minimizes risk of loss due to nonpayment from the counterparty.
The Company has not experienced any material losses due to credit impairment
of its foreign currency instruments.
Interest Rate Swaps: 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 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, 1997 and 1996, was $3.7 million
and $6.8 million, respectively. The net carrying amount of the swaps, which
reflects the net interest accrued for such swaps, totaled $2.0 million and
$2.1 million at December 31, 1997 and 1996, 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, 1997, 1996 and 1995, the weighted average
rate received on swaps was 7.57%, 6.71% and 7.29%, respectively, and the
weighted average rate paid on swaps was 5.38%, 5.68% and 6.56%, respectively.
Net interest income (loss) from swaps, including amortization of net losses on
terminated swaps, totaled $3.6 million in 1997, $2.5 million in 1996 and
($0.7) million in 1995.
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, 1997, the notional amount of the put and call
options were $33.7 million and $50.1 million, respectively. 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, 1997 and 1996. 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, 1997: 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 9 days 5.65%
Other short-term
investments - 439
-------- --------
Total $ 150 $ 589
======== ========
December 31, 1996:
- ------------------
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
======== =========
<FN>
* 3- and 6-month LIBOR rates are reset every 3 or 6 months. At December 31,
1997, the 3-month LIBOR rate and the 6-month LIBOR rate were 5.8%. At December
31, 1996, the 3-month LIBOR rate and the 6-month LIBOR rate were 5.6%.
** 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 three external money
managers in 1997 and two external money managers in 1996 to manage part of its
investment portfolio. Three portfolios in 1997, which had a combined carrying
value of $145.1 million at December 31, 1997, and one portfolio in 1996, which
had a carrying value of $37.2 million at December 31, 1996, consisted of
primarily non-dollar denominated investments. To hedge the non-dollar
denominated investments, the money managers enter into forward contracts. The
notional amounts of the forward contracts at December 31, 1997 and 1996, were
$209.3 million and $41.7 million, respectively. The fair value at December
31, 1997 and 1996, of the forward contracts, totaled $3.3 million and $0.8
million, respectively. The average fair value during 1997 and 1996 totaled
$2.1 million and $0.3 million, respectively. Net realized and unrealized
trading gains on the portfolio totaled approximately $9.1 million in 1997 and
$2.4 million in 1996, respectively, 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, 1997 and 1996, 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 (in thousands):
1997 1996
------------------ -------------------
Carrying Fair Carrying Fair
Financial Instrument Value Value Value Value
- ------------------------------------------------------------------------------
Assets:
Investment securities
(including accrued interest
and traded forward contracts) $1,042,041 $1,042,060 $951,816 $951,588
Convertible equity loans 55,248 55,248 15,668 15,668
Purchased foreign exchange put
options 3,891 14,468 4,616 7,273
Outstanding interest rate swaps 5,742 165,559 6,757 226,189
Liabilities:
Long-term debt 150,000 139,500 150,000 139,500
Equity collars 12,161 15,533 1,222 4,892
Outstanding interest rate swaps 3,732 153,732 4,635 214,634
OTHER ACCRUED LIABILITIES
Other accrued liabilities at December 31 are as follows (in thousands):
1997 1996
- ------------------------------------------------------------------------------
Accrued compensation $ 44,624 $ 42,716
Accrued clinical and other studies 40,269 39,981
Accrued royalties 30,905 25,098
Accrued marketing and promotion costs 13,369 11,889
Other 55,678 56,328
------------------------------
Total other accrued liabilities $184,845 $176,012
=============================
LONG-TERM DEBT
The Company's long-term debt as of December 31, 1997 and 1996 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, net of sublease income,
at December 31, 1997 are as follows (in thousands):
1998 1999 2000 2001 2002 Thereafter Total
- ------------------------------------------------------------------------------
$15,068 15,622 15,196 14,950 14,969 14,759 $90,564
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, $11.7 million and $9.5 million for the years
1997, 1996 and 1995, 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
$293.7 million. The Company also is required to maintain certain financial
ratios and is limited to the amount of additional debt it can assume.
The Company and CuraGen Corporation (CuraGen) entered into a research
collaborative agreement in November 1997, whereby the Company will invest $5.0
million in equity of CuraGen and provide a convertible equity loan to CuraGen
of up to $26.0 million. As of December 31, 1997, no amounts have been funded
to CuraGen.
In December 1997, the Company and Alteon Inc. entered into a collaborative
agreement to develop and market pimagedine, an advanced glycosylation end-
product formation inhibitor which Alteon currently has in Phase III clinical
trials, to treat kidney disease in diabetic patients. Under the terms of the
agreement, the Company licensed pimagedine from Alteon and made an initial
equity investment in Alteon stock of $15.0 million and will make additional
equity investments of up to $48.0 million to fund development costs for
pimagedine. A $16.0 million investment is scheduled for the first quarter of
1998.
Also, in December 1997, the Company and LeukoSite Inc. entered into a
collaboration agreement to develop and commercialize LeukoSite's LDP-02, a
humanized monoclonal antibody for the potential treatment of inflammatory
bowel diseases. Under the terms of the agreement, the Company made a $4.0
million equity investment in LeukoSite and will provide a convertible equity
loan for approximately $15.0 million to fund Phase II development costs. Upon
successful completion of Phase II, if LeukoSite agrees to fund 25% of Phase
III development costs, the Company will provide a second loan to LeukoSite for
such funding.
In addition, the Company has entered into research collaborations with
companies whereby potential future payments may be due to selective
collaborative partners achieving 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 limited partner in the Vector Later-Stage Equity Fund II,
L.P. (Vector Fund). The General Partner is Vector Fund Management II, L.L.C.,
a Delaware limited liability company. The purpose of the Vector Fund is to
invest in biotech equity and equity-related securities. Under the terms of
the Vector Fund agreement, the Company makes contributions to the capital of
the Vector Fund through installments in cash as called by the General Partner.
The Company's total commitment to the Vector Fund through September 2003 is
$25.0 million, of which $1.0 million was contributed as of December 31, 1997
and another $1.8 million was contributed in January 1998. The Vector Fund
will terminate and be dissolved in September 2007.
The Company is a party to various legal proceedings including patent
infringement cases involving human growth hormone products and Activase,
product liability cases involving Protropin and other matters. In addition,
in July 1997, an action was filed in the U.S. District Court for the Northern
District of California alleging that the Company's manufacture, use and sale
of its Nutropin human growth hormone products infringed a patent (the Goodman
Patent) owned by the Regents of the University of California (UC). This
action is substantially the same as a previous action filed in 1990 against
the Company by UC alleging that the Company's manufacture, use and sale of its
Protropin human growth hormone products infringed the Goodman Patent and it
has been consolidated with that prior case. The case is expected to commence
trial on June 22, 1998. In October 1997, the Company was named, along with
several other pharmaceutical companies, in a lawsuit brought by Novo Nordisk
A/S (Novo) in the U.S. District Court for the District of New Jersey alleging
infringement of a patent held by Novo relating to the Company's manufacture,
use and sale of its Nutropin human growth hormone products. Novo seeks to
permanently enjoin the Company from the alleged patent infringement and also
seeks compensatory and enhanced damages from the Company. In addition, in
1995 the Company received and responded to grand jury document subpoenas from
the U.S. District Court for the Northern District of California for documents
relating to the Company's past clinical, sales and marketing activities
associated with human growth hormone. In February 1997 and February 1998, the
Company received grand jury document subpoenas from the same court related to
the same subject matter. The government is investigating this matter, and the
Company believes that it is a subject of that investigation.
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 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, 1998, the call price is
$75.00 per share and increases by $1.50 per share each quarter through the end
of the option period on June 30, 1999, on which date the price will be $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 the event of the put, wherein sufficient shares of the Company's special
common stock are tendered to result in Roche owning at least 85% of the total
outstanding shares of the Company's stock, the Company has in place an
Incentive Units Program (Program) which could result in amounts payable to
eligible employees. These amounts are based on specified performance
benchmarks achieved by the Company during the term of the Program. At
December 31, 1997, no such amounts were payable under the Program.
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
(the license agreement). In the second quarter of 1997, the Company and HLR
agreed in principle to changes to the license agreement. Key changes to the
license agreement are summarized as follows: (1) For future products, HLR may
choose to exercise its option either when the Company determines to move a
product into development, or at the end of Phase II clinical trials (as in the
1995 agreement). U.S. and European development costs will be shared
(discontinuing the distinction regarding location or purpose of studies). (2)
If HLR exercises its option at the development determination point, U.S. and
European development costs will be shared 50/50. (3) If HLR exercises its
option at the end of Phase II clinical trials, HLR will reimburse the Company
for 50 percent of any development costs incurred, and subsequent U.S. and
European development costs will be shared 75/25, HLR/Genentech. (4) For nerve
growth factor (NGF), which HLR has already exercised its option to develop,
prospective U.S. and European development costs will be shared 60/40,
HLR/Genentech. (5) HLR has assumed development of Xubix, trademark, (the oral
IIb/IIIa antagonist) globally on its own. The Company may subsequently opt-in
and join development at any time up to the New Drug Application (NDA) filing
for the first indication. If the Company does not opt-in, it will receive
from HLR a 6.0% royalty on worldwide sales of Xubix.
In general, with respect to the Company's products, HLR pays a royalty of
12.5% until a product reaches $100.0 million in aggregate sales outside of the
U.S. on a country-by-country basis, at which time the royalty rate on all
sales increases to 15%. In addition, HLR has rights to, and pays the Company
20% royalties on, Canadian sales of the Company's existing products, except
Rituxan, trademark, (the C2B8 antibody), and European sales of Pulmozyme and
Rituxan. Consequently, in the fourth quarter of 1995, the Company transferred
to HLR the rights to sell Pulmozyme exclusively in Canada and Europe and
commenced recording royalty revenue from HLR on such sales. The Company
supplies its products to HLR, and has agreed to supply its 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
66.9% of the outstanding common equity of the Company as of December 31, 1997.
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 license agreement with respect to the development of three
projects - Rituxan, insulin-like growth factor (IGF-I) and NGF. The Company
recorded non-recurring contract revenues in 1996 of $44.7 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 $67.6 million in 1997, $50.6 million in 1996
and $13.4 million in 1995. All other revenue from Roche, HLR and their
affiliates, principally royalties under previous product licensing agreements,
and royalties and product sales under the license agreement, totaled $42.8
million in 1997, $39.5 million in 1996 and $14.3 million in 1995. Development
of IGF-I was discontinued in September 1997 due to the amount of additional
clinical effort and the greater period of time that would be required to
address potential concerns about retinopathy when using IGF-I in Type I and
Type II diabetes mellitus. 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 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, stock awards and stock appreciation rights to employees, non-employee
directors and consultants of the Company. Incentive stock options may only be
granted to employees under these plans. Generally, non-qualified options have
a maximum term of 20 years, except those granted under the 1996 Plan and
options granted prior to 1992 under the 1984 Plan, which have a term of 10
years. 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, 1995 and 1997. The 1991 Plan allows
eligible employees to purchase special common stock at 85% of the lower of the
fair market value of the special common stock on the grant date or the fair
market value on the first business day of each calendar quarter. Purchases
are limited to 15% of each employee's eligible compensation. All full-time
employees of the Company are eligible to participate in the 1991 Plan. Of the
4,500,000 shares of special common stock reserved for issuance under the 1991
Plan, 3,316,826 shares have been issued as of December 31, 1997. During 1997,
2,624 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, Accounting for Stock-Based Compensation, requires the
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB 25, Accounting for Stock Issued to
Employees, 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 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 and the
earnings per share method under FAS 128. The resulting effect on pro forma
net income and earnings per share disclosed is not likely to be representative
of the effects on net income and earnings per share on a pro forma basis in
future years, due to subsequent years including additional grants and years of
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 for 1997, 1996 and 1995, respectively: risk-free interest rates
of 6.2%, 5.8% and 6.0%; dividend yields of 0%; volatility factors of the
expected market price of the Company's common stock of 9.2%, 6.2% and 6.2%;
and a weighted-average expected life of the option of five years.
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):
1997 1996 1995
------ ------ ------
Net income - as reported $ 129,044 $ 118,348 $ 146,432
Net income - pro forma $ 111,441 104,358 142,370
Earnings per share - as reported:
Basic 1.05 0.98 1.24
Diluted 1.02 0.95 1.20
Earnings per share - pro forma:
Basic 0.91 0.87 1.20
Diluted 0.89 0.84 1.17
A summary of the Company's stock option activity and related information were
as follows:
Shares Weighted Average
Price
------------ ----------------
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
Grants 329,505 58.21
Exercises (2,443,696) 30.07
Cancellations (1,248,709) 52.35
------------
Options outstanding at December 31, 1997 16,239,609 $ 44.41
============
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 - $20.625 753,169 1.19 $ 17.21 753,169 $ 17.21
$21.375 - $31.000 3,064,884 11.59 26.42 3,011,197 26.42
$32.125 - $48.125 2,484,800 15.69 41.83 2,102,035 40.69
$48.250 - $59.000 9,936,756 12.44 52.68 2,677,214 52.07
----------- -----------
16,239,609 8,543,615
=========== ===========
Using the Black-Scholes option valuation model, the weighted average fair
value of options granted in 1997, 1996 and 1995, respectively was $15.37,
$13.36 and $12.27. Shares of special common stock available for future grants
under all stock option plans were 5,401,056 at December 31, 1997.
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 $0.10 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 and 1997.
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, 1997 and 1996, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
Ernst & Young LLP
San Jose, California
January 20, 199
QUARTERLY FINANCIAL DATA (UNAUDITED)
(thousands, except per share amounts)
1997 Quarter Ended
----------------------------------------------
December 31 September 30 June 30 March 31
- -------------------------------------------------------------------------------
Total revenues $277,053 $248,917 $233,493 $257,285
Product sales 143,352 142,306 145,018 154,213
Gross margin from product sales 120,633 115,741 119,451 126,528
Net income 41,529 32,122 23,794 31,599
Earnings per share:
Basic 0.34 0.26 0.19 0.26
Diluted 0.33 0.25 0.19 0.25
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
Earnings per share:
Basic 0.06 0.42 0.18 0.32
Diluted 0.06 0.41 0.17 0.31
11-YEAR FINANCIAL SUMMARY (UNAUDITED)
(millions, except per share and employee data)
1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------
Total revenues $1,016.7 $ 968.7 $ 917.8 $ 795.4 $ 649.7
Product sales 584.9 582.8 635.3 601.0 457.4
Royalties 241.1 214.7 190.8 126.0 112.9
Contract & other 121.6 107.0 31.2 25.6 37.9
Interest 69.1 64.2 60.5 42.8 41.5
----------------------------------------------
Total costs and expenses $ 846.9 $ 820.8 $ 745.6 $ 665.8 $ 590.8
Cost of sales 102.5 104.5 97.9 95.8 70.5
Research & development 470.9 471.1 363.0 314.3 299.4
Marketing, general & administrative 269.9 240.1 251.7 248.6 214.4
Special charge - - 25.0(1) - -
Interest 3.6 5.1 8.0 7.1 6.5
----------------------------------------------
Income data
Income (loss) before taxes $ 169.8 $ 147.9 $ 172.2 $ 129.6 $ 58.9
Income tax provision 40.8 29.6 25.8 5.2 -
Net income (loss) 129.0 118.3 146.4 124.4 58.9
Earnings (loss) per share:
Basic 1.05 0.98 1.24 1.07 0.52
Diluted 1.02 0.95 1.20 1.03 0.50
----------------------------------------------
Selected balance sheet data
Cash, short-term investments
& long-term marketable securities $1,286.5 $1,159.1 $1,096.8 $ 920.9 $ 719.8
Accounts receivable 189.2 197.6 172.2 146.3 130.5
Inventories 116.0 91.9 93.6 103.2 84.7
Property, plant & equipment, net 683.3 586.2 503.7 485.3 456.7
Other long-term assets 177.2 149.2 105.5 61.0 64.1
Total assets 2,507.6 2,226.4 2,011.0 1,745.1 1,468.8
Total current liabilities 289.6 250.0 233.4 220.5 190.7
Long-term debt 150.0 150.0 150.0 150.4 151.2
Total liabilities 476.4 425.3 408.9 396.3 352.0
Total stockholders' equity 2,031.2 1,801.1 1,602.0 1,348.8 1,116.8
----------------------------------------------
Other data
Depreciation and amortization expense $ 65.5 $ 62.1 $ 58.4 $ 53.5 $ 44.0
Capital expenditures 154.9 141.8 70.2 82.8 87.5
----------------------------------------------
Share information
Shares used to compute EPS:
Basic 123.0 120.6 118.3 116.0 113.9
Diluted 126.4 124.0 121.7 120.2 118.7
Actual year-end 124.2 121.4 119.3 117.2 114.8
----------------------------------------------
Per share data
Market price: High $ 60.63 $ 55.38 $ 53.00* $ 53.50 $ 50.50
Low $ 53.25 $ 51.38 $ 44.50* $ 41.75 $ 31.25
Book value $ 16.35 $ 14.84 $ 13.43 $ 11.50 $ 9.73
----------------------------------------------
Number of employees 3,242 3,071 2,842 2,738 2,510
----------------------------------------------
<FN>
The Company has paid no dividends.
The Financial Summary above reflects adoption of FAS 128 and 129 in 1997, 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 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) Reflect amounts previously reported. Information was not available to restate
these amounts pursuant to FAS 128.
1992 1991 1990 1989 1988 1987
- --------------------------------------------------------------------
$ 544.3 $ 515.9 $ 476.1 $ 400.5 $ 334.8 $ 230.5
391.0 383.3 367.2 319.1 262.5 141.4
91.7 63.4 47.6 36.7 26.7 20.1
16.7 20.4 31.9 27.5 33.5 57.1
44.9 48.8 29.4 17.2 12.1 11.9
- --------------------------------------------------------------------
$ 522.3 $ 469.8 $ 572.7 $ 352.9 $ 311.7 $ 186.6
66.8 68.4 68.3 60.6 46.9 23.8
278.6 221.3 173.1 156.9 132.7 96.5
172.5 175.3 158.1 127.9 101.9 59.5
- - 167.7(2) - 23.3(3) -
4.4 4.8 5.5 7.5 6.9 6.8
- --------------------------------------------------------------------
$ 21.9 $ 46.1 $ (96.6) $ 47.6 $ 23.1 $ 43.9
1.1 1.8 1.5 3.6 2.5 1.7
20.8 44.3 (98.0) 44.0 20.6 42.2
0.19 0.40 - - 0.25 0.54
0.18 0.39 (1.05)(4) 0.51(4) 0.24 0.50
- --------------------------------------------------------------------
$ 646.9 $ 711.4 $ 691.3 $ 205.0 $ 152.5 $ 158.3
93.9 69.0 58.8 66.8 63.9 92.2
65.3 56.2 39.6 49.3 63.4 58.0
432.5 342.5 300.2 299.1 289.4 195.7
37.1 42.7 61.7 85.0 89.7 108.7
1,305.1 1,231.4 1,157.7 711.2 662.9 619.0
133.5 118.6 101.4 75.9 95.4 82.8
152.0 152.9 153.5 154.4 155.3 168.1
297.8 281.7 264.5 242.2 263.6 263.6
1,007.3 949.7 893.2 469.0 399.3 355.4
- --------------------------------------------------------------------
$ 52.2 $ 46.9 $ 47.6 $ 44.6 $ 38.3 $ 23.5
126.0 71.3 36.0 37.2 110.9 65.3
- --------------------------------------------------------------------
111.9 111.0 - - 82.2 78.1
115.0 113.2 93.0(4) 86.0(4) 85.0 85.1
112.9 111.3 110.6 84.3 82.9 78.7
- --------------------------------------------------------------------
$ 39.50 $ 36.25 $ 30.88 $ 23.38 $ 47.50 $ 64.75
$ 27.50**
$ 25.88 $ 20.75 $ 20.13 $ 16.00 $ 14.38 $ 28.00
$ 21.75**
$ 8.92 $ 8.53 $ 8.08 $ 5.56 $ 4.82 $ 4.52
- --------------------------------------------------------------------
2,331 2,202 1,923 1,790 1,744 1,465
- --------------------------------------------------------------------
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 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 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, 1997, there were approximately 15,122 stockholders of
record of the Company's special common stock.
Stock Prices Special Common/Redeemable Common/Common Stock
1997 1996
- --------------------------------------------------------------------------
High Low High Low
-------------------------------------------------
4th Quarter $ 60 5/8 $ 57 1/2 $ 54 3/8 $ 52 3/4
3rd Quarter 58 15/16 56 1/2 53 1/4 51 3/8
2nd Quarter 59 1/4 56 1/2 53 3/8 51 7/8
1st Quarter 58 53 1/4 55 3/8 52 1/2
Draft # 2 (3/3/98)