UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarterly period ended June 30, 2001.
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the transition period from to .
Commission File Number
1-9813
GENENTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2347624
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
1 DNA Way, South San Francisco, California 94080-4990
(Address of principal executive offices and zip code)
(650) 225-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Number of Shares Outstanding
----- ----------------------------
Common Stock $0.02 par value 527,478,953
Outstanding at June 30, 2001
GENENTECH, INC.
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations -
for the three months and six months ended June 30, 2001 and 2000...... 3
Condensed Consolidated Statements of Cash Flows -
for the six months ended June 30, 2001 and 2000....................... 4
Condensed Consolidated Balance Sheets -
June 30, 2001 and December 31, 2000................................... 5
Notes to Condensed Consolidated Financial Statements.................. 6-14
Independent Accountants' Review Report................................ 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Review...................................................... 16-35
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 37
Item 4. Submission of Matters to a Vote of Security Holders.............. 37
Item 6. Exhibits and Reports on Form 8-K................................. 38
Signatures................................................................ 39
In this report, "Genentech," "we," "us" and "our" refer to Genentech, Inc.
"Common Stock" refers to Genentech's common stock, par value $0.02 per share,
"Special Common Stock" refers to Genentech's callable putable common stock, par
value $0.02 per share. All numbers related to the number of shares, price per
share and per share amounts of Common Stock and Special Common Stock give
effect to the two-for-one split of our Common Stock that was effected in
October 2000.
We own or have rights to various copyrights, trademarks and trade names used in
our business including the following: Actimmune, registered trademark,
interferon gamma-1b; Activase, registered trademark, (Alteplase, recombinant)
tissue-plasminogen activator; Herceptin, registered trademark, (Trastuzumab)
anti-HER2 antibody; Nutropin, registered trademark, (somatropin (rDNA origin)
for injection) growth hormone; Nutropin AQ, registered trademark, (somatropin
(rDNA origin) injection) liquid formulation growth hormone; Nutropin Depot,
registered trademark, (somatropin (rDNA origin) for injectable suspension)
encapsulated sustained-release growth hormone; Protropin, registered trademark,
(somatrem for injection) growth hormone; Pulmozyme, registered trademark,
(dornase alfa, recombinant) inhalation solution; TNKase, trademark,
(Tenecteplase) single-bolus thrombolytic agent; Xolair, trademark, (Omalizumab)
anti-IgE antibody; Xanelim, trademark, (Efalizumab) anti-CD11a antibody.
Rituxan, registered trademark, (Rituximab) anti-CD20 antibody is a registered
trademark of IDEC Pharmaceuticals Corporation. This report also includes
trademarks, service marks and trade names of other companies.
Page 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Six Months
Ended June 30, Ended June 30,
------------------- ---------------------
2001 2000 2001 2000
-------- -------- ---------- --------
(Restated) (Restated)
Revenues:
Product sales (including amounts from related parties:
three months - 2001-$16,265; 2000-$17,639;
six months - 2001-$38,302; 2000-$41,766) $410,258 $309,414 $ 802,161 $592,592
Royalties (including amounts from related parties:
three months - 2001-$17,801; 2000-$11,021;
six months - 2001-$41,420; 2000-$21,826) 52,446 49,643 127,077 96,987
Contract and other (including amounts from related parties:
three months - 2001-$487; 2000-$1,989;
six months - 2001-$2,686; 2000-$2,489) 20,935 34,507 59,419 70,361
Interest 32,235 22,262 67,299 43,736
-------- -------- ---------- --------
Total revenues 515,874 415,826 1,055,956 803,676
Costs and expenses:
Cost of sales (including amounts from related parties:
three months - 2001-$13,546; 2000-$15,439;
six months - 2001-$32,052; 2000-$35,329) 76,188 97,657 159,984 203,792
Research and development (including contract related:
three months - 2001-$3,391; 2000-$6,114;
six months - 2001-$6,339; 2000-$10,671) 123,448 115,563 259,788 226,969
Marketing, general and administrative 107,800 86,259 235,719 169,872
Collaboration profit sharing 57,908 30,897 104,281 49,231
Recurring charges related to redemption 81,490 98,072 163,007 196,619
Interest 1,345 1,240 2,836 2,526
-------- -------- ---------- --------
Total costs and expenses 448,179 429,688 925,615 849,009
Income (loss) before taxes and cumulative effect of
accounting change 67,695 (13,862) 130,341 (45,333)
Income tax provision (benefit) 29,047 (997) 59,305 (7,858)
-------- -------- ---------- --------
Income (loss) before cumulative effect of accounting change 38,648 (12,865) 71,036 (37,475)
Cumulative effect of accounting change, net of tax - - (5,638) (57,800)
-------- -------- ---------- --------
Net income (loss) $ 38,648 $(12,865) $ 65,398 $(95,275)
======== ======== ========== ========
Earnings (loss) per share:
Basic: Earnings (loss) before cumulative effect of
accounting change $ 0.07 $ (0.02) $ 0.13 $ (0.07)
Cumulative effect of accounting change, net of tax - - (0.01) (0.11)
-------- -------- ---------- --------
Net earnings (loss) per share $ 0.07 $ (0.02) $ 0.12 $ (0.18)
======== ======== ========== ========
Diluted: Earnings (loss) before cumulative effect of
accounting change $ 0.07 $ (0.02) $ 0.13 $ (0.07)
Cumulative effect of accounting change, net of tax - - (0.01) (0.11)
-------- -------- ---------- --------
Net earnings (loss) per share $ 0.07 $ (0.02) $ 0.12 $ (0.18)
======== ======== ========== ========
Weighted average shares used to compute earnings (loss) per share:
Basic 526,998 521,233 526,396 520,182
======== ======== ========== ========
Diluted 535,142 521,233 535,181 520,182
======== ======== ========== ========
See Notes to Condensed Consolidated Financial Statements.
Page 3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
(unaudited)
Six Months
Ended June 30,
---------------------
2001 2000
--------- ---------
(Restated)
Cash flows from operating activities:
Net income (loss) $ 65,398 $ (95,275)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 212,312 237,832
Deferred income taxes 16,283 (116,454)
Gain on sales of securities available-for-sale (27,494) (55,683)
Loss on sales of securities available-for-sale 1,913 2,554
Write-down of securities available-for-sale 21,209 -
Loss on fixed asset dispositions 1,145 500
Changes in assets and liabilities:
Investments in trading securities (66,988) (13,947)
Receivables and other current assets (17,435) 6,079
Inventories, including inventory write-up effect in 2000 (50,489) 35,056
Accounts payable, other current liabilities and other
long-term liabilities 4,207 (15,070)
--------- ---------
Net cash provided by (used in) operating activities 160,061 (14,408)
Cash flows from investing activities:
Purchases of securities available-for-sale (822,870) (196,990)
Proceeds from sales of securities available-for-sale 576,144 190,986
Purchases of non-marketable equity securities (10,830) (1,660)
Capital expenditures (85,668) (53,571)
Change in other assets (57,736) (20,357)
--------- ---------
Net cash used in investing activities (400,960) (81,592)
Cash flows from financing activities:
Stock issuances 63,083 95,150
--------- ---------
Net cash provided by financing activities 63,083 95,150
--------- ---------
Net decrease in cash and cash equivalents (177,816) (850)
Cash and cash equivalents at beginning of period 551,384 337,682
--------- ---------
Cash and cash equivalents at end of period $ 373,568 $ 336,832
========= =========
See Notes to Condensed Consolidated Financial Statements.
Page 4
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands)
June 30, December 31,
2001 2000(1)
(unaudited)
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 373,568 $ 551,384
Short-term investments 1,019,238 642,475
Accounts receivable, net (including amounts
from related party: 2001-$41,976; 2000-$36,299) 272,680 261,682
Inventories 316,319 265,830
Deferred tax assets 50,903 40,619
Prepaid expenses and other current assets 45,314 26,821
------------ ------------
Total current assets 2,078,022 1,788,811
Long-term marketable securities 1,208,305 1,265,515
Property, plant and equipment (net of accumulated 790,504 752,892
depreciation: 2001-$651,014; 2000-$604,332)
Goodwill (net of accumulated amortization:
2001-$920,137; 2000-$843,494) 1,379,136 1,455,778
Other intangible assets (net of accumulated
amortization: 2001-$1,370,214; 2000-$1,282,090) 1,194,020 1,280,359
Other long-term assets 243,121 168,458
------------ ------------
Total assets $ 6,893,108 $ 6,711,813
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 149,692 $ -
Accounts payable 24,838 34,503
Other accrued liabilities (including amounts from
related party: 2001-$11,730; 2000-$12,265) 386,918 414,178
------------ ------------
Total current liabilities 561,448 448,681
Long-term debt - 149,692
Deferred tax liabilities 372,541 349,848
Other long-term liabilities 139,114 89,389
------------ ------------
Total liabilities 1,073,103 1,037,610
Commitments and contingencies
Stockholders' equity:
Preferred stock - -
Common stock 10,550 10,510
Additional paid-in capital 6,732,568 6,651,428
Accumulated deficit, since June 30, 1999 (1,253,956) (1,319,353)
Accumulated other comprehensive income 330,843 331,618
------------ ------------
Total stockholders' equity 5,820,005 5,674,203
------------ ------------
Total liabilities and stockholders' equity $ 6,893,108 $ 6,711,813
============ ============
(1) Amounts obtained from audited financial statements.
See Notes to Condensed Consolidated Financial Statements.
Page 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Statement of Accounting Presentation and Significant Accounting
Policies
Basis of Presentation
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with accounting
principles generally accepted in the United States for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States for
complete financial statements. In the opinion of management, all adjustments
(consisting only of adjustments of a normal recurring nature) considered
necessary for a fair presentation have been included. Operating results for
the three- and six-month periods ended June 30, 2001 and 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2001. The condensed consolidated balance sheet as of December 31,
2000 has been derived from the audited financial statements as of that date.
For further information, refer to the consolidated financial statements and
notes thereto included in our Annual Report to Stockholders on Form 10-K for
the year ended December 31, 2000.
Collaboration Profit Sharing: Collaboration profit sharing includes the net
operating profit sharing with IDEC Pharmaceuticals Corporation on Rituxan
sales, and the sharing of costs with collaborators related to the
commercialization and development of future products.
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.
Changes in Accounting Principles
Securities and Exchange Commission's Staff Accounting Bulletin No. 101: We
adopted the Securities and Exchange Commission's Staff Accounting Bulletin No.
101, in the fourth quarter of 2000, effective January 1, 2000, and recorded a
$57.8 million charge, net of tax, as a cumulative effect of the change in
accounting principle. The cumulative effect was initially recorded as deferred
revenue that will be recognized as revenue over the remaining term of the
research and development collaboration or distribution agreements, as
appropriate. The results for the three- and six-months ended June 30, 2000
were restated to reflect the effects of the accounting change. For the quarter
ended March 31, 2000, the impact of the change in accounting principle was to
increase net loss by $56.5 million, or $0.11 per share, comprised of the $57.8
million cumulative effect of the change (net of tax impact) as described above
($0.11 per share), net of $1.3 million of the related deferred revenue (net of
tax) that was recognized as revenue during the quarter ended March 31, 2000
($0.0 per share). For the quarter ended June 30, 2000, the impact of the
change in accounting principle was to reduce net loss by $1.3 million (net of
tax) of the related deferred revenue recognized as revenue during the quarter
ended June 30, 2000 ($0.0 per share). For the three- and six-month periods
ended June 30, 2001, we recognized $5.9 (net of tax) and $8.2 million (net of
tax) respectively, of the related deferred revenue.
Page 6
Statement of Financial Accounting Standards No. 133 (FAS 133): In June 1998,
the Financial Accounting Standards Board issued Statement No. 133, "Accounting
for Derivative Instruments and Hedging Activities." FAS 133 requires us to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives are either offset against the change in fair value of
assets, liabilities, or firm commitments through earnings or recognized in
other comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. The adoption of FAS 133 on January 1, 2001
resulted in a $5.6 million charge, net of tax, ($0.01 per share) as a
cumulative effect of an accounting change in the statement of operations and an
increase of $5.0 million, net of tax, in other comprehensive income.
Derivative and Hedging Activities
Accounting Policy for Derivative Instruments: We use derivatives to partially
offset our market exposure to foreign currencies, U.S. interest rates and
marketable equity investments. We record all derivatives on the balance sheet
at fair value. For derivative instruments that are designated and qualify as a
fair value hedge (i.e., hedging the exposure to changes in the fair value of an
asset or a liability or an identified portion thereof that is attributable to a
particular risk), the gain or loss on the derivative instrument as well as the
offsetting loss or gain on the hedged item attributable to the hedged risk is
recognized in current earnings during the period of the change in fair values.
For derivative instruments that are designated and qualify as a cash flow hedge
(i.e., hedging the exposure to variability in expected future cash flows that
is attributable to a particular risk), the effective portion of the gain or
loss on the derivative instrument is reported as a component of other
comprehensive income and reclassified into earnings in the same period or
periods during which the hedged transaction affects earnings. The remaining
gain or loss on the derivative instrument in excess of the cumulative change in
the present value of future cash flows of the hedged item, if any, is
recognized in current earnings during the period of change. For derivative
instruments not designated as hedging instruments, the gain or loss is
recognized in current earnings during the period of change.
Fair Value Hedging Strategy: Our marketable equity securities portfolio
consists primarily of investments in biotechnology companies whose risk of
market fluctuations is greater than the stock market in general. To manage a
portion of this risk, we enter into derivative instruments such as costless
collar instruments and forward contracts to hedge equity securities against
changes in market value. As of March 31, 2001, all collars have matured and
have been settled.
During the quarter ended March 31, 2001, we recognized a net gain of
$10.0 million related to the change in the time value of certain hedging
instruments. In the second quarter of 2001, we had no such gains or losses.
We record gains in contract and other revenues, and losses in marketing,
general and administrative expenses in the statement of operations.
Cash Flow Hedging Strategy: To protect against currency exchange risks on
forecasted foreign currency cash flows from royalties to be received from
licensees' international product sales over the next one to three years and
expenses related to our foreign facility and our collaboration development
expenses denominated in foreign currencies, we have instituted a foreign
currency cash flow hedging program. We hedge portions of our forecasted
Page 7
foreign currency revenues with option contracts and we hedge our foreign
currency expenses from our foreign facility with forward contracts. When the
dollar strengthens significantly against the foreign currencies, the decline in
value of future foreign currency revenues or expenses is offset by gains or
losses, respectively, in the value of the option or forward contracts
designated as hedges. Conversely, when the dollar weakens, the increase in the
value of future foreign currency expenses is offset by gains in the value of
the forward contracts. In accordance with FAS 133, hedges related to
anticipated transactions are designated and documented at hedge inception as
cash flow hedges and evaluated for hedge effectiveness at least quarterly.
We enter into interest-rate swap agreements to limit our exposure to
fluctuations in U.S. interest rates. Our material interest bearing assets, or
interest bearing portfolio, consisted of cash equivalents, restricted cash,
short-term investments, convertible preferred stock investments, convertible
loans and long-term investments as of December 31, 2000 and June 30, 2001. Our
interest-rate swap agreements effectively convert a portion of our short-term
investments in our interest bearing portfolio to a fixed-rate basis for the
next three years, thus reducing the impact of interest-rate changes on future
interest income. Our interest-rate swaps meet the criteria for accounting
under the short-cut method defined in FAS 133 for cash flow hedges. Interest
income from approximately $200.0 million of our interest bearing portfolio was
designated as the hedged item to interest-rate swap agreements at June 30,
2001.
During the quarter ended June 30, 2001 and the first six months of 2001,
the ineffective portion of our hedging instruments was not material. Gains and
losses related to option and forward contracts that hedge future cash flows are
recorded against the hedged revenues or expenses in the statement of
operations. Gains and losses related to early termination of interest rate
swaps are included in interest income in the statement of operations.
At June 30, 2001, we expect to reclassify $3.8 million of net gains on
derivative instruments from accumulated other comprehensive income to earnings
during the next twelve months due to the receipt of net revenues denominated in
foreign currencies.
Derivative Activity in Accumulated Other Comprehensive Income
The following table summarizes activity in other comprehensive income
related to derivatives, net of taxes, held by us during the second quarter and
first six months of 2001 (in thousands):
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
------------------ ----------------
Cumulative effect of adopting FAS 133 $ - $ 5,020
Changes in fair value of derivatives 1,199 4,887
Gains reclassified from other comprehensive income (898) (1,739)
------- -------
Accumulated derivative gains $ 301 $ 8,168
======= =======
Note 2. Redemption of Our Special Common Stock
On June 30, 1999, we redeemed all of our outstanding Special Common Stock held
by stockholders other than Roche Holdings, Inc., commonly known as Roche, with
funds deposited by Roche for that purpose. This event, referred to as the
Page 8
"Redemption," caused Roche to own 100% of our common stock on that date. The
Redemption was reflected as a purchase of a business which under U.S. generally
accepted accounting principles required push-down accounting to reflect in our
financial statements the amount paid for our stock in excess of our net book
value plus Roche's transaction costs at June 30, 1999. In 1990 and 1991
through 1997 Roche purchased 60% and 5%, respectively, of the outstanding stock
of Genentech.
Push-Down Accounting Adjustments
The following is a description of accounting adjustments that reflect push-down
accounting in our financial statements. These adjustments were based on
management's estimates of the value of the tangible and intangible assets
acquired:
- The estimated useful life of an inventory adjustment to fair value resulting
from the Redemption was approximately one year based upon the expected time
to sell inventories on hand at June 30, 1999. Those inventories have been
sold as of December 31, 2000. We recorded expense of $31.4 million in cost
of sales in the second quarter of 2000 and $74.7 million in the first six
months of 2000 related to the inventory adjustment.
- We recorded $1,091.2 million of goodwill less accumulated amortization of
$613.6 million through June 30, 1999, as a result of Roche's 1990 through
1997 purchases. We also recorded $1,208.1 million of goodwill as a result
of the Redemption.
- We recorded $1,040.0 million of other intangible assets less accumulated
amortization of $911.5 million through June 30, 1999, as a result of Roche's
1990 through 1997 purchases. We also recorded $1,370.5 million of other
intangible assets as a result of the Redemption.
- We recorded amortization expense related to goodwill and other intangible
assets of $79.4 million and $95.3 million during the second quarter of 2001
and 2000, respectively, and $158.8 million and $190.5 million in the first
six months of 2001 and 2000, respectively.
- In connection with the Redemption, options under the 1996 Stock Option/Stock
Incentive Plan, or the Plan, were cancelled. Alternative arrangements were
provided for certain holders of some of the unvested options under the Plan.
We recorded compensation expense related to these alternative arrangements
of $2.1 million and $2.8 million in the second quarter of 2001 and 2000,
respectively, and $4.2 million and $6.1 million in the first six months of
2001 and 2000, respectively.
Note 3. Relationship with Roche
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in
connection with our stock option and stock purchase plans, and we may issue
additional shares for other purposes. Our affiliation agreement with Roche
provides, among other things, that we will establish a stock repurchase
program designed to maintain Roche's percentage ownership interest in our
common stock. The affiliation agreement provides that we will repurchase a
sufficient number of shares pursuant to this program such that, with respect
to any issuance of common stock by Genentech in the future, the percentage of
Genentech common stock owned by Roche immediately after such issuance will be
Page 9
no lower than Roche's lowest percentage ownership of Genentech common stock at
any time after the offering of common stock occurring in July 1999 and prior
to the time of such issuance, except that Genentech may issue shares up to an
amount that would cause Roche's lowest percentage ownership to be no more than
2% below the "Minimum Percentage." The Minimum Percentage equals the lowest
number of shares of Genentech common stock owned by Roche since the July 1999
offering (to be adjusted in the future for dispositions of shares of Genentech
common stock by Roche as well as for stock splits or stock combinations)
divided by 509,194,352 (to be adjusted in the future for stock splits or stock
combinations), which is the number of shares of Genentech common stock
outstanding at the time of the July 1999 offering, as adjusted for the two-
for-one splits of Genentech common stock in October 2000 and November 1999.
As long as Roche's percentage ownership is greater than 50%, prior to issuing
any shares, the affiliation agreement provides that we will repurchase a
sufficient number of shares of our common stock such that, immediately after
our issuance of shares, Roche's percentage ownership will be greater than 50%.
The affiliation agreement also provides that, upon Roche's request, we will
repurchase shares of our common stock to increase Roche's ownership to the
Minimum Percentage. In addition, Roche will have a continuing option to buy
stock from us at prevailing market prices to maintain its percentage ownership
interest. On June 30, 2001, Roche's percentage ownership of our common stock
was 58.12%, which was 2.09% below the Minimum Percentage. Genentech and Roche
are in discussion concerning the matter.
Note 4. Comprehensive Income
Comprehensive income is comprised of net income (loss) and other comprehensive
income. Other comprehensive income includes certain changes in stockholders'
equity that are excluded from net income. Other comprehensive income includes
changes in fair value of derivatives designated as and effective as cash flow
hedges and unrealized gains and losses on our available-for-sale securities.
Comprehensive income (loss) and its components for the three- and six-month
periods ended June 30, 2001 and June 30, 2000 are as follows (in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
2001 2000 2001 2000
------- -------- ------- --------
(Restated) (Restated)
Net income (loss) $38,648 $(12,865) $65,398 $(95,275)
Changes in unrealized (loss) gain on securities
available-for-sale, net of tax 59,390 27,055 (8,943) 63,811
Changes in fair value of derivative instruments,
net of tax 301 - 8,168 -
------- -------- ------- --------
Comprehensive income (loss) $98,339 $ 14,190 $64,623 $(31,464)
======= ======== ======= ========
The components of accumulated other comprehensive income, net of related
taxes, are as follows (in thousands):
June 30, 2001 December 31,2000
------------- ----------------
Unrealized gains on securities available-for-sale $322,675 $331,618
Unrealized gains on derivatives instruments 8,168 -
-------- --------
Accumulated other comprehensive income $330,843 $331,618
======== ========
Page 10
Note 5. Earnings (Loss) Per Share
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings (loss) per share (EPS) computations for the three-
and six-month periods ended June 30, 2001 and June 30, 2000 (in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
------------------- -------- --------
2001 2000 2001 2000
-------- -------- -------- --------
(Restated) (Restated)
Numerator:
Net income (loss) - numerator
for basic and diluted earnings
(loss) per share: $ 38,648 $(12,865) $ 65,398 $(95,275)
======== ======== ======== ========
Denominator:
Denominator for basic earnings
(loss) per share - weighted-
average shares 526,998 521,233 526,396 520,182
Effect of dilutive securities:
Stock options 8,144 - 8,785 -
-------- -------- -------- --------
Denominator for diluted earnings
(loss) per share - adjusted
weighted-average shares and
assumed conversions 535,142 521,233 535,181 520,182
======== ======== ======== ========
Options to purchase 9,919,165 shares of common stock between $52.00 and $95.66
per share were outstanding in the second quarter of 2001, and options to
purchase 9,759,965 shares of common stock between $54.00 and $95.66 per share
were outstanding in the first six months of 2001, but were not included in the
computation of diluted EPS because the options were anti-dilutive.
Note 6. Legal Proceedings
We are a party to various legal proceedings, including patent infringement
litigation relating to our antibody products, one of our thrombolytic products,
as well as licensing and contract disputes, and other matters.
On May 28, 1999, GlaxoSmithKline plc (formerly Glaxo Wellcome, Inc.), or Glaxo,
filed a patent infringement lawsuit against us in the U.S. District Court in
Delaware. The suit asserts that we infringe four U.S. patents owned by Glaxo.
Two of the patents relate to the use of specific kinds of antibodies for the
treatment of human disease, including cancer. The other two patents asserted
against us relate to preparations of specific kinds of antibodies which are
made more stable and the methods by which such preparations are made. Although
the complaint failed to specify which of our products or methods of manufacture
are allegedly infringing the four patents at issue, we believe that the suit
relates to the manufacture, use and sale of our Herceptin and Rituxan antibody
products. On July 19, 1999, we filed our answer to Glaxo's complaint, and in
our answer we also stated counterclaims against Glaxo. The trial of this suit
began on April 17, 2001. On May 4, 2001 the jury hearing the lawsuit
Page 11
unanimously found that Herceptin and Rituxan do not infringe the patents and
therefore that Genentech is not required to pay royalties to Glaxo. The jury
also unanimously found that all of the patent claims that Glaxo asserted
against Genentech were invalid. On May 31, 2001, Glaxo filed a notice of
appeal of the jury's verdict with the U.S. Court of Appeals for the Federal
Circuit.
On September 14, 2000, Glaxo filed another patent infringement lawsuit against
us in the U.S. District Court in Delaware, alleging that we are infringing U.S.
Patent No. 5,633,162 owned by Glaxo. The patent relates to specific methods
for culturing Chinese Hamster Ovary cells. The complaint fails to specify
which of our products or methods of manufacture are allegedly infringing that
patent. However, the complaint makes a general reference to Genentech's
making, using, and selling "monoclonal antibodies," and so we believe that the
suit relates to our Herceptin and Rituxan antibody products. On October 4,
2000, we filed our answer to Glaxo's complaint, and in our answer we also
stated counterclaims against Glaxo. The trial of this suit has been
rescheduled to begin on June 17, 2002. This lawsuit is separate from and in
addition to the Glaxo suit mentioned above.
We and the City of Hope Medical Center are parties to a 1976 agreement relating
to work conducted by two City of Hope employees, Arthur Riggs and Keiichi
Itakura, and patents that resulted from that work, which are referred to as the
"Riggs/Itakura Patents." Since that time, Genentech has entered into license
agreements with various companies to make, use and sell the products covered by
the Riggs/Itakura Patents. On August 13, 1999 the City of Hope filed a
complaint against us in the Superior Court in Los Angeles County, California,
alleging that we owe royalties to the City of Hope in connection with these
license agreements, as well as product license agreements that involve the
grant of licenses under the Riggs/Itakura Patents. The complaint states claims
for declaratory relief, breach of contract, breach of implied covenant of good
faith and fair dealing, and breach of fiduciary duty. On December 15, 1999, we
filed our answer to the City of Hope's complaint. On or about December 22,
2000, City of Hope filed a dismissal of its declaratory relief claims. The
trial of this suit has been rescheduled to begin on August 22, 2001.
On June 7, 2000, Chiron Corporation filed a patent infringement suit against us
in the U.S. District Court in the Eastern District of California (Sacramento),
alleging that the manufacture, use, sale and offer for sale of our Herceptin
antibody product infringes Chiron's U.S. Patent No. 6,054,561. This patent
relates to certain antibodies that bind to breast cancer cells and/or other
cells. On August 4, 2000, we filed our answer to Chiron's complaint, and in
our answer we also stated counterclaims against Chiron. The judge has
scheduled the trial of this suit to begin on June 25, 2002.
On March 13, 2001, Chiron filed another patent infringement lawsuit against us
in the U.S. District Court in the Eastern District of California, alleging that
the manufacture, use, sale, and/or offer for sale of our Herceptin antibody
product infringes Chiron's U.S. Patent No. 4,753,894. Genentech filed a motion
to dismiss this second lawsuit, which was denied. The judge has scheduled the
trial of this suit to begin in March 2003. This lawsuit is separate from and
in addition to the Chiron suit mentioned above.
We and Pharmacia AB (formerly Pharmacia & Upjohn AB) are parties to a 1978
agreement relating to Genentech's development of recombinant human growth
hormone products, under which Pharmacia is obligated to pay Genentech royalties
on sales of Pharmacia's growth hormone products throughout the world. On
January 5, 1999, Pharmacia filed a Request for Arbitration with the
Page 12
International Chamber of Commerce ("ICC") to resolve several disputed issues
between Genentech and Pharmacia under the 1978 agreement. One of the claims
made by Pharmacia is for a refund of some of the royalties previously paid to
Genentech for sales of Pharmacia's growth hormone products in certain
countries. The ICC has not yet given a decision on that claim.
On March 13, 2001, Genentech filed a complaint in the United States District
Court in Delaware against Genzyme Corporation seeking a declaratory judgment
that Genentech does not infringe Genzyme's U.S. Patent No. 5,344,773 and that
Genentech has not breached a 1992 Patent License and Interference Settlement
Agreement between Genentech and Genzyme relating to that patent. Genentech's
filing followed communications earlier in 2001 from Genzyme claiming that
Genentech's TNKase product infringes Genzyme's patent. Genentech is seeking a
declaration that Genzyme's patent is not infringed by any Genentech product,
that the patent is invalid, that Genzyme be enjoined from further legal action
against Genentech regarding the patent, and that Genentech has not breached the
1992 Agreement. On May 2, 2001, Genzyme filed its answer to our complaint.
On or about April 6, 2001, Genzyme filed a complaint in the same court against
Genentech alleging that our TNKase product infringes the Genzyme patent and
that Genentech is in breach of the 1992 Agreement referred to above. Genzyme's
complaint also alleges willful infringement and reckless breach of contract by
Genentech. Genzyme filed an amended complaint on or about April 11, 2001, that
added no new substantive allegations or new claims. Genzyme is seeking to
enjoin Genentech from infringing the patent, and also is seeking attorneys fees
and costs. On May 3, 2001, we filed our answer to Genzyme's complaint. The
court has consolidated this lawsuit and the declaratory judgement lawsuit suit
referred to above for further proceedings. No trial date has yet been
scheduled for the consolidated lawsuit.
Based upon the nature of the claims made and the information available to date
to us and our counsel through investigations and otherwise, we believe the
outcome of these actions is not likely to have a material adverse effect on our
financial position, result of operations or cash flows. However, were an
unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the operating results of that period.
Note 7. Inventories
In anticipation of the launch of Xolair, we have built approximately $35.0
million of Xolair inventory, net of amounts paid by collaborators and inventory
reserves. Due to the launch delay of Xolair, we will continually assess the
recoverability of our Xolair inventory based on an expected U.S. Food and Drug
Administration, or FDA, approval date and sales.
Inventories are summarized below (in thousands):
June 30, 2001 December 31, 2000
------------- -----------------
Raw materials and supplies $ 25,478 $ 17,621
Work in process 269,705 233,121
Finished goods 21,136 15,088
------------- -----------------
Total $316,319 $265,830
============= =================
Page 13
Note 8. New Accounting Pronouncement
On June 29, 2001, the Financial Accounting Standards Board, or FASB, approved
the final standards resulting from its deliberations on the business
combinations project. The FASB is expected to issue two statements in late
July 2001, Statement of Financial Accounting Standards No. 141, or FAS 141, on
Business Combinations and FAS 142 on Goodwill and Other Intangible Assets. FAS
141 will be effective for any business combinations initiated after June 30,
2001 and also includes the criteria for the recognition of intangible assets
separately from goodwill. FAS 142 will be effective for fiscal years beginning
after December 15, 2001 and will require that goodwill not be amortized, but
rather be subject to an impairment test at least annually. Separately
identified and recognized intangible assets resulting from business
combinations completed before July 1, 2001 that do not meet the new criteria
for separate recognition of intangible assets will be subsumed into goodwill
upon adoption. In addition, the useful lives of recognized intangible assets
acquired in transactions completed before July 1, 2001 will be reassessed and
the remaining amortization periods adjusted accordingly.
The adoption of FAS 141 and 142 is not expected to have a significant
impact on our financial position at transition. We expect that the elimination
of goodwill amortization related to push-down accounting would have a positive
impact on reported net income in 2002 of approximately $153.0 million.
Page 14
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors and Stockholders
Genentech, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Genentech, Inc. as of June 30, 2001, and the related condensed consolidated
statements of operations for the three-month and six-month periods ended June
30, 2001 and 2000 and the condensed consolidated statements of cash flows for
the six-month periods ended June 30, 2001 and 2000. These financial statements
are the responsibility of Genentech's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we
do not express such opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
referred to above for them to be in conformity with accounting principles
generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Genentech,
Inc. as of December 31, 2000, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year then ended (not
presented herein) and in our report dated January 17, 2001, we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 2000, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
ERNST & YOUNG LLP
Palo Alto, California
July 9, 2001
Page 15
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENENTECH, INC.
FINANCIAL REVIEW
Overview
Genentech, Inc. is a leading biotechnology company using human genetic
information to discover, develop, manufacture and market human pharmaceuticals
that address significant unmet medical needs. Fourteen of the approved
products of biotechnology stem from or are based on our science. We
manufacture and market nine protein-based pharmaceuticals listed below, and
license several additional products to other companies.
- Herceptin (trastuzumab) antibody for the treatment of certain patients with
metastatic breast cancer whose tumors overexpress the human epidermal growth
factor receptor2, or HER2, protein;
- Rituxan (rituximab) antibody which we market together with IDEC
Pharmaceuticals Corporation, commonly known as IDEC, for the treatment of
patients with relapsed or refractory low-grade or follicular, CD20-positive,
B-cell non-Hodgkin's lymphoma;
- TNKase (tenecteplase) single-bolus thrombolytic agent for the treatment of
acute myocardial infarction;
- Activase (alteplase, recombinant) tissue plasminogen activator, or t-PA, for
the treatment of acute myocardial infarction, acute ischemic stroke within
three hours of the onset of symptoms and acute massive pulmonary embolism;
- Nutropin Depot [somatropin (rDNA origin) for injectable suspension] long-
acting growth hormone for the treatment of growth failure associated with
pediatric growth hormone deficiency;
- Nutropin AQ [somatropin (rDNA origin) injection] liquid formulation growth
hormone for the same indications as Nutropin;
- Nutropin [somatropin (rDNA origin) for injection] growth hormone for the
treatment of growth hormone deficiency in children and adults, growth
failure associated with chronic renal insufficiency prior to kidney
transplantation and short stature associated with Turner syndrome;
- Protropin (somatrem for injection) growth hormone for the treatment of
inadequate endogenous growth hormone secretion, or growth hormone
deficiency, in children; and
- Pulmozyme (dornase alfa, recombinant) inhalation solution for the treatment
of cystic fibrosis.
We receive royalties on sales of rituximab outside of the United States
(excluding Japan), on sales of Pulmozyme and Herceptin outside of the United
States and on sales of certain products in Canada from F. Hoffmann-La Roche
Ltd, an affiliate of Roche Holdings, Inc., that is commonly known as Hoffmann-
La Roche. We receive royalties on sales of growth hormone products and t-PA
outside of the United States and Canada, and on sales of tenecteplase outside
of the United States (excluding Japan and Canada). We will receive royalties
Page 16
on sales of rituximab in Japan through other licensees. We also receive
worldwide royalties on seven additional licensed products that are marketed by
other companies. Six of these products originated from our technology.
Redemption of Our Special Common Stock
On June 30, 1999, we redeemed all of our outstanding Special Common Stock held
by stockholders other than Roche Holdings, Inc., commonly known as Roche. This
event, referred to as the "Redemption," caused Roche to own 100% of our common
stock on that date. Consequently, under U.S. generally accepted accounting
principles, we were required to use push-down accounting to reflect in our
financial statements the amounts paid for our stock in excess of our net book
value. Push-down accounting required us to record $1,685.7 million of goodwill
and $1,499.0 million of other intangible assets onto our balance sheet on June
30, 1999. For more information about push-down accounting, you should read the
"Redemption of Our Special Common Stock" note in the Notes to Condensed
Consolidated Financial Statements.
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in
connection with our stock option and stock purchase plans, and we may issue
additional shares for other purposes. Our affiliation agreement with Roche
provides, among other things, that we will establish a stock repurchase
program designed to maintain Roche's percentage ownership interest in our
common stock. The affiliation agreement provides that we will repurchase a
sufficient number of shares pursuant to this program such that, with respect
to any issuance of common stock by Genentech in the future, the percentage of
Genentech common stock owned by Roche immediately after such issuance will be
no lower than Roche's lowest percentage ownership of Genentech common stock at
any time after the offering of common stock occurring in July 1999 and prior
to the time of such issuance, except that Genentech may issue shares up to an
amount that would cause Roche's lowest percentage ownership to be no more than
2% below the "Minimum Percentage." The Minimum Percentage equals the lowest
number of shares of Genentech common stock owned by Roche since the July 1999
offering (to be adjusted in the future for dispositions of shares of Genentech
common stock by Roche as well as for stock splits or stock combinations)
divided by 509,194,352 (to be adjusted in the future for stock splits or stock
combinations), which is the number of shares of Genentech common stock
outstanding at the time of the July 1999 offering, as adjusted for the two-
for-one splits of Genentech common stock in November 1999 and October 2000.
As long as Roche's percentage ownership is greater than 50%, prior to issuing
any shares, the affiliation agreement provides that we will repurchase a
sufficient number of shares of our common stock such that, immediately after
our issuance of shares, Roche's percentage ownership will be greater than 50%.
The affiliation agreement also provides that, upon Roche's request, we will
repurchase shares of our common stock to increase Roche's ownership to the
Minimum Percentage. In addition, Roche will have a continuing option to buy
stock from us at prevailing market prices to maintain its percentage ownership
interest. On June 30, 2001, Roche's percentage ownership of our common stock
was 58.12%, which was 2.09% below the Minimum Percentage. Genentech and Roche
are in discussion concerning the matter.
Page 17
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Three Months Six Months
Ended June 30, Ended June 30,
--------------- -----------------
REVENUES 2001 2000 % Change 2001 2000 % Change
------------------- ------ ------ -------- -------- ------ --------
(Restated) (Restated)
Revenues $515.9 $415.8 24% $1,055.9 $803.7 31%
====== ====== ======== ======== ====== ========
Revenues increased 24% in the second quarter and 31% in the first six months of
2001 from the comparable periods in 2000 primarily as a result of higher
product sales, royalty income and interest income. These increases were
partially offset by lower contract and other revenues. These revenue changes
are further discussed below.
Three Months Six Months
Ended June 30, Ended June 30,
--------------- ---------------
PRODUCT SALES 2001 2000 % Change 2001 2000 % Change
------------------- ------ ------ -------- ------ ------ --------
Herceptin $ 78.8 $ 66.7 18% $160.1 $135.4 18%
Rituxan 187.7 102.8 83 359.8 187.9 91
Activase/TNKase 51.6 56.8 (9) 103.7 104.3 (1)
Growth Hormone 62.5 49.9 25 118.0 105.0 12
Pulmozyme 28.1 32.3 (13) 58.0 59.1 (2)
Actimmune 1.6 0.9 78 2.5 0.9 178
------ ------ -------- ------ ------ --------
Total product sales $410.3 $309.4 33% $802.1 $592.6 35%
====== ====== ======== ====== ====== ========
Total product sales increased 33% in the second quarter and 35% in the first
six months of 2001 from the comparable periods in 2000 primarily as a result of
higher sales from our bio-oncology products, Rituxan and Herceptin, and higher
sales from our Growth Hormone products.
Herceptin: Net sales of Herceptin increased 18% in the second quarter and in
the first six months of 2001 from the comparable periods in 2000. An increase
in penetration into the metastatic breast cancer market has contributed to a
positive sales trend.
Rituxan: Net sales of Rituxan increased 83% in the second quarter and 91% in
the first six months of 2001 from the comparable periods in 2000. This
increase was primarily due to increased use of the product in the treatment of
B-cell non-Hodgkin's lymphoma.
Activase/TNKase: Combined net sales of our two cardiovascular products,
Activase and TNKase, decreased 9% in the second quarter of 2001 and were
slightly lower in the first six months of 2001 compared to the same periods
last year. These decreases reflect the continued decline in the overall size
of the thrombolytic therapy market due to increasing use of mechanical
reperfusion and competition from Centocor, Inc.'s Retavase, registered
trademark (reteplase). TNKase received U.S. Food and Drug Administration, or
FDA, approval in early June 2000 and was launched in mid-June 2000.
Growth Hormone: Net sales of our four growth hormone products, Nutropin Depot,
Nutropin AQ, Nutropin and Protropin, increased 25% in the second quarter and
12% in the first six months of 2001 from the comparable periods in 2000. This
net sales growth primarily reflects an increase in market penetration and the
effects of a price increase for these products.
Page 18
Pulmozyme: Net sales of Pulmozyme decreased 13% in the second quarter of 2001
compared to last year and were slightly lower in the first six months of 2001
compared to the same periods last year. These decreases were primarily due to
lower sales of the product to Hoffmann-La Roche.
Three Months Six Months
Ended June 30, Ended June 30,
ROYALTIES, CONTRACT AND --------------- ---------------
OTHER, AND INTEREST INCOME 2001 2000 % Change 2001 2000 % Change
-------------------------- ------ ------ -------- ------ ------ --------
(Restated) (Restated)
Royalties $ 52.5 $ 49.6 6% $127.1 $ 97.0 31%
Contract and other 20.9 34.5 (39) 59.4 70.4 (16)
Interest income 32.2 22.3 44 67.3 43.7 54
Royalties: Royalty income increased 6% in the second quarter and 31% in the
first six months of 2001 from the comparable periods in 2000. These increases
were primarily due to higher third-party sales from various licensees offset in
part by lower sales from two licensees that are addressing manufacturing issues
which has temporarily impacted their ability to produce product for sales.
Contract and Other Revenues: Contract and other revenues in the second quarter
and first six months of 2001 decreased 39% and 16%, respectively, from the
comparable periods in 2000. The decrease in the second quarter was primarily
due to lower gains from the sale of biotechnology equity securities partially
offset by higher contract revenues. The decrease in the first six months of
2001 was attributable to lower gains from the sale of biotechnology equity
securities partially offset by higher contract revenues and the recognition of
$10.0 million in gains related to the change in the time value of certain
hedging instruments in the first quarter of 2001. (See Note 1, "Statement of
Accounting Presentation and Significant Accounting Policies," of the Notes to
Condensed Consolidated Financial Statements for more information on our
derivative and hedging activities.) The increase in contract revenues in the
second quarter and first six months of 2001 was primarily due to the
recognition of revenues from third-party collaborators that were previously
deferred under the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101. (See the "Changes in Accounting Principles" section of Note
1, "Statement of Accounting Presentation and Significant Accounting Policies,"
of the Notes to Condensed Consolidated Financial Statements.)
Interest Income: Interest income in the second quarter and in the first six
months of 2001 increased 44% and 54%, respectively, from the comparable periods
in 2000. The increase in the second quarter of 2001 was due to higher cash
balances. The increase in the first six months of 2001 was primarily due to
higher cash balances and slightly higher portfolio yields.
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
COSTS AND EXPENSES 2001 2000 % Change 2001 2000 % Change
--------------------------------------- ------ ------ -------- ------ ------ --------
Cost of sales $ 76.2 $ 97.6 (22)% $160.0 $203.8 (21)%
Research and development 123.5 115.6 7 259.8 227.0 14
Marketing, general and administrative 107.8 86.3 25 235.7 169.9 39
Collaboration profit sharing 57.9 30.9 87 104.3 49.2 112
Recurring charges related to redemption 81.5 98.1 (17) 163.0 196.6 (17)
Interest expense 1.3 1.2 8 2.8 2.5 12
------ ------ -------- ------ ------ --------
Total costs and expenses $448.2 $429.7 4% $925.6 $849.0 9%
====== ====== ======== ====== ====== ========
Page 19
Cost of Sales: Cost of sales in the second quarter of 2001 decreased to $76.2
million compared to $97.6 million in the second quarter of 2000 and $160.0
million in the first six months of 2001 compared to $203.8 million in the first
six months of 2000. Cost of sales as a percent of product sales decreased to
19% in the second quarter of 2001 from 32% in the prior year. Cost of sales as
a percent of product sales decreased to 20% in the first six months of 2001
from 34% in the prior year. The decrease in the ratios primarily reflects a
decline in the costs recognized on the sale of inventory that was written up at
the Redemption due to push-down accounting. This inventory had been sold at
December 31, 2000.
Research and Development: Research and development, or R&D, expenses increased
7% in the second quarter and 14% in the first six months of 2001 from the
comparable periods in 2000. The increase in the second quarter of 2001 was
largely due to higher expenses related to late-stage clinical trials and higher
development production partially offset by lower in-licensing expense. The
increase in the first six months of 2001 was primarily due to higher expenses
related to late-stage clinical trials, higher development production, costs
related to the termination of a collaboration agreement partially offset by
lower in-licensing expense and reimbursements from collaborators for clinical
materials. R&D expenses included $15.0 million in both the first six months of
2001 and 2000 of upfront payments for the purchase of in-process research and
development, or IPR&D, under in-licensing agreements with collaborators. We
determined that the acquired IPR&D was not yet technologically feasible and
that it had no future alternative uses.
Marketing, General and Administrative: Overall marketing, general and
administrative, or MG&A, expenses increased 25% in the second quarter and 39%
in the first six months of 2001 from the comparable periods in 2000. The
increase in the second quarter and first six months of 2001 was due to higher
marketing and selling expenses primarily in support of the continued growth of
our bio-oncology products and commercial development of pipeline products, the
write-down of certain biotechnology investments due to unfavorable market
conditions, increased royalty expenses associated with higher sales by us as a
licensee and higher legal and other corporate expenses.
Collaboration Profit Sharing: Collaboration profit sharing includes the net
operating profit sharing with IDEC on Rituxan sales, and the sharing of costs
with collaborators related to the commercialization and development of future
products. Collaboration profit sharing expenses increased to $57.9 million in
the second quarter of 2001 from $30.9 million in the second quarter of 2000.
Collaboration profit sharing expenses increased to $104.3 million in the first
six months of 2001 from $49.2 million in the first six months of 2000. These
increases were primarily due to increased Rituxan profit sharing due to higher
Rituxan sales.
Recurring Charges Related to Redemption: We began recording recurring charges
related to the Redemption and push-down accounting in the third quarter of
1999. These charges were approximately $81.5 million in the quarter ended June
30, 2001, and were comprised of $79.4 million for the amortization of
intangibles and goodwill and $2.1 million of compensation expense. These
charges were approximately $163.0 million in the first six months of 2001 and
were comprised of $158.8 million for the amortization of intangibles and
goodwill and $4.2 million of compensation expense. The compensation expense
was related to alternative arrangements provided at the time of the Redemption
for certain holders of some of the unvested options under the 1996 Stock
Option/Stock Incentive Plan.
Page 20
Interest Expense: Interest expense will fluctuate depending on the amount of
capitalized interest related to the amount of construction projects. Interest
expense, net of amounts capitalized, relates to interest on our 5% convertible
subordinated debentures.
INCOME (LOSS) BEFORE TAXES AND Three Months Six Months
CUMULATIVE EFFECT OF ACCOUNTING Ended June 30, Ended June 30,
CHANGE, INCOME TAXES AND CUMULATIVE --------------- ---------------
EFFECT OF ACCOUNTING CHANGE 2001 2000 % Change 2001 2000 % Change
--------------------------------------- ------ ------ -------- ------ ------ --------
(Restated) (Restated)
Income (loss) before taxes and
cumulative effect of accounting
change $ 67.7 $(13.9) 587% $130.3 $(45.3) 388%
Income tax provision (benefit) 29.1 (1.0) 3,010 59.3 (7.8) 860
Income (loss) before cumulative
effect of accounting change 38.6 (12.9) 399 71.0 (37.5) 289
Cumulative effect of accounting change,
net of tax - - - (5.6) (57.8) 90
Changes in Accounting Principles: We adopted the Statement of Financial
Accounting Standards No. 133, or FAS 133, "Accounting for Derivatives and
Hedging Activities," on January 1, 2001. Upon adoption, we recorded a $5.6
million charge, net of tax, as a cumulative effect of a change in accounting
principle and an increase of $5.0 million, net of tax, in other comprehensive
income related to recording derivative instruments at fair value. See Note 1,
"Statement of Accounting Presentation and Significant Accounting Policies" in
the Notes to Condensed Consolidated Financial Statements for further
information on our adoption of FAS 133.
We adopted the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101, or SAB 101, on revenue recognition effective January 1, 2000
and recorded a $57.8 million charge, net of tax, as a cumulative effect of a
change in accounting principle related to contract revenues recognized in prior
periods. The related deferred revenue is being recognized over the term of the
agreements. For the quarter ended March 31, 2000, the impact of the change in
accounting principle was to increase net loss by $56.5 million, or $0.11 per
share, comprised of the $57.8 million cumulative effect of the change (net of
tax impact) as described above ($0.11 per share), net of $1.3 million of the
related deferred revenue (net of tax) that was recognized as revenue during the
quarter ended March 31, 2000 ($0.0 per share). For the quarter ended June 30,
2000, the impact of the change in accounting principle was to reduce net loss
by $1.3 million (net of tax) of the related deferred revenue recognized as
revenue during the quarter ended June 30, 2000 ($0.0 per share). For the
three- and six-month periods ended June 30, 2001, we recognized $5.9 (net of
tax) and $8.2 million (net of tax) respectively, of the related deferred
revenue. See Note 1, "Statement of Accounting Presentation and Significant
Accounting Policies," in the Notes to Condensed Consolidated Financial
Statements for further information on our adoption of SAB 101.
Income Tax: The tax provision of $29.1 million for the second quarter of 2001
increased over the tax benefit of $1.0 million for the second quarter of 2000
and the tax provision of $59.3 million for the first six months of 2001
increased over the tax benefit of $7.8 million for the first six months of 2000
primarily due to increased pretax income and decreased charges related to the
Redemption.
Our effective tax rates were approximately 43% for the second quarter and
46% for the first six months of 2001 and 7% for the second quarter and 17% for
the first six months of 2000, which reflect the non-deductibility of goodwill
amortization.
Page 21
The effective tax rate of 32% in the second quarter and first six months
of 2001 on pretax income, excluding charges related to the Redemption and
cumulative effect of accounting change, is higher than the comparative tax rate
of 31% in the second quarter and first six months of 2000 primarily due to
decreased R&D tax credits.
Three Months Six Months
Ended June 30, Ended June 30,
--------------- ---------------
NET INCOME (LOSS) 2001 2000 % Change 2001 2000 % Change
-------------------------------------------- ------ ------ -------- ------ ------ --------
(Restated) (Restated)
Net income (loss) $ 38.6 $(12.9) 399% $ 65.4 $(95.3) 169%
Earnings (loss) per share:
Basic: Earnings (loss) before cumulative
effect of accounting change $ 0.07 $(0.02) 450% $ 0.13 $(0.07) 286%
Cumulative effect of accounting
change, net of tax - - - (0.01) (0.11) 91
------ ------ -------- ------ ------ --------
Net earnings (loss) per share $ 0.07 $(0.02) 450% $ 0.12 $(0.18) 167%
====== ====== ======== ====== ====== ========
Diluted: Earnings (loss) before cumulative
effect of accounting change $ 0.07 $(0.02) 450% $ 0.13 $(0.07) 286%
Cumulative effect of accounting
change, net of tax - - - (0.01) (0.11) 91
------ ------ -------- ------ ------ --------
Net earnings (loss) per share $ 0.07 $(0.02) 450% $ 0.12 $(0.18) 167%
====== ====== ======== ====== ====== ========
Net Income (Loss): Net income of $38.6 million, or $0.07 per share in the
second quarter of 2001 and net income of $65.4 million, or $0.12 per share in
the first six months of 2001, primarily reflect an increase in product sales,
royalties and interest income and a decrease in cost of sales and recurring
charges related to redemption. These favorable variances were offset in part
by increased MG&A, collaboration profit sharing and R&D expenses and a decrease
in contract and other revenues.
In-Process Research and Development: At June 30, 1999, the Redemption date, we
determined that the acquired in-process technology was not technologically
feasible and that the in-process technology had no future alternative uses. As
a result, $500.5 million of in-process research and development, or IPR&D,
related to Roche's 1990 through 1997 purchases of our common stock was charged
to retained earnings, and $752.5 million of IPR&D related to the Redemption was
charged to operations at June 30, 1999.
Except as otherwise noted below, there have been no significant changes to
the projects since December 31, 2000. We do not track all costs associated
with research and development on a project-by-project basis. Therefore, we
believe a calculation of cost incurred as a percentage of total incurred
project cost as of the FDA approval is not possible. We estimate, however,
that the research and development expenditures that will be required to
complete the in-process projects will total at least $600.0 million, as
compared to $700.0 million as of the Redemption date. This estimate reflects
costs incurred since the Redemption date, discontinued projects, and decreases
in cost to complete estimates for other projects, partially offset by an
increase in certain cost estimates related to early stage projects and changes
in expected completion dates.
The following are significant changes that occurred during the first six
months of 2001 to the projects included in the IPR&D charge at the Redemption:
Page 22
- Dornase alfa AERx - project has been discontinued.
- Herceptin antibody for non-small cell lung cancer (NSCLC) - project has been
discontinued in this indication.
LIQUIDITY AND CAPITAL RESOURCES June 30, 2001 December 31, 2000
--------------------------------- ------------- -----------------
Cash and cash equivalents,
short-term investments and
long-term marketable securities $ 2,601.1 $ 2,459.4
Working capital 1,516.6 1,340.1
We used cash generated from operations, income from investments and proceeds
from stock issuances to fund operations, purchase marketable securities and
make capital and equity investments.
Cash and cash equivalents, short-term investments and long-term marketable
securities at June 30, 2001 increased from December 31, 2000 by $141.7
million. Working capital increased by $176.5 million in the second quarter of
2001 from December 31, 2000.
Capital expenditures totaled $85.7 million in the first six months of 2001
compared to $53.6 million in the comparable period of 2000. The increase in
2001 compared to 2000 was primarily due to an increase in machinery and
equipment and leasehold improvements.
We believe that our cash, cash equivalents and short-term investments, together
with funds provided by operations and leasing arrangements, will be sufficient
to meet our foreseeable operating cash requirements. In addition, we believe
we could access additional funds from the debt and, under certain
circumstances, capital markets. See also "Forward-Looking Information and
Cautionary Factors that May Affect Future Results - Affiliation Agreement with
Roche Could Adversely Affect Our Cash Position" below for factors that could
negatively affect our cash position.
FORWARD-LOOKING INFORMATION AND CAUTIONARY FACTORS THAT MAY AFFECT FUTURE
RESULTS
The following section contains forward-looking information based on our current
expectations. Because our actual results may differ materially from any
forward-looking statements made by or on behalf of Genentech, this section
includes a discussion of important factors that could affect our actual future
results, including, but not limited to, our product sales, royalties, contract
revenues, expenses and net income.
Fluctuations in Our Operating Results Could Affect the Price of Our Common
Stock
Our operating results may vary from period to period for several reasons
including:
- The overall competitive environment for our products.
For example, sales of our Activase product decreased in the first six months
of 2001, and in 2000, 1999 and 1998 primarily due to competition from
Centocor's Retavase and more recently to a decreasing size of the
thrombolytic marketplace as other forms of acute myocardial infarction
treatment gain acceptance.
- The amount and timing of sales to customers in the United States.
Page 23
For example, sales of our Growth Hormone products increased in 2000 and 1999
due to fluctuations in distributor ordering patterns.
- The amount and timing of our sales to Hoffmann-La Roche of products for sale
outside of the United States and the amount and timing of its sales to its
customers, which directly impact both our product sales and royalty
revenues.
For example, sales of Pulmozyme to Hoffmann-La Roche decreased in the second
quarter of 2001 compared to last year and were slightly lower in the first
six months of 2001 compared to the same period last year.
For example, in the third quarter of 2000, Hoffmann-La Roche's approval of
Herceptin in Europe increased our sales of Herceptin product.
- The timing and volume of bulk shipments to licensees.
- The availability of third-party reimbursements for the cost of therapy.
- The effectiveness and safety of our various products as determined both in
clinical testing and by the accumulation of additional information on each
product after it is approved by the FDA for sale.
- The rate of adoption and use of our products for approved indications and
additional indications.
For example, sales of Rituxan increased in the last quarter of 2000 and the
first six months of 2001 due to the announcement at the American Society of
Clinical Oncology of the results of a study conducted by the Groupe d'Etude
des Lymphomes de l'Adulte, or GELA, reporting on the benefits of using
Rituxan, combined with standard chemotherapy, for treating aggressive non-
Hodgkin's lymphoma.
- The potential introduction of new products and additional indications for
existing products in 2001 and beyond.
- The ability to successfully manufacture sufficient quantities of any
particular marketed product.
- The number and size of any product price increases we may issue.
The Successful Development of Pharmaceutical Products Is Highly Uncertain
Successful pharmaceutical product development is highly uncertain and is
dependent on numerous factors, many of which are beyond our control. Products
that appear promising in the early phases of development may fail to reach the
market for several reasons including:
- Preclinical and clinical trial results that may show the product to be less
effective than desired or to have harmful problematic side effects. For
example, in June 2000, we announced that the preliminary results from our
415-patient Phase II clinical trial of our recombinant humanized anti-CD18
monoclonal antibody fragment, which is known as rhuMAb CD18, for the
treatment of myocardial infarction, more commonly known as a heart attack,
did not meet its primary objectives.
For example, in April 2001, we announced that a Phase III clinical trial of
Veletri, trademark, (tezosentan) - an intravenous dual endothelin receptor
Page 24
antagonist for the treatment of symptoms (dyspnea, or shortness of breath)
associated with acute heart failure (AHF)- did not meet its primary
objectives.
- Failure to receive the necessary regulatory approvals or delay in receiving
such approvals.
For example, in July 2001, we received a Complete Response letter from the
FDA for the license application for Xolair that was filed with the FDA in
2000. The letter requests additional preclinical and clinical data, as well
as pharmacokinetic information. With the requirement of additional data,
FDA approval of Xolair has been delayed beyond 2001. It is also anticipated
that the initial proposed label claim will likely be for only adult allergic
asthma. The exact timing of resubmission to the FDA will be dependent on the
scope of the discussions with the FDA but is expected to occur in 2002 or
early 2003. The application for approval of Xolair submitted to the European
Medical Evaluations Agency has been withdrawn which will also result in a
delay in European Union approval.
- Manufacturing costs or other factors that make the product uneconomical.
- The proprietary rights of others and their competing products and
technologies that may prevent the product from being commercialized.
Success in preclinical and early clinical trials does not ensure that
large-scale clinical trials will be successful. Clinical results are
frequently susceptible to varying interpretations that may delay, limit or
prevent regulatory approvals. The length of time necessary to complete
clinical trials and to submit an application for marketing approval for a final
decision by a regulatory authority varies significantly and may be difficult to
predict.
Factors affecting our research and development, or R&D, expenses include, but
are not limited to:
- The number of and the outcome of clinical trials currently being conducted
by us and/or our collaborators.
For example, we have experienced an increase in R&D expenses in the second
quarter and first six months of 2001 due to the number of late-stage
clinical trials being conducted by us and/or our collaborators.
- The number of products entering into development from late-stage research.
For example, there is no guarantee that internal research efforts will
succeed in generating sufficient data for us to make a positive development
decision or that an external candidate will be available on terms acceptable
to us. In the past, promising candidates have not yielded sufficiently
positive preclinical results to meet our stringent development criteria.
- Hoffmann-La Roche's decisions whether to exercise its options to develop and
sell our future products in non-U.S. markets and the timing and amount of
any related development cost reimbursements.
- In-licensing activities, including the timing and amount of related
development funding or milestone payments.
For example, in February 2000, we entered into an agreement with Actelion
Ltd. for the purchase of rights for the development and co-promotion in the
Page 25
United States of tezosentan and paid Actelion an upfront fee of $15.0
million which was recorded as an R&D expense.
For example, in January 2001, we entered into an agreement with OSI
Pharmaceuticals, Inc. for the global co-development and commercialization of
an anti-cancer drug, OSI-774, and paid OSI an upfront fee of $15.0 million
for the purchase of IPR&D which was recorded as an R&D expense.
- As part of our strategy, we invest in R&D. R&D as a percent of revenues can
fluctuate with the changes in future levels of revenue. Lower revenues can
lead to more disciplined spending of R&D efforts.
- Future levels of revenue.
Roche, Our Controlling Stockholder, May Have Interests That Are Adverse to
Other Stockholders
Roche, as our majority stockholder, controls the outcome of actions requiring
the approval of our stockholders. Our bylaws provide, among other things, that
the composition of our board of directors shall consist of two Roche directors,
three independent directors nominated by a nominating committee and one
Genentech employee nominated by the nominating committee. As long as Roche
owns in excess of 50% of our common stock, Roche directors will comprise two of
the three members of the nominating committee. However, at any time until
Roche owns less than 5% of our stock, Roche will have the right to obtain
proportional representation on our board. Roche intends to continue to allow
our current management to conduct our business and operations as we have done
in the past. However, we cannot assure stockholders that Roche will not
institute a new business plan in the future. Roche's interests may conflict
with minority shareholder interests.
Our Affiliation Agreement With Roche Could Limit Our Ability to Make
Acquisitions and Could Have a Material Negative Impact on Our Liquidity
The affiliation agreement between us and Roche contains provisions that:
- Require the approval of the directors designated by Roche to make any
acquisition or any sale or disposal of all or a portion of our business
representing 10% or more of our assets, net income or revenues.
- Enable Roche to maintain its percentage ownership interest in our common
stock.
- Require us to establish a stock repurchase program designed to maintain
Roche's percentage ownership interest in our common stock based on an
established Minimum Percentage. For information regarding Minimum
Percentage, see Note 3, "Relationship with Roche -- Roche's Right to
Maintain Its Percentage Ownership Interest in Our Stock" in the Notes to
Condensed Consolidated Financial Statements.
These provisions may have the effect of limiting our ability to make
acquisitions and while the dollar amounts associated with the stock repurchase
program cannot currently be estimated, these stock repurchases could have a
material adverse impact on our liquidity, credit rating and ability to access
capital in the financial markets.
Our Stockholders May Be Unable to Prevent Transactions That Are Favorable to
Roche but Adverse to Us
Page 26
Our certificate of incorporation includes provisions relating to:
- Competition by Roche with us.
- Offering of corporate opportunities.
- Transactions with interested parties.
- Intercompany agreements.
- Provisions limiting the liability of specified employees.
Our certificate of incorporation provides that any person purchasing or
acquiring an interest in shares of our capital stock shall be deemed to have
consented to the provisions in the certificate of incorporation relating to
competition with Roche, conflicts of interest with Roche, the offer of
corporate opportunities to Roche and intercompany agreements with Roche. This
deemed consent may restrict your ability to challenge transactions carried out
in compliance with these provisions.
Potential Conflicts of Interest Could Limit Our Ability to Act on Opportunities
That Are Adverse to Roche
Persons who are directors and/or officers of Genentech and who are also
directors and/or officers of Roche may decline to take action in a manner that
might be favorable to us but adverse to Roche. Two of our directors, Dr. Franz
B. Humer and Dr. Jonathan K.C. Knowles, currently serve as directors, officers
and employees of Roche Holding Ltd and its affiliates.
We May Be Unable to Retain Skilled Personnel and Maintain Key Relationships
The success of our business depends, in large part, on our continued ability to
attract and retain highly qualified management, scientific, manufacturing and
sales and marketing personnel, and on our ability to develop and maintain
important relationships with leading research institutions and key
distributors. Competition for these types of personnel and relationships is
intense.
Roche has the right to maintain its percentage ownership interest in our
common stock. Our affiliation agreement with Roche provides that, among other
things, we will establish a stock repurchase program designed to maintain
Roche's percentage ownership in our common stock if we issue or sell any
shares. This right of Roche may limit our flexibility as to the number of
shares we are able to grant under our stock option plans. We therefore cannot
assure you that we will be able to attract or retain skilled personnel or
maintain key relationships.
We Face Growing and New Competition
We face growing competition in two of our therapeutic markets and expect new
competition in a third market. First, in the thrombolytic market, Activase has
lost market share and could lose additional market share to Centocor's
Retavase, either alone or in combination with the use of another Centocor
product, ReoPro, registered trademark, (abciximab) and to the use of mechanical
reperfusion therapies to treat acute myocardial infarction; the resulting
adverse effect on sales has been and could continue to be material. Retavase
received approval from the FDA in October 1996 for the treatment of acute
myocardial infarction. We expect that the use of mechanical reperfusion in lieu
of thrombolytic therapy for the treatment of acute myocardial infarction will
continue to grow.
Page 27
Second, in the growth hormone market, we continue to face increased
competition from four other companies currently selling growth hormone and an
additional company which may enter the market in the near future. As a result
of that competition, we have experienced a loss in market share. The four
competitors have also received approval to market their existing human growth
hormone products for additional indications. As a result of this competition,
sales of our Growth Hormone products may decline, perhaps significantly.
Third, in the non-Hodgkin's lymphoma market, Corixa Corporation, formerly
Coulter Pharmaceutical, Inc., has filed a revised Biologics License
Application, or BLA, for Bexxar, trademark, (tositumomab and iodine I 131
tositumomab), which may potentially compete with our product Rituxan, and IDEC
has filed a BLA for Zevalin, trademark, (ibritumomab tiuxetan), a product which
could also potentially compete with Rituxan. Both Bexxar and Zevalin are
radiolabeled molecules while Rituxan is not. We are also aware of other
potentially competitive biologic therapies for non-Hodgkin's lymphoma in
development.
Other Competitive Factors Could Affect Our Product Sales
Other competitive factors that could affect our product sales include, but are
not limited to:
- The timing of FDA approval, if any, of competitive products.
For example, in June 2000 one of our competitors, Novo, received FDA
approval for a liquid formulation of its growth hormone product that will
directly compete with our liquid formulation, Nutropin AQ. Also in June
2000, another of our competitors, Serono S.A., received FDA approval to
deliver its competitive growth hormone product in a needle-free device.
- Our pricing decisions and the pricing decisions of our competitors.
For example, we raised the prices of Rituxan in May 2000 and Pulmozyme in
June 2000 by approximately 5%.
For example, we raised the prices of Herceptin by 3% and on Growth Hormone
Product by 5% in January 2001.
- The degree of patent protection afforded our products by patents granted to
us and by the outcome of litigation involving our patents.
For example, in January 2000, a federal court judge lifted a preliminary
injunction that had been in effect since 1995 against Bio-Technology General
Corporation, or BTG. Although an appeal of the judge's decision is pending,
BTG is now permitted to sell its competitive growth hormone product in the
United States.
- The outcome of litigation involving patents of other companies concerning
our products or processes related to production and formulation of those
products or uses of those products.
For example, as described in Note 6, "Legal Proceedings," in the Notes to
Condensed Consolidated Financial Statements of Part I, several companies
have filed patent infringement lawsuits against us alleging that the
manufacture, use and sale of certain of our products infringe their patents.
- The increasing use and development of alternate therapies.
Page 28
For example, the overall size of the market for thrombolytic therapies, such
as our Activase product, continues to decline as a result of the increasing
use of mechanical reperfusion.
- The rate of market penetration by competing products.
For example, in the past, we have lost market share to new competitors in
the thrombolytic and growth hormone markets.
In Connection With the Redemption of Our Special Common Stock, We Recorded
Substantial Goodwill and Other Intangibles, the Amortization of Which May
Adversely Affect Our Earnings
As a result of the redemption of our Special Common Stock, Roche owned all of
our outstanding common stock. Consequently, push-down accounting under
generally accepted accounting principles was required. Push-down accounting
required us to establish a new accounting basis for our assets and liabilities,
based on Roche's cost in acquiring all of our stock. In other words, Roche's
cost of acquiring Genentech was "pushed down" to us and reflected on our
financial statements. Push-down accounting required us to record goodwill and
other intangible assets of approximately $1,685.7 million and $1,499.0 million,
respectively, on June 30, 1999.
Effective for fiscal years beginning after December 15, 2001, the adoption
of the Financial Accounting Standards Board, or FASB, Statement of Financial
Accounting Standards No. 142, or FAS 142, will require that goodwill not be
amortized, but rather be subject to an impairment test at least annually.
Separately identified and recognized intangible assets resulting from business
combinations completed before July 1, 2001, that do not meet the new criteria
for separate recognition of intangible assets will be subsumed into goodwill
upon adoption. In addition, the useful lives of recognized intangible assets
acquired in transactions completed before July 1, 2001, will be reassessed and
the remaining amortization periods adjusted accordingly. We will continuously
evaluate whether events and circumstances have occurred that indicate the
remaining balance of goodwill and other intangible assets may not be
recoverable. If our evaluation of the assets results in a possible impairment,
we may have to reduce the carrying value of our intangible assets. This could
have a material adverse effect on our financial condition and results of
operations during the periods in which we recognize a reduction. We may have
to write down intangible assets in future periods. For more information about
push-down accounting, see the Note 2, "Redemption of Our Special Common Stock,"
in the Notes to Condensed Consolidated Financial Statements of Part I. For
more information regarding FAS 142, see "New Accounting Pronouncement Could
Impact Our Financial Position and Results of Operations" below.
Our Royalty and Contract Revenues Could Decline
Royalty and contract revenues in future periods could vary significantly.
Major factors affecting these revenues include, but are not limited to:
- Hoffmann-La Roche's decisions whether to exercise its options and option
extensions to develop and sell our future products in non-U.S. markets and
the timing and amount of any related development cost reimbursements.
- Variations in Hoffmann-La Roche's sales and other licensees' sales of
licensed products.
- The conclusion of existing arrangements with other companies and Hoffmann-
La Roche.
Page 29
For example, in the second quarter of 2001, we reacquired from Schwarz
Pharma AG the exclusive development and marketing rights for Nutropin AQ and
Nutropin Depot in Europe and other countries outside the United States,
Canada, China and Japan.
- The timing of non-U.S. approvals, if any, for products licensed to Hoffmann-
La Roche and to other licensees.
For example, we expect the approval of Herceptin outside the United States,
which occurred in third quarter of 2000, to have a continuing positive
impact on royalties.
- Fluctuations in foreign currency exchange rates.
- The initiation of new contractual arrangements with other companies.
- Whether and when contract benchmarks are achieved.
- The failure of or refusal of a licensee to pay royalties.
- The expiration or invalidation of patents or licensed intellectual property.
- Decreases in licensees' sales of product due to competition, manufacturing
difficulties or other factors that affect sales of product.
Protecting Our Proprietary Rights Is Difficult and Costly
The patent positions of pharmaceutical and biotechnology companies can be
highly uncertain and involve complex legal and factual questions.
Accordingly, we cannot predict the breadth of claims allowed in these
companies' patents. Patent disputes are frequent and can preclude the
commercialization of products. We have in the past been, are currently, and
may in the future be, involved in material patent litigation. Our current
patent litigation matters are discussed in Note 6, " Legal Proceedings," in
the Notes to Condensed Consolidated Financial Statements of Part I. Patent
litigation is costly in its own right and could subject us to significant
liabilities to third parties. In addition, an adverse decision could force us
to either obtain third-party licenses at a material cost or cease using the
technology or product in dispute.
The presence of patents or other proprietary rights belonging to other
parties may lead to our termination of the R&D of a particular product.
We believe that we have strong patent protection or the potential for
strong patent protection for a number of our products that generate sales and
royalty revenue or that we are developing. However, the courts will determine
the ultimate strength of patent protection of our products and those on which
we earn royalties.
We May Incur Material Litigation Costs
Litigation to which we are currently or have been subjected relates to, among
other things, our patent and intellectual property rights, licensing
arrangements with other persons, product liability and financing activities.
We cannot predict with certainty the eventual outcome of pending litigation,
and we might have to incur substantial expense in defending these lawsuits.
Page 30
We May Incur Material Product Liability Costs
The testing and marketing of medical products entail an inherent risk of
product liability. Pharmaceutical product liability exposures could be
extremely large and pose a material risk. Our business may be materially and
adversely affected by a successful product liability claim in excess of any
insurance coverage that we may have.
We May Be Unable to Obtain Regulatory Approvals for Our Products
The pharmaceutical industry is subject to stringent regulation with respect to
product safety and efficacy by various federal, state and local authorities.
Of particular significance are the FDA's requirements covering R&D, testing,
manufacturing, quality control, labeling and promotion of drugs for human use.
A pharmaceutical product cannot be marketed in the United States until it has
been approved by the FDA, and then can only be marketed for the indications and
claims approved by the FDA. As a result of these requirements, the length of
time, the level of expenditures and the laboratory and clinical information
required for approval of a New Drug Application, or NDA, or a BLA, are
substantial and can require a number of years. In addition, after any of our
products receive regulatory approval, they remain subject to ongoing FDA
regulation, including, for example, changes to their label, written advisements
to physicians and product recall.
We cannot be sure that we can obtain necessary regulatory approvals on a
timely basis, if at all, for any of the products we are developing or that we
can maintain necessary regulatory approvals for our existing products, and all
of the following could have a material adverse effect on our business:
- Significant delays in obtaining or failing to obtain required approvals.
For example, see "The Successful Development of Pharmaceutical Products is
Highly Uncertain" above for a description of the delay in receipt of FDA
approval for Xolair.
- Loss of or changes to previously obtained approvals.
For example, in May 2000, we issued letters to physicians advising them of
some serious adverse events associated with the administration of Herceptin.
In October 2000, we issued a new package insert for Herceptin including this
information.
- Failure to comply with existing or future regulatory requirements.
Moreover, it is possible that the current regulatory framework could
change or additional regulations could arise at any stage during our product
development, which may affect our ability to obtain approval of our products.
Difficulties or Delays in Product Manufacturing Could Harm Our Business
We currently produce all of our products at our manufacturing facilities
located in South San Francisco, California and Vacaville, California or through
various contract manufacturing arrangements. Problems with any of our or our
contractors' manufacturing processes could result in product defects, which
could require us to delay shipment of products, recall products previously
shipped or be unable to supply products at all.
For example, in March 2000, we issued an important drug notification
regarding a defect in the packaging of our Pulmozyme product. During a quality
Page 31
assurance inspection, we had discovered that there was a defect in the
packaging of Pulmozyme which occasionally caused a small puncture in ampules of
that product. We suspended shipping the product while we determined the source
and extent of the defect. We ultimately recalled some of the product.
In April 2001, we issued another important drug notification regarding a
separate defect in the manufacture of a Pulmozyme product lot which was causing
a small puncture in a small number of ampules of the product. We suspended
shipping the product upon discovery of this defect and recalled the few cases
of the product lot that had been distributed.
On December 27, 2000, we received a Warning Letter from the FDA regarding
our quality control at our South San Francisco manufacturing plant. The
products cited were for Pulmozyme, Herceptin and Activase. On February 7,
2001, we received a letter from the FDA accepting our responses and corrective
actions with respect to the Warning Letter. If we were to experience
additional quality control or other related manufacturing problems in the
future, the FDA could take more significant action, including causing us to
cease manufacturing of one or more products for a period of time.
In addition, any prolonged interruption in the operations of our or our
contractors' manufacturing facilities could result in cancellations of
shipments or loss of product in the process of being manufactured. A number
of factors could cause interruptions, including equipment malfunctions or
failures, or damage to a facility due to natural disasters, rolling blackouts
imposed by a utility such as Pacific Gas & Electric Company or otherwise.
Because our manufacturing processes and those of our contractors are highly
complex and are subject to a lengthy FDA approval process, alternative
qualified production capacity may not be available on a timely basis or at
all. Difficulties or delays in our and our contractors' manufacturing of
existing or new products could increase our costs, cause us to lose revenue or
market share and damage our reputation.
Our Stock Price, Like That of Many Biotechnology Companies, Is Highly Volatile
The market prices for securities of biotechnology companies in general have
been highly volatile and may continue to be highly volatile in the future. In
addition, due to the absence of the put and call that were associated with our
Special Common Stock, the market price of our common stock has been and may
continue to be more volatile than our Special Common Stock was in the past.
For example, our common stock reached a high of $122.50 per share in March 2000
and decreased, as the biotech sector and stock market in general decreased, to
$38.50 per share in March 2001.
In addition, the following factors may have a significant impact on the
market price of our common stock:
- Announcements of technological innovations or new commercial products by us
or our competitors.
- Developments concerning proprietary rights, including patents.
- Publicity regarding actual or potential medical results relating to products
under development or being commercialized by us or our competitors.
- Regulatory developments concerning our products in the United States and
foreign countries.
- Issues concerning the safety of our products or of biotechnology products
generally.
Page 32
- Economic and other external factors or a disaster or crisis.
- Period-to-period fluctuations in financial results.
Our Affiliation Agreement With Roche Could Adversely Affect Our Cash Position
Our affiliation agreement with Roche provides that we will establish a stock
repurchase program designed to maintain Roche's percentage ownership interest
in our common stock based on an established Minimum Percentage. For
information regarding Minimum Percentage, see Note 3, "Relationship with Roche
-- Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock" in
the Notes to Condensed Consolidated Financial Statements. While the dollar
amounts associated with these future purchases cannot currently be estimated,
those stock repurchases could have a material adverse effect on our cash
position and may have the effect of limiting our ability to use our capital
stock as consideration for acquisitions.
These provisions may have the effect of limiting our ability to make
acquisitions and while the dollar amounts associated with the stock repurchase
program cannot currently be estimated, these stock repurchases could have a
material adverse impact on our liquidity, credit rating and ability to access
capital in the financial markets.
Future Sales by Roche Could Cause the Price of Our Common Stock to Decline
As of June 30, 2001, Roche owned 306,594,352 shares of our common stock or
approximately 58.12% of our outstanding shares. All of our shares owned by
Roche are eligible for sale in the public market subject to compliance with the
applicable securities laws. We have agreed that, upon Roche's request, we will
file one or more registration statements under the Securities Act in order to
permit Roche to offer and sell shares of our common stock. We have agreed to
use our best efforts to facilitate the registration and offering of those
shares designated for sale by Roche. Sales of a substantial number of shares
of our common stock by Roche in the public market could adversely affect the
market price of our common stock.
We Are Exposed to Market Risk
We are exposed to market risk, including changes to interest rates, foreign
currency exchange rates and equity investment prices. To reduce the volatility
relating to these exposures, we enter into various derivative investment
transactions pursuant to our investment and risk management policies and
procedures in areas such as hedging and counterparty exposure practices. We do
not use derivatives for speculative purposes.
We maintain risk management control systems to monitor the risks
associated with interest rates, foreign currency exchange rates and equity
investment price changes, and our derivative and financial instrument
positions. The risk management control systems use analytical techniques,
including sensitivity analysis and market values. Though we intend for our
risk management control systems to be comprehensive, there are inherent risks
that may only be partially offset by our hedging programs should there be
unfavorable movements in interest rates, foreign currency exchange rates or
equity investment prices.
Our Interest Income is Subject to Fluctuations in Interest Rates
Our material interest bearing assets, or interest bearing portfolio, consisted
of cash equivalents, restricted cash, short-term investments, convertible
Page 33
preferred stock investments, convertible loans and long-term investments. The
balance of our interest bearing portfolio was $1,879.6 million or 28% of total
assets at December 31, 2000. Interest income related to this portfolio was
$90.4 million or 5% of total revenues at December 31, 2000. Our interest
income is sensitive to changes in the general level of interest rates,
primarily U.S. interest rates. In this regard, changes in U.S. interest rates
affect the interest bearing portfolio. To mitigate the impact of fluctuations
in U.S. interest rates, for a portion of our portfolio, we have entered into
swap transactions, which involve the receipt of fixed rate interest and the
payment of floating rate interest without the exchange of the underlying
principal.
We Are Exposed to Risks Relating to Foreign Currency Exchange Rates and Foreign
Economic Conditions
We receive royalty revenues from licensees selling products in countries
throughout the world. As a result, our financial results could be
significantly affected by factors such as changes in foreign currency exchange
rates or weak economic conditions in the foreign markets in which our licensed
products are sold. We are exposed to changes in exchange rates in Europe, Asia
(primarily Japan) and Canada. Our exposure to foreign exchange rates primarily
exists with the Euro. When the dollar strengthens against the currencies in
these countries, the dollar value of non-dollar-based revenue decreases; when
the dollar weakens, the dollar value of the non-dollar-based revenues
increases. Accordingly, changes in exchange rates, and in particular a
strengthening of the dollar, may adversely affect our royalty revenues as
expressed in dollars. Increasingly however, these royalties are being offset
by expenses arising from our foreign facility as well as non-dollar expenses
incurred in our collaborations. Currently, our foreign royalty revenues exceed
our expenses. In addition, as part of our overall investment strategy, a
portion of our portfolio is primarily in non-dollar denominated investments.
As a result, we are exposed to changes in the exchange rates of the countries
in which these non-dollar denominated investments are made.
To mitigate our net foreign exchange exposure, our policy allows us to
hedge certain of our anticipated revenues by purchasing option contracts with
expiration dates and amounts of currency that are based on 25% to 90% of
probable future revenues so that the potential adverse impact of movements in
currency exchange rates on the non-dollar denominated revenues will be at least
partly offset by an associated increase in the value of the option. Currently,
the term of these options is generally one to two years. To hedge the non-
dollar expenses arising from our foreign facility, we may enter into forward
contracts to lock in the dollar value of a portion of these anticipated
expenses.
Our Investments in Equity Securities Are Subject to Market Risks
As part of our strategic alliance efforts, we invest in equity instruments of
biotechnology companies. Our biotechnology equity investment portfolio totaled
$652.7 million or 10% of total assets at December 31, 2000. These investments
are subject to fluctuations from market value changes in stock prices. For
example, in the first quarter of 2001, we took a significant charge on an
equity security investment that had an other than temporary impairment.
To mitigate the risk of market value fluctuation, certain equity
securities are hedged with costless collars and forward contracts. A costless
collar is a purchased put option and a written call option in which the cost
of the purchased put and the proceeds of the written call offset each other;
Page 34
therefore, there is no initial cost or cash outflow for these instruments at
the time of purchase. The purchased put protects us from a decline in the
market value of the security below a certain minimum level (the put "strike"
level), while the call effectively limits our potential to benefit from an
increase in the market value of the security above a certain maximum level
(the call "strike" level). A forward contract is a derivative instrument
where we pay the counterparty the total return of the security above the
current spot price and receive interest income on the notional amount for the
contract term. The forward contract protects us from a decline in the market
value of the security below the spot price and limits our potential benefit
from an increase in the market value of the security above the spot price. In
addition, as part of our strategic alliance efforts, we hold dividend-bearing
convertible preferred stock and have made interest-bearing loans that are
convertible into the equity securities of the debtor.
We Are Exposed to Credit Risk of Counterparties
We could be exposed to losses related to the financial instruments described
above under "We Are Exposed to Market Risk" should one of our counterparties
default. We attempt to mitigate this risk through credit monitoring
procedures.
New Accounting Pronouncement Could Impact Our Financial Position and Results of
Operations
On June 29, 2001, the Financial Accounting Standards Board, or FASB, approved
the final standards resulting from its deliberations on the business
combinations project. The FASB is expected to issue two statements in late
July 2001, Statement of Financial Accounting Standards No. 141, or FAS 141, on
Business Combinations and FAS 142 on Goodwill and Other Intangible Assets. FAS
141 will be effective for any business combinations initiated after June 30,
2001 and also includes the criteria for the recognition of intangible assets
separately from goodwill. FAS 142 will be effective for fiscal years beginning
after December 15, 2001 and will require that goodwill not be amortized, but
rather be subject to an impairment test at least annually. Separately
identified and recognized intangible assets resulting from business
combinations completed before July 1, 2001 that do not meet the new criteria
for separate recognition of intangible assets will be subsumed into goodwill
upon adoption. In addition, the useful lives of recognized intangible assets
acquired in transactions completed before July 1, 2001 will be reassessed and
the remaining amortization periods adjusted accordingly.
The adoption of FAS 141 and 142 is not expected to have a significant
impact on our financial position at transition. We expect that the elimination
of goodwill amortization related to push-down accounting would have a positive
impact on reported net income in 2002 of approximately $153.0 million.
Page 35
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risks at June 30, 2001 have not changed significantly from those
discussed in our Form 10-K for the period ended December 31, 2000 on file with
the Securities and Exchange Commission.
Page 36
GENENTECH, INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In connection with the patent infringement lawsuit filed against us by
GlaxoSmithKline plc on May 28, 1999, the jury hearing the lawsuit unanimously
found that Herceptin and Rituxan do not infringe the Glaxo patents and
therefore that Genentech is not required to pay royalties to Glaxo. The jury
also unanimously found that all of the patent claims that Glaxo asserted
against Genentech were invalid. On May 31, 2001, Glaxo filed a notice of
appeal of the jury's verdict with the U.S. Court of Appeals for the Federal
Circuit.
In connection with the second patent infringement lawsuit filed against us by
GlaxoSmithKline plc on September 14, 2000, the trial of that suit has been
rescheduled to begin on June 17, 2002.
In connection with the second patent infringement lawsuit filed against us by
Chiron Corporation on March 13, 2001, Genentech's motion to dismiss that suit
was denied. The trial of that suit is scheduled to begin in March 2003. This
lawsuit is separate from and in addition to the other patent infringement
lawsuit filed against us by Chiron on June 7, 2000.
In connection with the declaratory judgement lawsuit filed by Genentech against
Genzyme Corporation on March 13, 2001, and the patent infringement lawsuit
filed by Genzyme against us on April 6, 2001, Genzyme filed its answer to our
complaint on May 2, 2001 and Genentech filed its answer to Genzyme's complaint
on May 3, 2001. The court has consolidated these two lawsuits for further
proceedings. No trial date has yet been scheduled for the consolidated
lawsuit.
See also Item 3 of our report on Form 10-K for the period ended December 31,
2000.
See also Note 6, "Legal Proceedings," in the Notes to Condensed Consolidated
Financial Statements of Part I.
Item 4. Submission of Matters to a Vote of Security Holders
At Genentech's Annual Meeting of Stockholders held on May 10, 2001, three
matters were voted upon. A description of each matter and tabulation of votes
follows:
1. To elect six directors.
Votes
-------------------------
Nominee For Withheld
---------------------------- ----------- ---------
Herbert W. Boyer, Ph.D. 499,443,916 1,263,434
Franz B. Humer, Ph.D. 499,431,296 1,276,054
Jonathan K.C. Knowles, Ph.D. 499,433,494 1,273,856
Arthur D. Levinson, Ph.D. 499,468,036 1,239,314
Charles A. Sanders, M.D. 499,464,938 1,242,412
Sir Mark Richmond, Ph.D. 499,464,705 1,242,645
There were no broker nonvotes.
Page 37
2. To approve the amendment to Genentech's Amended and Restated
Certificate of Incorporation to increase the number of authorized
shares of Common Stock from 600,000,000 to 1,200,000,000.
Votes
-----------------------------------
For Against Abstain
----------- --------- -------
491,741,999 8,864,971 100,380
There were no broker nonvotes.
3. To ratify the appointment of Ernst & Young LLP as Genentech's
independent auditors for the fiscal year ending December 31, 2001:
Votes
-----------------------------------
For Against Abstain
----------- --------- -------
463,883,562 36,761,574 62,214
There were no broker nonvotes.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.2 Certificate of Amendment to Amended and Restated
Certificate of Incorporation
15.1 Letter regarding Unaudited Interim Financial
Information.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter
ended June 30, 2001.
Page 38
GENENTECH, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: July 27, 2001 GENENTECH, INC.
/s/ARTHUR D. LEVINSON /s/LOUIS J. LAVIGNE, JR.
------------------------------------- ------------------------------
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr.
Chairman and Chief Executive Officer Executive Vice President and
Chief Financial Officer
/s/JOHN M. WHITING
------------------------------
John M. Whiting
Vice President, Controller and
Chief Accounting Officer
Page 39
2001'Q1 FORM 10-Q (SKELETON) 07/27/01 @ 12:14
PM