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 March 31, 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 526,397,367
Outstanding at March 31, 2001
GENENTECH, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Condensed Consolidated Statements of Operations -
for the three months ended March 31, 2001 and 2000 3
Condensed Consolidated Statements of Cash Flows -
for the three months ended March 31, 2001 and 2000 4
Condensed Consolidated Balance Sheets -
March 31, 2001 and December 31, 2000 5
Notes to Condensed Consolidated Financial Statements 6-13
Independent Accountants' Review Report 14
Financial Review 15-35
Quantitative and Qualitative Disclosures About Market Risk 36
PART II. OTHER INFORMATION 37
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,
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) 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
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months
Ended March 31,
---------------------
2001 2000
--------- ---------
(Restated)
Revenues:
Product sales (including amounts from related parties:
2001-$22,037; 2000-$24,127) $ 391,904 $ 283,178
Royalties (including amounts from related parties:
2001-$23,619; 2000-$10,805) 74,631 47,344
Contract and other (including amounts from
related parties: 2001-$2,199; 2000-$500) 38,483 35,854
Interest 35,064 21,474
--------- ---------
Total revenues 540,082 387,850
Costs and expenses:
Cost of sales (including amounts from related parties:
2001-$18,506; 2000-$19,890) 83,796 106,135
Research and development (including contract related:
2001-$2,948; 2000-$4,557) 136,340 111,406
Marketing, general and administrative 127,920 83,613
Collaboration profit sharing 46,373 18,333
Recurring charges related to redemption 81,516 98,548
Interest 1,491 1,287
--------- ---------
Total costs and expenses 477,436 419,322
Income (loss) before taxes and cumulative effect of accounting change 62,646 (31,472)
Income tax provision (benefit) 30,258 (6,862)
--------- ---------
Income (loss) before cumulative effect of accounting change 32,388 (24,610)
Cumulative effect of accounting change, net of tax (5,638) (57,800)
--------- ---------
Net income (loss) $ 26,750 $ (82,410)
========= =========
Earnings (loss) per share:
Basic: Earnings (loss) before cumulative effect of
accounting change $ 0.06 $ (0.05)
Cumulative effect of accounting change, net of tax (0.01) (0.11)
--------- ---------
Net earnings (loss) per share $ 0.05 $ (0.16)
========= =========
Diluted: Earnings (loss) before cumulative effect of
accounting change $ 0.06 $ (0.05)
Cumulative effect of accounting change, net of tax (0.01) (0.11)
--------- ---------
Net earnings (loss) per share $ 0.05 $ (0.16)
========= =========
Weighted average shares used to compute earnings (loss) per share:
Basic 525,795 519,131
========= =========
Diluted 535,209 519,131
========= =========
See Notes to Condensed Consolidated Financial Statements.
Page 3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
(unaudited)
Three Months
Ended March 31,
---------------------
2001 2000
--------- ---------
(Restated)
Cash flows from operating activities:
Net income (loss) $ 26,750 $ (82,410)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 105,954 118,595
Deferred income taxes 34,526 (85,409)
Gain on sales of securities available-for-sale (22,245) (26,572)
Loss on sales of securities available-for-sale 909 2,502
Write-down of securities available-for-sale 19,850 -
Loss on fixed asset dispositions 747 -
Changes in assets and liabilities:
Investments in trading securities (69,631) (3,656)
Receivables and other current assets (10,546) 1,477
Inventories, including inventory write-up effect in 2000 (28,789) 20,324
Accounts payable, other current liabilities and other
long-term liabilities (25,484) (60,298)
--------- ---------
Net cash provided by (used in) operating activities 32,041 (115,447)
Cash flows from investing activities:
Purchases of securities available-for-sale (270,086) (98,152)
Proceeds from sales of securities available-for-sale 277,157 146,224
Purchases of non-marketable equity securities (5,550) (1,450)
Capital expenditures (36,324) (28,243)
Change in other assets (2,038) (5,214)
--------- ---------
Net cash (used in) provided by investing activities (36,841) 13,165
Cash flows from financing activities:
Stock issuances 35,355 71,589
--------- ---------
Net cash provided by financing activities 35,355 71,589
--------- ---------
Net increase (decrease) in cash and cash equivalents 30,555 (30,693)
Cash and cash equivalents at beginning of period 551,384 337,682
--------- ---------
Cash and cash equivalents at end of period $ 581,939 $ 306,989
========= =========
See Notes to Condensed Consolidated Financial Statements.
Page 4
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands)
March 31, December 31,
2001 2000(1)
(unaudited)
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 581,939 $ 551,384
Short-term investments 750,134 642,475
Accounts receivable, net (including amounts
from related party: 2001-$31,996; 2000-$36,299) 269,570 261,682
Inventories 294,620 265,830
Deferred tax assets 51,021 40,619
Prepaid expenses and other current assets 35,815 26,821
------------ ------------
Total current assets 1,983,099 1,788,811
Long-term marketable securities 974,873 1,265,515
Property, plant and equipment (net of accumulated 765,176 752,892
depreciation: 2001-$627,512; 2000-$604,332)
Goodwill (net of accumulated amortization:
2001-$881,815; 2000-$843,494) 1,417,457 1,455,778
Other intangible assets (net of accumulated
amortization: 2001-$1,326,165; 2000-$1,282,090) 1,239,335 1,280,359
Other long-term assets 220,415 168,458
------------ ------------
Total assets $ 6,600,355 $ 6,711,813
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 149,692 $ -
Accounts payable 24,321 34,503
Other accrued liabilities (including amounts from
related party: 2001-$17,358; 2000-$12,265) 374,304 414,178
------------ ------------
Total current liabilities 548,317 448,681
Long-term debt - 149,692
Deferred tax liabilities 285,661 349,848
Other long-term liabilities 90,535 89,389
------------ ------------
Total liabilities 924,513 1,037,610
Commitments and contingencies
Stockholders' equity:
Preferred stock - -
Common stock 10,528 10,510
Additional paid-in capital 6,686,765 6,651,428
Accumulated deficit, since June 30, 1999 (1,292,603) (1,319,353)
Accumulated other comprehensive income 271,152 331,618
------------ ------------
Total stockholders' equity 5,675,842 5,674,203
------------ ------------
Total liabilities and stockholders' equity $ 6,600,355 $ 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-month periods ended March 31, 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
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.
Reclassification: Certain reclassifications of prior year amounts have been
made to conform with the current year presentation.
Changes in Accounting Principle
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 first quarter of 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
Page 6
quarter ended March 31, 2000 ($0.0 per share). For the quarter ended March
31, 2001, we recognized $2.3 million (net of tax impact) of the related
deferred revenue.
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 $8.4 million 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 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 are 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. All gains are recorded in contract and other revenues and
losses are recorded in marketing, general and administrative expenses in the
statement of operations.
Page 7
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
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. 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 March 31, 2001.
During the quarter ended March 31, 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 March 31, 2001, we expect to reclassify $3.3 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 and the receipt of variable interest
associated with floating rate investments.
Derivative Activity in Accumulated Other Comprehensive Income
The following table summarizes activity in other comprehensive income
related to derivatives held by us during the period from January 1, 2001
through March 31, 2001 (in thousands):
Cumulative effect of adopting FAS 133 $ 8,367
Changes in fair value of derivatives 6,148
Gains reclassified from other comprehensive income (1,402)
-------
Accumulated derivative gains $13,113
=======
Page 8
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 "Redemption," caused Roche to own 100% 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
$43.2 million in cost of sales in the first quarter of 2000 related to the
inventory adjustment. The entire inventory adjustment related to Roche's
1990 through 1997 purchases was reflected as an adjustment to paid-in
capital.
- 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. The accumulated amortization was recorded as an
adjustment to additional paid-in capital at June 30, 1999. 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. The accumulated amortization was
recorded as an adjustment to additional paid-in capital at June 30, 1999.
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 during the first quarter of 2001 and $95.3 million
during the first quarter of 2000.
- 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 in the first quarter of 2001 and
$3.3 million in the first quarter of 2000.
Note 3. Relationship with Roche
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
Page 9
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 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. Roche's percentage ownership of
our common stock was 58.24% at March 31, 2001.
Note 4. Comprehensive Income
Comprehensive income is comprised of net income 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 quarter
ended March 31, 2001 and 2000 are as follows (in thousands):
Three Months
Ended March 31,
--------------------
2001 2000
-------- --------
(Restated)
Net income (loss) $ 26,750 $(82,410)
Changes in unrealized (loss) gain on securities
available-for-sale, net of tax (68,334) 36,756
Changes in fair value of derivative instruments,
net of tax of $5,245 7,868 -
-------- --------
Comprehensive loss $(33,716) $(45,654)
======== ========
Page 10
Note 5. Earnings (Loss) Per Share
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share (EPS) computations for the quarters
ended March 31, 2001 and 2000 (in thousands).
Three Months
Ended March 31,
-------------------
2001 2000
-------- --------
(Restated)
Numerator:
Net income (loss) - numerator for basic
and diluted earnings (loss) per share: $ 26,750 $(82,410)
-------- --------
Denominator:
Denominator for basic earnings (loss) per
share - weighted-average shares 525,795 519,131
Effect of dilutive securities:
Stock options 9,414 -
-------- --------
Denominator for diluted earnings (loss) per
share - adjusted weighted-average shares
and assumed conversions 535,209 519,131
======== ========
Options to purchase 9,828,383 shares of common stock between $56.50 per share
and $95.66 per share were outstanding in the three-month period ended March
31, 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 human growth hormone products, antibody products,
one of our thrombolytic products, 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. On or about October 27, 2000, Glaxo filed a
motion for summary judgment that our Herceptin and Rituxan antibody products
Page 11
infringe two of the patents asserted against us in this suit. Genentech has
filed multiple summary judgment motions relating to non-infringement and
invalidity. All of those motions are currently pending before the judge.
The trial of this suit began on April 17, 2001 and is ongoing.
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 is scheduled to begin January 25, 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 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 has
filed a motion to dismiss this second lawsuit, and the Court has scheduled a
hearing on the motion for May 21, 2001. No trial date has yet been scheduled
for this second lawsuit. This lawsuit is currently 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
Page 12
royalties on sales of Pharmacia's growth hormone products throughout the
world. On January 5, 1999, Pharmacia filed a Request for Arbitration with
the 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. Although the ICC has not yet given a decision on that claim, we
do not believe its decision is likely to have a material adverse effect on
our financial position, result of operations or cash flows.
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. Genzyme has not yet 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. Genentech has not yet filed its answer
to this complaint. Although this lawsuit is currently separate from and in
addition to the declaratory judgement suit referred to above, it is possible
that the suits will be consolidated in some respect.
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
Inventories are summarized below (in thousands):
March 31, 2001 December 31, 2000
-------------- -----------------
Raw materials and supplies $ 18,163 $ 17,621
Work in process 258,620 233,121
Finished goods 17,837 15,088
-------------- -----------------
Total $294,620 $265,830
============== =================
Page 13
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 March 31, 2001, and the related condensed consolidated
statements of operations for the three-month periods ended March 31, 2001 and
2000 and the condensed consolidated statements of cash flows for the three-
month periods ended March 31, 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
April 10, 2001
Page 14
GENENTECH, INC.
FINANCIAL REVIEW
Overview
Genentech 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 we will receive
royalties on sales of rituximab in Japan through other licensees. We also
receive worldwide royalties on seven additional licensed products that are
Page 15
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. Roche's percentage
ownership of our common stock was 58.24% at March 31, 2001.
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Page 16
Three Months Ended
March 31,
------------------
REVENUES 2001 2000 % Change
------------------- ------ ------ --------
Revenues $540.1 $387.9 39%
====== ====== =========
Revenues increased 39% in the first quarter of 2001 from the comparable
period in 2000 primarily as a result of higher product sales and royalty
income and, to a lesser extent, higher interest income. These increases are
further discussed below.
Three Months Ended
March 31,
------------------
PRODUCT SALES 2001 2000 % Change
------------------- ------ ------ --------
Herceptin $ 81.4 $ 68.7 18%
Rituxan 172.1 85.1 102
Activase/TNKase 52.1 47.5 10
Growth Hormone 55.5 55.1 1
Pulmozyme 29.9 26.8 12
Actimmune 0.9 - -
------ ------ ---------
Total product sales $391.9 $283.2 38%
====== ====== =========
Total product sales increased 38% in the first quarter of 2001 from the
comparable period in 2000 primarily as a result of higher sales from our bio-
oncology products, Rituxan and Herceptin.
Herceptin: Net sales of Herceptin increased 18% in the first quarter of 2001
from the comparable period in 2000. Since launch, an increase in penetration
into the metastatic breast cancer market has contributed to a positive sales
trend. To a lesser extent, the increase was also due to a slight increase in
price.
Rituxan: Net sales of Rituxan increased 102% in the first quarter of 2001
from the comparable period 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: Net sales of our two cardiovascular products, Activase and
TNKase, were $52.1 million in the first quarter of 2001 compared to $47.5
million of Activase sales in the first quarter of 2000. The increase
reflects the steady growth of TNKase sales due to the ease of administering
the product through a single, 5-second injection. 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 slightly in the first
quarter of 2001 from the comparable period in 2000. Nutropin Depot was
launched on June 28, 2000.
Page 17
Pulmozyme: Net sales of Pulmozyme increased 12% in the first quarter of 2001
from the comparable period in 2000. This increase was primarily as a result
of programs to encourage patient compliance with therapy, and to a lesser
extent, a price increase.
Three Months Ended
March 31,
ROYALTIES, CONTRACT AND ------------------
OTHER, AND INTEREST INCOME 2001 2000 % Change
-------------------------- ------ ------ --------
Royalties $ 74.6 $ 47.3 58%
Contract and other 38.5 35.9 7
Interest income 35.1 21.5 63
Royalties: Royalty income increased 58% in the first quarter of 2001 from
the comparable period in 2000. The increase was due to higher third-party
sales from various licensees. During the quarter we received approximately
$5.0 million of retroactive royalties on an interferon product from Roche.
Contract and Other Revenues: Contract and other revenues in the first
quarter of 2001 increased 7% from the comparable period in 2000 due to the
recognition of $10.0 million in gains related to the change in the time value
of certain hedging instruments, offset in part by lower gains from the sale
of biotechnology equity securities. (See Note 1, "Statement of Accounting
Presentation and Significant Accounting Policies," in the Notes to Condensed
Consolidated Statements for more information on our derivative and hedging
activities.)
Interest Income: Interest income in the first quarter 2001 increased 63%
from the first quarter of 2000. The increase was due to a higher average
portfolio balance and higher returns in our cash and investment portfolio.
Three Months Ended
March 31,
------------------
COSTS AND EXPENSES 2001 2000 % Change
--------------------------------------- ------ ------ --------
Cost of sales $ 83.8 $106.1 (21)%
Research and development 136.3 111.4 22
Marketing, general and administrative 127.9 83.6 53
Collaboration profit sharing 46.4 18.3 154
Recurring charges related to redemption 81.5 98.6 (17)
Interest expense 1.5 1.3 15
------ ------ --------
Total costs and expenses $477.4 $419.3 14%
====== ====== ========
Cost of Sales: Cost of sales in the first quarter of 2001 decreased to $83.8
million compared to $106.1 million in the first quarter of 2000. Cost of
sales as a percent of product sales decreased to 21% in the first quarter of
2001 from 37% in the prior year. The decrease in the ratio 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.
Page 18
Research and Development: Research and development, or R&D, expenses
increased 22% in the first quarter of 2001 from the comparable period in
2000. The increase was primarily due to an increase in expenses related to
late-stage clinical trials and the termination of a collaboration
arrangement. In addition, R&D expenses in each of the first quarters of 2001
and 2000 include a $15.0 million upfront payment 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 53% in the first quarter from the
comparable period in 2000. This increase was due to the write-down of
certain biotech investments due to current market conditions, preparation for
the Xolair market introduction, an increase in the marketing and selling
expenses in continuing support of our oncology products, and increased
royalty expenses associated with licensee sales.
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 commercialization and development of future
products. Collaboration profit sharing expenses increased to $46.4 million
in the first quarter of 2001, from $18.3 million in the first quarter of
2000. The increase was 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 March 31, 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 $98.6 million in the first quarter
of 2000 and were comprised of $95.3 million for the amortization of
intangibles and goodwill, and $3.3 million of compensation expense. The
compensation expense was related to alternative arrangements provided at the
time of the Redemption for certain holders of some of the unvested options
under the 1996 Stock Option/Stock Incentive Plan.
Interest Expense: Interest expense will fluctuate depending on the amount of
capitalized interest related to the amount of construction projects.
Interest expense, net of amounts capitalized, relates to interest on our 5%
convertible subordinated debentures.
Three Months Ended
INCOME (LOSS) BEFORE TAXES AND CUMULATIVE March 31,
EFFECT OF ACCOUNTING CHANGE, INCOME TAXES ------------------
AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 2001 2000 % Change
------------------------------------------ ------ ------ --------
Income (loss) before taxes and cumulative
effect of accounting change $ 62.7 $(31.4) 300%
Income tax provision (benefit) 30.3 (6.8) 546
Income (loss) before cumulative effect of
accounting change 32.4 (24.6) 232
Cumulative effect of accounting change,
net of tax (5.6) (57.8) -
Page 19
Changes in Accounting Principle: 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 $8.4 million 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 was to increase net loss by $56.5 million, comprised
of the $57.8 million cumulative effect of the change (net of tax) as
described above, 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.
For the quarter ended March 31, 2001, we recognized $2.3 million (net of tax)
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 $30.3 million for the first quarter of 2001
increased over the tax benefit of $6.8 million for the first quarter of 2000
primarily due to increased pretax income and decreased charges related to the
Redemption.
Our effective tax rates were approximately 48% for the first quarter of 2001
and 22% for the first quarter of 2000, which reflect the non-deductibility of
goodwill amortization.
The effective tax rate of 32% in the first quarter 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
first quarter of 2000 primarily due to decreased R&D tax credits.
Three Months Ended
March 31,
------------------
NET INCOME (LOSS) 2001 2000 % Change
------------------------------------------------------------- ------ ------ --------
(Restated)
Net income (loss) $ 26.8 $(82.4) 133%
Earnings (loss) per share:
Basic: Earnings (loss) before cumulative effect of
accounting change $ 0.06 $(0.05) 220%
Cumulative effect of accounting change, net of tax (0.01) (0.11) -
------------------------------
Net earnings (loss) per share $ 0.05 $(0.16) 131%
==============================
Diluted: Earnings (loss) before cumulative effect of
accounting change $ 0.06 $(0.05) 220%
Cumulative effect of accounting change, net of tax (0.01) (0.11) -
------------------------------
Net earnings (loss) per share $ 0.05 $(0.16) 131%
==============================
Page 20
Net Income (Loss): The net income of $26.8 million, or earnings of $0.05 per
share in 2001, primarily reflects an increase in product sales, royalties,
contract revenue and interest income and a decrease in cost of sales, offset
in part by increased R&D, MG&A and Collaboration profit sharing expenses.
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 the only significant changes that occurred during the
quarter ended March 31, 2001 to the projects included in the IPR&D charge at
the Redemption:
- Dornase alfa AERx - project has been discontinued.
- Herceptin antibody for non-small cell lung cancer (NSCLC) - project has
been discontinued in this indication.
LIQUIDITY AND CAPITAL RESOURCES March 31, 2001 December 31, 2000
--------------------------------- -------------- -----------------
Cash and cash equivalents,
short-term investments and
long-term marketable securities $ 2,306.9 $ 2,459.4
Working capital 1,434.8 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 March 31, 2001 decreased from December 31, 2000 by $152.5
million. Working capital increased by $94.7 million in the first three
months of 2001 from December 31, 2000.
Capital expenditures totaled $36.3 million in the first quarter of 2001
compared to $28.2 million in the comparable period of 2000. The increase in
2001 compared to 2000 was primarily due to an increase in leasehold
improvements.
We believe that our cash, cash equivalents and short-term investments,
Page 21
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 2000, 1999 and
1998 primarily due to competition from Centocor Inc.'s Retavase and more
recently to a decreasing size of the thrombolytic marketplace as other
forms of acute myocardial infarction treatment gain acceptance.
- The amount and timing of sales to customers in the United States.
For example, sales of our Growth Hormone products increased in 2000 and
1999 due to fluctuations in distributor ordering patterns.
- The amount and timing of our sales to Hoffmann-La Roche of products for
sale outside of the United States and the amount and timing of its sales
to its customers, which directly impact both our product sales and royalty
revenues.
For example, 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 Pulmozyme increased in 1998 due, in part, to new
Page 22
patients who were attracted to our product as a result of an FDA approval
for a label extension to include cystic fibrosis patients under the age of
five.
For example, sales of Rituxan increased in the last quarter of 2000 and
the first quarter 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-Hodgkins 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.
- In 1999, our Phase III clinical trial of recombinant human nerve
growth factor, which is known as rhNGF, for use in diabetic
peripheral neuropathy did not meet its objectives and we decided not
to file for product approval with the FDA.
- In 1999, our Phase II clinical study of recombinant human vascular
endothelial growth factor, which is known as VEGF, protein failed to
meet the primary endpoints of the study.
- In April 2001, we announced that a Phase III clinical trial of
Veletri, trademark, (tezosentan) - an intravenous dual endothelin
receptor antagonist for the treatment of symptoms (dyspnea, or
shortness of breath) associated with acute heart failure (AHF)- did
not meet its primary objectives.
- Failure to receive the necessary regulatory approvals or delay in
receiving such approvals;
- Manufacturing costs or other factors that make the product uneconomical;
or
Page 23
- 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 first
quarter of 2001 due to the number of late-stage clinical trials being
conducted by us and/or our collaborators.
- The number of products entering into development from late-stage research.
For example, there is no guarantee that internal research efforts will
succeed in generating sufficient data for us to make a positive
development decision or that an external candidate will be available on
terms acceptable to us. In the past, promising candidates have not
yielded sufficiently positive preclinical results to meet our stringent
development criteria.
- Hoffmann-La Roche's decisions whether to exercise its options to develop
and sell our future products in non-U.S. markets and the timing and amount
of any related development cost reimbursements.
- In-licensing activities, including the timing and amount of related
development funding or milestone payments.
For example, in February 2000, we entered into an agreement with Actelion
Ltd. for the purchase of rights for the development and co-promotion in
the United States of tezosentan and paid Actelion an upfront fee of $15.0
million which was recorded as an R&D expense.
For example, in January 2001, we entered into an agreement with OSI
Pharmaceuticals, Inc. for the global co-development and commercialization
of an anti-cancer drug, OSI-774, and paid OSI an upfront fee of $15.0
million for the purchase of IPR&D which was recorded as an R&D expense.
- As part of our strategy, we invest in R&D. R&D as a percent of revenues
can fluctuate with the changes in future levels of revenue. Lower
revenues can lead to more disciplined spending of R&D efforts.
- Future levels of revenue.
Roche, Our Controlling Stockholder, May Have Interests That Are Adverse to
Other Stockholders
Roche, as our majority stockholder, controls the outcome of actions requiring
the approval of our stockholders. Our bylaws provide, among other things,
Page 24
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; and
- Establish a stock repurchase program designed to maintain Roche's
percentage ownership interest in our common stock.
These provisions may have the effect of limiting our ability to make
acquisitions and while the dollar amounts associated with the stock
repurchase program cannot currently be estimated, these stock repurchases
could have a material adverse impact on our liquidity, credit rating and
ability to access capital in the financial markets.
Our Stockholders May Be Unable to Prevent Transactions That Are Favorable to
Roche but Adverse to Us
Our certificate of incorporation includes provisions relating to:
- Competition by Roche with us;
- Offering of corporate opportunities;
- Transactions with interested parties;
- Intercompany agreements; and
- 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
Page 25
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 other
mechanical therapies to treat acute myocardial infarction; the resulting
adverse effect on sales has been and could continue to be material. Retavase
received approval from the FDA in October 1996 for the treatment of acute
myocardial infarction. We expect that the use of mechanical reperfusion in
lieu of thrombolytic therapy for the treatment of acute myocardial infarction
will continue to grow.
Second, in the growth hormone market, we continue to face increased
competition from four other companies currently selling growth hormone and an
additional company which may enter the market in the near future. As a
result of that competition, we have experienced a loss in market share. The
four competitors have also received approval to market their existing human
growth hormone products for additional indications. As a result of this
competition, sales of our Growth Hormone products may decline, perhaps
significantly.
Third, in the non-Hodgkin's lymphoma market, Corixa Corporation,
formerly Coulter Pharmaceutical, Inc., has filed and received an expedited
review of a revised Biologics License Application, or BLA, in 2000 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.
Page 26
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 further described in "Protecting Our Proprietary Rights Is
Difficult and Costly," in May 1999, June 2000 and September 2000, several
companies filed patent infringement lawsuits against us alleging that we
are infringing certain of their patents.
- The increasing use and development of alternate therapies.
For example, the overall size of the market for thrombolytic therapies,
such as our Activase product, continues to decline as a result of the
increasing use of mechanical reperfusion.
- The rate of market penetration by competing products.
For example, in the past, we have lost market share to new competitors in
the thrombolytic and growth hormone markets.
In Connection With the Redemption of Our Special Common Stock, We Recorded
Substantial Goodwill and Other Intangibles, the Amortization of Which May
Adversely Affect Our Earnings
As a result of the redemption of our special common stock, Roche owned all of
our outstanding common stock. Consequently, push-down accounting under
generally accepted accounting principles was required. Push-down accounting
Page 27
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. The amortization of
this goodwill and other intangible assets will have a significant negative
impact on our financial results in future years. In addition, we will
continuously evaluate whether events and circumstances have occurred that
indicate the remaining balance of this and other intangible assets may not be
recoverable. If our assets need to be evaluated for 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.
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.
For example, we began receiving royalty revenues from Immunex Corporation's
sale of Enbrel, registered trademark, in 1999.
- The conclusion of existing arrangements with other companies and Hoffmann-
La Roche.
For example, royalty revenues decreased in 1999 from 1998 due to the
expiration of royalty payments primarily on sales of human insulin, from
Eli Lilly and Company in August 1998.
- The timing of non-U.S. approvals, if any, for products licensed to
Hoffmann-La Roche and 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.
For example, license fees from Immunex and Schwarz Pharma AG increased
contract revenues in 1999.
- Whether and when contract benchmarks are achieved.
Page 28
For example, milestone payments from Pharmacia increased contract
revenue in 1997.
- The failure of or refusal of a licensee to pay royalties.
- The expiration or invalidation of patents or licensed intellectual
property.
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. 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. For example, in late 1999 we settled a
patent infringement lawsuit brought against us by the Regents of the
University of California in which the University alleged that the manufacture
and sale of our Protropin and Nutropin growth hormone products infringed a
patent owned by the University. In connection with that settlement we paid
the University of California $150.0 million and donated $50.0 million for the
construction of a new life sciences building on the University of California,
San Francisco campus.
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.
Three lawsuits have been filed against us in which the companies
involved allege that we have infringed their patents by the manufacture and
sale of certain of our products:
- In May 1999, GlaxoSmithKline plc, or Glaxo, filed a complaint in which it
appears to claim that our manufacture, use and sale of Rituxan and
Herceptin antibody products infringe four Glaxo patents that relate to
certain uses and preparations of antibodies.
- In June 2000, Chiron Corporation filed a complaint in which it claims that
our manufacture and sale of Herceptin infringe a patent it owns.
- In September 2000, Glaxo filed another complaint in which it appears to
claim that our manufacture, use and sale of Rituxan and Herceptin antibody
products infringe a Glaxo patent that relates to certain cell culture
methods.
We May Incur Material Litigation Costs
Litigation to which we are currently or have been subjected relates to, among
Page 29
other things, our patent and intellectual property rights, licensing
arrangements with other persons, product liability and financing activities.
We cannot predict with certainty the eventual outcome of pending litigation,
and we might have to incur substantial expense in defending these lawsuits.
We have in the past taken substantial special charges relating to litigation,
including $230.0 million in 1999.
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.
- 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.
For example, in 1999, we paid a $50.0 million settlement to the federal
government in connection with a federal investigation of our former
clinical, sales and marketing activities associated with our human growth
hormone products.
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
Page 30
We currently produce all of our products at our manufacturing facilities
located in South San Francisco, California and Vacaville, California or
through various contract manufacturing arrangements. Problems with any of
our or our contractors' manufacturing processes could result in product
defects, which could require us to delay shipment of products, recall
products previously shipped or be unable to supply products at all.
For example, in March 2000, we issued an important drug notification
regarding a defect in the packaging of our Pulmozyme product. During a
quality assurance inspection, we had discovered that there was a defect in
the packaging of Pulmozyme which occasionally caused a small puncture in
ampules of that product. We suspended shipping the product while we
determined the source and extent of the defect. We ultimately recalled some
of the product.
In April 2001, we issued another important drug notification regarding a
separate defect in the manufacture of a Pulmozyme product lot which was
causing a small puncture in a small number of ampules of the product. We
suspended shipping the product upon discovery of this defect and recalled the
few cases of the product lot that had been distributed.
On December 27, 2000, we received a Warning Letter from the FDA
regarding our quality control at our South San Francisco manufacturing plant.
The products cited were for Pulmozyme, Herceptin and Activase. On February
7, 2001, we received a letter from the FDA accepting our responses and
corrective actions with respect to the Warning Letter. If we were to
experience 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 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.
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.
Page 31
For example, our stock increased by approximately 19% on the day we
announced FDA approval for our TNKase product.
- Developments concerning proprietary rights, including patents.
For example, our stock price decreased by approximately 4% on the day one
of our competitors, Chiron, announced a patent infringement suit against
us.
- Publicity regarding actual or potential medical results relating to
products under development by us or our competitors.
For example, our stock price increased by approximately 9% on the day we
announced positive preliminary Phase III results from the Anti-IgE asthma
clinic.
For example, our stock price decreased by approximately 9% on the day we
announced negative Phase III results from the clinical trials of Veletri.
- Regulatory developments in the United States and foreign countries.
- Public concern as to the safety of biotechnology products.
For example, on May 8, 2000, we issued a warning concerning our Herceptin
drug after 15 deaths resulted from the administration of Herceptin. Our
stock price decreased by approximately 2% at that time.
- Economic and other external factors or other disaster or crisis.
For example, our 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 a low of $38.50 per share in March 2001.
- Period-to-period fluctuations in financial results.
For example, our stock price has historically been affected by whether we
met or exceeded analyst expectations, and accordingly, our stock increased
by more than 6% after we announced that our first quarter 2001 earnings
had met analysts' expectations.
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. 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.
Page 32
Future Sales by Roche Could Cause the Price of Our Common Stock to Decline
As of March 31, 2001, Roche owned 306,594,352 shares of our common stock or
approximately 58.24% of our outstanding shares. All of our shares owned by
Roche are eligible for sale in the public market subject to compliance with
the applicable securities laws. We have agreed that, upon Roche's request,
we will file one or more registration statements under the Securities Act in
order to permit Roche to offer and sell shares of our common stock. We have
agreed to use our best efforts to facilitate the registration and offering of
those shares designated for sale by Roche. Sales of a substantial number of
shares of our common stock by Roche in the public market could adversely
affect the market price of our common stock.
We Are Exposed to Market Risk
We are exposed to market risk, including changes to interest rates, foreign
currency exchange rates and equity investment prices. To reduce the
volatility relating to these exposures, we enter into various derivative
investment transactions pursuant to our investment and risk management
policies and procedures in areas such as hedging and counterparty exposure
practices. We do not use derivatives for speculative purposes.
We maintain risk management control systems to monitor the risks
associated with interest rates, foreign currency exchange rates and equity
investment price changes, and our derivative and financial instrument
positions. The risk management control systems use analytical techniques,
including sensitivity analysis and market values. Though we intend for our
risk management control systems to be comprehensive, there are inherent risks
that may only be partially offset by our hedging programs should there be
unfavorable movements in interest rates, foreign currency exchange rates or
equity investment prices.
Our Interest Income is Subject to Fluctuations in Interest Rates
Our material interest bearing assets, or interest bearing portfolio,
consisted of cash equivalents, restricted cash, short-term investments,
convertible preferred stock investments, convertible loans and long-term
investments. The balance of our interest bearing portfolio was $1,879.6
million or 28% of total assets at December 31, 2000. Interest income related
to this portfolio was $90.4 million or 5% of total revenues at December 31,
2000. Our interest income is sensitive to changes in the general level of
interest rates, primarily U.S. interest rates. In this regard, changes in
U.S. interest rates affect the interest bearing portfolio. To mitigate the
impact of fluctuations in U.S. interest rates, for a portion of our
portfolio, we have entered into swap transactions, which involve the receipt
of fixed rate interest and the 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
Page 33
in Europe, Asia (primarily Japan) and Canada. Our exposure to foreign
exchange rates primarily exists with the Euro. When the dollar strengthens
against the currencies in these countries, the dollar value of non-dollar-
based revenue decreases; when the dollar weakens, the dollar value of the
non-dollar-based revenues increases. Accordingly, changes in exchange rates,
and in particular a strengthening of the dollar, may adversely affect our
royalty revenues as expressed in dollars. Increasingly however, these
royalties are being offset by expenses arising from our foreign facility as
well as non-dollar expenses incurred in our collaborations. Currently, our
foreign royalty revenues exceed our expenses. In addition, as part of our
overall investment strategy, a portion of our portfolio is primarily in non-
dollar denominated investments. As a result, we are exposed to changes in
the exchange rates of the countries in which these non-dollar denominated
investments are made.
To mitigate our net foreign exchange exposure, our policy allows us to
hedge certain of our anticipated revenues by purchasing option contracts with
expiration dates and amounts of currency that are based on 25% to 90% of
probable future revenues so that the potential adverse impact of movements in
currency exchange rates on the non-dollar denominated revenues will be at
least partly offset by an associated increase in the value of the option.
Currently, the term of these options is generally one to two years. To hedge
the non-dollar expenses arising from our foreign facility, we may enter into
forward contracts to lock in the dollar value of a portion of these
anticipated expenses.
Our Investments in Equity Securities Are Subject to Market Risks
As part of our strategic alliance efforts, we invest in equity instruments of
biotechnology companies. Our biotechnology equity investment portfolio
totaled $652.7 million or 10% of total assets at December 31, 2000. These
investments are subject to fluctuations from market value changes in stock
prices. For example, in the first quarter of 2001, we took a significant
charge on an equity security investment that had an other than temporary
impairment.
To mitigate the risk of market value fluctuation, certain equity
securities are hedged with costless collars and forward contracts. A
costless collar is a purchased put option and a written call option in which
the cost of the purchased put and the proceeds of the written call offset
each other; therefore, there is no initial cost or cash outflow for these
instruments at the time of purchase. The purchased put protects us from a
decline in the market value of the security below a certain minimum level
(the put "strike" level), while the call effectively limits our potential to
benefit from an increase in the market value of the security above a certain
maximum level (the call "strike" level). A forward contract is a derivative
instrument where we pay the counterparty the total return of the security
above the 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.
Page 34
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
The Financial Accounting Standards Board, or FASB, is expected to issue a new
accounting standard on Business Combinations in June 2001. If the proposed
accounting standard is adopted, it would require that goodwill not be
amortized, but rather be subject to an impairment test. In addition,
separately identified and recognized intangibles resulting from business
combinations completed prior to the adoption of the proposed accounting
standard that do not meet the new criteria for separate recognition of
intangible assets will be subsumed into goodwill upon adoption. If adopted,
the proposed accounting standard could have a significant impact on our
financial position and results of operations.
Page 35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Genentech's market risk disclosures set forth in the Form 10-K for the period
ended December 31, 2000, have not changed significantly.
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, Genentech has filed multiple summary
judgment motions relating to non-infringement and invalidity. All of those
motions are currently pending before the judge. The trial of this suit began
on April 17, 2001 and is ongoing.
On March 13, 2001, Chiron Corporation filed a second 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 has filed a motion to dismiss this second lawsuit, and the Court
has scheduled a hearing on the motion for May 21, 2001. No trial date has
yet been scheduled for this second lawsuit. This lawsuit is currently
separate from and in addition to the patent infringement lawsuit filed
against us by Chiron on June 7, 2000.
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. Genzyme has not yet 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. Genentech has not yet filed its answer
to this complaint. Although this lawsuit is currently separate from and in
addition to the declaratory judgement suit referred to above, it is possible
that the suits will be consolidated in some respect.
See also Item 3 of the 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.
Page 37
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Change in Control Agreement, dated as of January 20,
2001, by and between Genentech, Inc. and Myrtle S.
Potter.
10.2 Promissory Note, dated as of December 22, 2000,
issued to Genentech, Inc. by Myrtle S. Potter.
15.1 Letter regarding Unaudited Interim Financial
Information.
(b) Reports on Form 8-K
There were no other reports on Form 8-K filed during the
quarter ended March 31, 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: May 1, 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) 05/01/01 @ 11:56
AM